All That Glitters Is Not Gold: A Look at The First Federal Securities PPP-Related Class Action
The CARES Act’s Paycheck Protection Program, while a commendable and necessary initiative, was certain to invite lawsuits against banks. It is a truism that financial institutions attract litigation. In the first round of litigation, borrowers and borrower agents pursued PPP claims against banks. Those lawsuits have now inspired a second round of litigation based upon securities fraud claims. In this second round, shareholders are suing banks and their executive officers, claiming that the proliferation of “first round” of cases constitutes evidence in support of their “second round” securities claims.
But for these second-round plaintiffs, all that glitters is not gold—because the first round of cases has been largely unsuccessful. Many of those cases have been dismissed or settled, leaving a dearth of evidence that will require the second-round plaintiffs to discover enough evidence to satisfy a stout burden of proof—that is—if they manage to survive motions to dismiss.
The “First Round” Allegations
In the first round of PPP-related lawsuits, small business owners alleged that “Wells Fargo prioritized loan applications seeking higher loan amounts because processing those applications first generated larger loan origination fees for the banks,” concealed the “reshuffling [of] the PPP applications,” and breached the small business owners’ trust that “Wells Fargo would process the applications on a first come, first served basis.”
Courts across the country have dismissed similar claims, largely because the CARES Act does not provide a private right of action for alleged violations. Other cases have settled. Most cases have not proceeded into fact discovery—nor have they generated factual conclusions or legal rulings for later plaintiffs to rely on.
The “Second Round” Allegations
Filed in June 2020 in the United States District Court for the Northern District of California, Guofeng Ma et al. v. Wells Fargo & Co. appears to be the first PPP-related class action that involves federal securities laws.
The Guofeng Ma plaintiffs allege that the bank’s press releases, SEC filings, and other market communications falsely represented that the bank would focus on extending PPP funds to “non-profits and small businesses with fewer than 50 employees.” Instead, plaintiffs contend, the bank “improperly allocate[d] government-backed loans under the PPP.” These allegations appear to be drawn from allegations made (but not established) in the first round of PPP litigation.
According to plaintiffs, the bank’s misrepresentations or omissions “artificially inflated prices” of the bank’s securities during the class period (between April 5, 2020, and May 5, 2020). Those prices, according to plaintiffs, plummeted at the same time as the reports of PPP-related lawsuits and increased regulatory scrutiny against the bank began to emerge. The price drop caused plaintiffs and other similarly situated investors to sustain economic loss.
The Securities Fraud Claims
From these allegations, the Guofeng Ma plaintiffs assert two claims: (1) violations of Section 10(b) of the Exchange Act against the bank, its Chief Executive Officer, and Chief Financial Officers; and (2) violations of Section 20(a) of the Exchange Act against the CEO and CFO for secondary liability.
Primary liability under section 10(b) arises when the primary actor makes material misrepresentations or fails to disclose a material fact in connection with the sale of securities. The primary actor makes a material misrepresentation or omission of a fact when that fact was objectively important to investors in deciding whether to buy or sell certain securities.
Section 20(a) creates secondary liability against so-called “control persons”—someone who controls the person who violated Section 10(b). Typical control persons would include a lender’s CEO and CFO. But for secondary liability to attach, a plaintiff must first prove Section 10(b) primary liability and must also show that the control persons had the power to control the business affairs of the primary actor and could influence the specific corporate policy that resulted in primary liability.
The Burdens of Proof
To satisfy their burden of proof, plaintiffs must overcome several preliminary hurdles—they must: (1) prove that the bank did in fact prioritize PPP business applicants with large loan amounts, as opposed to processing applications on a first-come, first-served basis; (2) establish that the allocation was intentional or reckless; and (3) show that the allocation was in fact wrongful.
These hurdles could be challenging because the proof that Wells Fargo improperly prioritized larger commercial loans may depend on the disposition of the PPP-related lawsuits mentioned above. If these other lawsuits settle—and one of them officially did on July 2—the Guofeng Ma plaintiffs will need to pursue independent, and likely expensive, discovery to establish their burdens of proof.
Whether they will find such evidence remains to be seen. It is also possible that the Guofeng Ma lawsuit settles. On November 12, 2020, the lead Guofeng Ma plaintiff filed its voluntary dismissal—no activity has occurred in the case since then, but the other Guofeng Ma plaintiffs may follow suit. If they do, the lawsuit will be dismissed entirely. On the other hand, Wells Fargo may wish to avoid the perception that it is an easy settlement target and may opt for a vigorous Rule 12 motion to dismiss defense. Either way, the case may inspire similar PPP-related securities fraud cases and we will follow its progression with interest.