Wells Fargo had issued a set of trust preferred securities, which are a hybrid form of perpetual, cumulative preferred stock. Trust preferreds have been commonly issued by bank holding companies (BHCs) since 1996 because they qualified as Tier I regulatory capital under the Federal Reserve Board's capital adequacy guidelines. These securities typically offered investors a high rate of interest in return for favorable regulatory and tax treatment.

Under the securities' trust indenture, Wells Fargo was entitled to redeem all of the securities on the occurrence of an event that would lead the bank to reasonably believe that it will not be able to treat an amount equal to the liquidation amount of the securities as Tier 1 capital. Wells Fargo redeemed these securities on October 3, 2011 in response to the Collins Amendment provision under the Dodd-Frank Act which disallowed the treatment of trust preferred securities as Tier I capital even though the phase-out period for these securities from Tier 1 regulatory capital only begins in January 2013 and extends until 2016.

The plaintiff in Turkle Trust v. Wells Fargo, a holder of the trust preferreds, brought a cause of action arguing that Wells Fargo breached its contract and the implied covenant of good faith and fair dealing by redeeming the securities under the capital treatment event clause before the securities' early redemption date (December 15, 2012) and before the securities were in fact no longer treated as Tier 1 regulatory capital.

The plaintiff attempted to differentiate the facts of this case from an earlier case, Call v. Wells Fargo, which has an almost identical fact pattern. In Call, the plaintiff argued that the Dodd-Frank Act should not constitute a capital treatment event until January 1, 2016, at which point the bank will no longer be able to treat any of its trust preferred securities as Tier I capital. The US District Court for the Northern District of California dismissed that cause of action, holding that under the capital treatment event clause, Wells Fargo was not required to wait to redeem the securities until trust preferred securities had been fully phased out Tier 1 capital. Rather, due to the forward-looking language of the clause, it was able to redeem the securities when it determined that there was more than an insubstantial risk that the securities will not be treated as Tier I Capital.

In Turkle Trust, the plaintiff pointed out that the trust preferred securities included an optional redemption date (December 15, 2012) that was earlier than the beginning of the trust preferred securities' phase-out period (January 1, 2013). The plaintiff argued that the capital treatment clause should be interpreted narrowly to relate only to changes in treatment of Tier 1 capital that take effect before the optional redemption date. In other words, Wells Fargo should have been required to wait to redeem its stock on the optional redemption date of December 15, 2012, instead of the earlier date of October 3, 2011.

The US District Court for the Northern District of California dismissed the plaintiff's claim and held that according to the language of the securities' capital treatment event clause, Wells Fargo was not required to wait until the optional redemption date once it made a reasonable determination that it will not be able to treat the trust preferred securities as Tier I Capital. The court focused on the future-looking language of the capital treatment clause and the absence of a temporal limitation under the clause in holding that Wells Fargo did not need to wait until the optional redemption date.

Other BHCs with trust preferred securities that have a similarly worded capital treatment event clause may be able to treat the date of enactment of the Dodd-Frank Act as a capital treatment event and redeem them, regardless of any optional redemption date governing the securities. However, the results may differ depending on the wording of any particular capital treatment event clause, as the bank's right to redeem the securities is generally a matter of contract law.

For more information on the phase-out of trust preferred securities from Tier 1 regulatory capital, see Practice Note, Summary of the Dodd-Frank Act: Bank Capital (Collins Amendment). For other information on regulatory capital reforms, see Article, Basel III and the New US Capital Framework Proposals.