Securities Regulation Daily Wrap Up, SHAREHOLDER ACTIVISM—Fifth Third shareholder derivative action dismissed for failure to allege demand futility, (Mar 13, 2023)

By R. Jason Howard, J.D.

Complaint dismissed with prejudice as the plaintiffs had an opportunity to amend the complaint to address the deficiencies previously identified by the court but failed to do so.

The Northern District of Illinois has ruled in favor of Fifth Third Bancorp in connection with a shareholder derivative action brought to remedy alleged wrongdoing committed by Fifth Third board members and officers from February 26, 2016 through the present, during which period the plaintiffs alleged that the individual defendants breached their fiduciary duties to Fifth Third, were unjustly enriched, wasted corporate assets, and committed violations of Sections 10(b) and 14(a) of the Securities Exchange Act of 1934 (In re: Fifth Third Bancorp Litigation, March 8, 2023, Ellis, S.).

Fifth Third. Fifth Third is headquartered in Cincinnati and provides financial services to corporations, individuals, and non-profits. Between 2010 and at least 2019, Fifth Third employed a cross-sell strategy, encouraging employees to sell additional services and/or products to existing customers to meet aggressive sales targets, all supported and awarded through various incentive programs. In connection with the strategy, Fifth Third set a goal of providing each customer with at least four products. In order to meet the aggressive sales targets, management encouraged or pressured employees into using improper sales tactics, such as opening false accounts, also known as gaming.

The success of the strategy led to inflated financial results and the impression that Fifth Third was growing organically but, because Fifth Third did not have a system to detect or stop unauthorized account activity, it relied on customer or employee reports which led to underreporting of the scope of the problem. Fifth Third did engage in monthly testing and reviews of account documentation but, to the extent Fifth Third reviewed improper activity “it only recorded the conduct as improper if the allegation was escalated above the bank branch, internally investigated, and determined to be substantiated by an investigator.”

On March 30, 2022, the court dismissed the plaintiffs’ consolidated complaint for failure to plead demand futility and the plaintiffs thereafter filed their amended complaint.

Amended complaint. The court’s opinion noted that the complaint highlighted that there were prior actions against Fifth Third before the relevant period at issue in the derivative action, including the 2015 Consumer Financial Protection Bureau (CFPB) credit card action, the 2015 CFPB auto lending enforcement action, and a CFPB consent order filed against Wells Fargo in which the CFPB determined that Wells Fargo employees opened unauthorized deposit accounts that could have been funded by the transfer of funds from existing accounts without the consumer’s knowledge or consent. Following disclosure of the consent order, CFPB notified Fifth Third of an investigation into its sales practices, providing Fifth Third with a civil investigation demand.

Demand futility. Looking to the substantive law of Fifth Third’s state of incorporation, Ohio, in addressing demand futility, the court noted that the plaintiffs did not allege they made a demand on the director defendants and, therefore, the plaintiffs needed to allege why making such a demand would be futile.

Despite the evidence that Fifth Third engaged in questionable sales tactics, and the court’s previous instruction to cure the deficiencies of the original complaint, the court explained that the plaintiffs’ amended complaint failed to create the required reasonable doubt as to the director defendants’ independence to excuse demand futility. Instead of adding additional allegations concerning the director defendants’ alleged lack of independence, the plaintiffs rested on “the same allegations the court previously rejected as insufficient.” The court also noted that the plaintiffs, in their response to the motion to dismiss, did not even acknowledge the court’s prior ruling and instead made the same arguments the court previously rejected.

The remaining claims asserted by the plaintiffs were all dismissed with the court noting that the plaintiffs failed to sufficiently plead particularized facts that would circumvent the requirement that the plaintiffs make a demand on the Fifth Third board.

Demand futility summary. The plaintiffs failed to allege demand futility as required by Rule 23.1 and their failure to comply with the demand requirements for shareholder derivative actions required for the court to dismiss the plaintiffs’ amended complaint. Because the plaintiffs had an opportunity to amend the complaint to address the deficiencies previously identified by the court but failed to do so, the court dismissed the complaint with prejudice.

The case is No. 1:20-cv-04115.

Attorneys: Phillip C. Kim (Rosen Law Firm, P.A.) for Stephen Pemberton. Charles F. Smith, Jr. (Skadden Arps Slate Meagher & Flom, LLP) for Greg D. Carmichael.

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