Plaintiffs Failed to Sufficiently Allege Knowledge or Recklessness by Company Concerning AML Compliance Problems, Despite Admissions Made by Company When Responding to Major Government Enforcement Actions 

On February 25, 2020, the Tenth Circuit Court of Appeals upheld the dismissal of shareholders’ securities-fraud class action against the Western Union Company (“Western Union”) and several of its current and former executive officers based on the company’s alleged anti-money laundering (“AML”) compliance failings.

The suit was filed in February 2017 following the announcement of a deferred prosecution agreement (“DPA”) between Western Union and the U.S. Department of Justice. The DPA was based upon Western Union’s alleged willful failure to maintain an effective AML program and aiding and abetting of wire fraud between 2004 and 2012. The DPA, about which we have previously blogged, charged Western Union with filing Suspicious Activity Reports (“SARs”) regarding activity by its customers but failing to file SARs regarding the actions of its own agents who were likely complicit. The DPA and related civil enforcement actions from the Federal Trade Commission and FinCEN required Western Union to pay a combined penalty of $586 million.

As we also have blogged, shareholder derivative suits based on alleged AML failures are proliferating, for both U.S.-based and foreign-based financial institutions – as well as their executives. Primary examples include Danske Bank and some of its former executives, as well as Westpac, Australia’s second-largest retail bank, which currently face such lawsuits in the U.S. Such lawsuits now represent predictable collateral consequences flowing from AML-related scandals. Here, Western Union obtained dismissal because the plaintiffs failed to allege sufficient facts regarding the key issue of mental state – that is, facts that would support a strong inference of actual knowledge or reckless disregard that the public statements regarding Western Union’s actual state of AML compliance were false. The detailed Tenth Circuit opinion illuminates the practical contours of the scienter standard regarding AML compliance, or alleged lack thereof. Ultimately, plaintiffs’ arguments based upon a “fraud by hindsight” theory will fail.

When the DPA was announced, Western Union stock prices dropped. Consequently, shareholders alleged securities fraud based on false or misleading public statements concerning Western Union’s compliance with AML and anti-fraud laws between February 2012 and May 2017. Specifically, shareholders alleged that Western Union and its executives made public statements and SEC filings misrepresenting that Western Union’s compliance efforts were legally sufficient and effectively combating the global AML and fraud problems facing the company.

The Federal District Court for the District of Colorado dismissed the suit, finding that shareholder plaintiffs failed to adequately plead “scienter”—that the defendants acted with intent to defraud or recklessness—regarding the misstatements under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), 15 U.S.C. § 78u-4. The Tenth Circuit agreed.

The Tenth Circuit noted that the PSLRA’s heightened pleading standard requires plaintiffs to “plead particularized facts giving rise to a strong inference [that Western Union and its executives] made their misstatements regarding Western Union’s AML or anti-fraud compliance systems with either knowledge or reckless disregard of their falsity.” Plaintiffs raised five allegations to support their claim that Western Union executives intended to defraud investors or acted recklessly: (1) various red flags regarding ongoing compliance violations; (2) discussions about compliance issues at board and committee meetings; (3) interactions with government regulators and the pending investigations; (4) Western Union’s admissions in the DPA and conclusions in the civil enforcement actions; and (5) the executives’ alleged motive to defraud investors. The Tenth Circuit found that the plaintiffs’ allegations fell short individually and in totality.

Red Flags

Plaintiffs alleged red flags include: that Western Union received at least 550,928 consumer complaints concerning at least $632,721,044 in fraudulent transactions; that fraudulent transfers involved Western Union’s agents in several countries; and several third-party agents were arrested for fraud and money laundering reaching as for back at 2007.

The Tenth Circuit found two problems with plaintiffs’ red flag argument. First, the Court did not find the relative dollar amount of the fraudulent transactions to be significant:

[A]lthough surely a noteworthy sum, the $632,721,044 in fraudulent transactions—which occurred over a twelve-year period—represents less than 1% of the dollars transferred through Western Union’s system in 2014 alone, which amounted to $85 billion. This is not a case where allegedly fraudulent transactions amounted to an overwhelming percentage of the company’s business.

Second, the Court found plaintiffs failed to demonstrate that the individual executives were aware of the consumer complaints, the agent arrests, or that Western Union’s compliance program had failed to redress these issues at the time the misstatements were made.

Discussions of Compliance Issues

Plaintiffs argued that the Court should infer knowledge based upon materials from Western Union’s board and committee meetings, which executives allegedly attended, between May 2010 and October 2013. Plaintiffs relied on evidence of materials cited in the meetings that discussed regulators increased attention to Western Union’s agents, the need for improvements in compliance programs to mitigate AML and fraud in high-risk regions, and a competitor’s settlement agreement with DOJ. The Court found this evidence unpersuasive noting that “mere attendance at meetings does not contribute to an inference of scienter.” The Court held, even assuming the executives were briefed on these matters, plaintiffs evidence failed to establish an inference of knowledge of ongoing, unaddressed compliance violations.

Interactions with Regulators and the Settlement Agreement

As to plaintiffs’ third argument, the Court noted that while “government investigations into a company can contribute to an inference of scienter . . . standing alone, [it] is insufficient to support a cogent and compelling inference of scienter.”

Plaintiffs argued that Western Union documents and internal reports that were produced to the government and provided the basis for the DPA and civil enforcement resolutions, established that executives knew of, or turned a blind eye to, the compliance violations. The Court rejected this argument because the plaintiffs did not show that the executives themselves dealt with the government regulators, reviewed the internal documents, or were otherwise informed of legal noncompliance that existed.

Plaintiffs also pointed to Western Union’s admission that it willfully failed to implement an effective AML compliance program from 2004 through December 2012 as evidence that the executives must have been aware of these ongoing legal violations when they made their alleged misstatements. The Court determined that this argument amounted to “fraud by hindsight” which is insufficient to demonstrate knowledge at the time the executives made the relevant statements.

Motive to Defraud

Plaintiffs argued that the executives had motive to defraud investors because they, along with other Western Union executives, allegedly used nonpublic information to profit from artificially inflated stock prices. The Court noted that suspicious insider stock trading can be a relevant consideration in favor of scienter, but the stock trading activity identified by plaintiffs failed to show that any of the executives had a motive to defraud investors.

The Tenth Circuit upheld the dismissal concluding that that plaintiffs failed to plead particularized facts giving rise to the strong inference that Western Union and its executives acted with either an intent to defraud investors or a conscious disregard of a risk that shareholders would be misled at the time the misstatements were made. The opinion illustrates the high pleading bar facing shareholders seeking to impose securities fraud liability on executives based upon AML compliance failings that are subsequently acknowledged by the company.