A Wachovia Shareholder's Personal Fraud Case Gets Whacked In Federal Court

December 28, 2011

John M. Rivers, Jr. owned 100,000 shares of  Wachovia Corporation stock.  Following the Great Recession, that wasn't exactly a great investment.  In fact, to put it bluntly, the shares of Wachovia got hammered.  Rivers opted to sue.

On October 1, 2009, Rivers filed a nearly 100-page Complaint in South Carolina state court citing fraud, negligent misrepresentation, breach of fiduciary duty, constructive fraud, breach of duties as corporate officers, gross negligence, and violation of the South Carolina Securities Act of 2005.  The Complaint named Wachovia Corporation (since acquired by Wells Fargo & Company) and four of its former officers, G. Kennedy Thompson, Robert K. Steel, Thomas J. Wurtz, and Donald K. Truslow.

Essentially, Rivers alleged that the Defendants misrepresented the financial health of Wachovia. As a consequence of the Defendants painting a rosier picture than Rivers believed had existed, he claimed to have been mislead into holding rather than selling his Wachovia shares.  As such, this was less about having incurred losses as a consequence of a sale of depreciated shares -- it was more about a diminution in value of shares that were not timely sold in reliance of allegedly misleading information.

SIDE BAR: Rivers alleged that the Defendants concealed problems growing out of Wachovia's 2006 acquisition of Golden West Financial Corporation, a California-based lender specializing in adjustable-rate mortgages ("ARM") . As the housing market began to weaken, Rivers alleged that the Defendants attempted to hide the true impact of this development by:

  • understating Wachovia's credit losses;
  • misrepresenting the riskiness of Wachovia's assets;  and
  • overstating the strength of Wachovia's balance sheet in press releases, SEC filings, shareholder conference calls, and other materials disseminated to shareholders.

Subprime Slime

Notwithstanding these alleged efforts to hide the worsening situation, Rivers asserted that by late 2007, the dam broke and word leaked out about Wachovia's dire financial condition. By the end of September 2008, as the Subprime Crisis worsened,  Wachovia's common stock fell from  $13.70 earlier that month and $56.65 in early 2007, to below $1.

Federal Case

The Defendants prevailed on their position that because of diversity considerations, Rivers' case did not belong in a state court.  Once in federal district court, the Defendants moved to dismiss the Complaint on the basis that "neither North Carolina law nor South Carolina law permits direct shareholder claims for losses resulting solely from a fall in the value of stock."  The federal District Court agreed and dismissed the Complaint; thereafter, Rivers appealed to the Fourth Circuit. John M. Rivers, , Jr., Plaintiff-Appellant, v. Wachovia Corporation; Wells Fargo & Company; G. Kennedy Thompson; Donald K. Truslow; Thomas J. Wurtz; Robert K. Steel; Does 1 Through 25, Defendants-Appellees. ( US Court of Appeals, Fourth Circuit, No. 10-2222, December 22, 2011).

Fourth Circuit

The Fourth Circuit's Opinion explains that Rivers' attempt to recover individually for the decline in Wachovia's share price contravenes firmly settled corporate law governing derivative claims. The Court upheld the  well-established doctrine  that shareholders cannot pursue individual causes of action against third parties for wrongs or injuries to the corporation that result in the diminution or destruction of the value of their stock. In such situations, the proper remedy is for the shareholders to pursue derivative suits on behalf of the corporation. Such derivative suits ensure that all shareholders who are harmed by a decline in the value of the company's stock are protected, and not merely the one shareholder who would file a personal claim to the detriment of similarly situated shareholders.

Although there are exceptions to the derivative rule, they largely require a showing of some unique relationship between the suing shareholder and the corporation, or a unique damage sustained by that shareholder in contradistinction to other shareholders. Not finding that Rivers was party to a separate contract with the defendants that created distinct duties personal to him, or that he was individually subject to misleading inducements outside the officer-shareholder relationship, the Circuit Court found that he failed to advance a compelling exception.

The Fourth Circuit held because Rivers' claim was derivative of the injury suffered by Wachovia, his individual cause of action was properly dismissed by the District Court.  Pointedly, the Circuit Court held:

In the end, Rivers has failed to articulate principled limits on the claims he seeks to press. Limiting individual suits to those who intended to sell is no limit at all; virtually every shareholder considers selling his shares at various points in time and every investor who suffers substantial monetary losses will be tempted to recall a prior intent to sell. Rivers claims his injury is unique but the number of people who may step forward with a similar tale of inducement not to sell is nigh infinite. Decisions to buy, sell, or hold shares inevitably involve a degree of risk and uncertainty. It is all too common to look back and wish one had invested differently. Investment presupposes risk-it is not the role of courts to reverse the consequences of infelicitous decisions after the fact or to allow one investor to recover losses at the expense of fellow shareholders. To the extent a shareholder wishes to litigate this sort of monetary loss due to the misrepresentations of corporate executives, his remedy lies within the framework of the derivative suit on behalf of the corporation. Because Rivers pursued a very different route, his suit was properly dismissed, and the judgment is affirmed.