Wells Fargo’s FHA Lapse Can’t Stick to Officers

SAN FRANCISCO (CN) - Shareholders cannot pursue claims that Wells Fargo's top officers lied about the insurance of high-risk home mortgage loans, which ultimately cost taxpayers nearly $109 million, a federal judge ruled.

U.S. District Judge Jacqueline Corley determined that the shareholders failed to prove that Wells Fargo's board of directors were connected to or responsible for the company's alleged wrongdoing.

Lead plaintiff Richard Gulbrandsen's complaint accused CEO John Stumpf and other top officers of unjust enrichment, waste of corporate assets and breach of duties in the 10 years leading up to the financial meltdown.

According to a synopsis of the complaint, Wells Fargo executives and members of the board of directors "'knew or recklessly disregarded' that a very substantial percentage of Wells Fargo's loans had not been properly underwritten, contained unacceptable risk, and were ineligible for FHA [Federal Housing Administration] insurance."

Gulbrandsen said the bank "engaged in this misconduct in an effort to increase loan volume."

Wells Fargo allegedly failed to report more than 6,000 materially deficient loans, which resulted in the FHA paying nearly $190 million in insurance benefits on defaulted mortgage loans.

Gulbrandsen said the bank's officials ignored "multiple red flags" of this wrongdoing and never took any corrective action.

Judge Corley found, however, that none of the allegations draw the conclusion that any of Wells Fargo's officials "knew of the misreporting, let alone actively carried out the scheme."

"Plaintiff has not adequately alleged that any director received any information that Wells Fargo was misreporting loan quality," Corley wrote. "In addition, while the existence of incentive structures to increase loan origination regardless of quality suggest Wells Fargo was engaged in an unsound business practice, plaintiff fails to connect any director to the creation or oversight of these incentive structures."

The shareholder had claimed that internal reports and memoranda allegedly circulated among management detailed Wells Fargo's violations of the Department of Housing and Urban Development (HUD) regulations, proving that bank officials had knowledge of the company's actions.

Corley found, however, that the "complaint does not actually allege that Stumpf was aware of the reports; rather, plaintiff generally alleges that these reports were made to 'senior management,' which may or may not include Stump, the company's CEO during part of the relevant time period. Plaintiff must allege more."

Gulbrandsen also argued that the board of directors would have become aware of the violations once HUD initiated an inquiry into Wells Fargo's noncompliance in 2005, but he failed to describe the nature of the inquiry, according to the ruling.

On this point, Corley found that Gulbrandsen "does not allege that any member of the board was actually aware of the inquiry or allege facts upon which such awareness may be inferred."

Because the lead shareholder failed to properly allege that any of the defendants breached his or her duty of loyalty, his claims of corporate waste and unjust enrichment also fail.

Gulbrandsen can nevertheless submit an amended complaint.

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