The story of the sham accounts scandal at Wells Fargo Bank is really pretty simple. An article published on October 13, 2016 in The New York Times explained it clearly: “Under intense pressure to meet aggressive sales goals, employees created sham accounts using the names—and sometimes, the actual money—of the bank’s real customers, and in some cases the customers did not discover the activity until they started accumulating fees.” On September 8, 2016, it was announced that the bank had entered into a settlement agreement with the federal Consumer Financial Protection Bureau that included fines and other payments of $185 million and included an acknowledgement from the bank that thousands of its employees, reacting to intense pressure from management to meet aggressive sales goals, has opened as many as two million sham accounts without the knowledge of customers and had often opened those accounts by forging the signatures of those customers.
However, the settlement was just the first act in what has become a scintillating story of widespread criticism of the bank’s treatment of its customers and employees and, more importantly, the apparent failure of members of the executive team and the board of directors to effectively carry out their oversight responsibilities and respond appropriately to the situation. On September 27, 2016, the bank’s board of directors announced that John G. Stumpf, the bank’s then-chief executive, would forfeit approximately $41 million worth of stock awards and receive no bonus for 2016. The board also said that it was launching an investigation into the bank’s sales practices and that Stumpf, who already had been called before Congressional committees to explain what he knew about the fake accounts, would not receive any salary while that investigation was going on. The board also announced that the former senior executive vice president of community banking, who ran the business unit where the fake accounts were created, would be retiring immediately and would forfeit $19 million in stock grants, would receive neither a bonus for 2016 nor any severance, and would be denied certain enhancements in retirement pay.
A little over two weeks later, Stumpf, who was famously told “you should resign” by Senator Elizabeth Warren during Senate hearings in early September, did just that. Analysts praised the move, which was unexpected, as an opportunity for the bank to remove a significant distraction and move forward with rebuilding its reputation. The board announced an extensive reshuffling of the bank’s top management team; however, for new leadership they stayed in-house and appointed Timothy J. Sloan, a long time insider, as president and COO and then CEO, but not chairman. Critics expressed concern that Sloan was also culpable in the fraudulent accounts scandal, given his central role in what was clearly a flawed chain of command that should have stopped the misconduct from occurring and handled it better once it became a matter of public knowledge. He was also on record as a staunch defender of cross-selling, was the face of the company in the departure of the head of the community banking unit and was a close ally of Stumpf who called his resignation “an incredibly selfless decision”.
Sloan was slow to act on making pronouncements about changes in the bank’s culture, a culture he was groomed in and helped to evolve and which has often seemed to be more interested in aggressively overwhelming and confusing customers as opposed to focusing on providing good service. Early indications were that the quality of the customer experience would be given greater weight in compensation decisions, as opposed to qualitative metrics like numbers of accounts; however, while some claimed the change could take effect quickly others expressed skepticism given the embeddedness of the prior culture and the fact that bank leadership remained essentially unchanged even through roles and reporting channels among senior executives and managers were restructured with great publicity..
For her part, Warren wanted more from Stumpf: return of all the money he received during the scam and investigations by Securities Exchange Commission (“SEC”) and the Department of Justice (“DOJ”). By November it appeared she had gotten at least part of her wish. Wells Fargo announced the following in its Form 10-Q filed with the SEC on November 3, 2016: “Federal, state and local government agencies, including the United States Department of Justice and the United States Securities and Exchange Commission, and state attorneys general and prosecutors’ offices, as well as Congressional committees, have undertaken formal or informal inquiries, investigations or examinations arising out of certain sales practices of the Company that were the subject of settlements with the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency and the Office of the Los Angeles City Attorney announced by the Company on September 8, 2016.” Given the changes in leadership at the SEC and the DOJ that will occur with the beginning of the Trump Administration, the timing and outcome of these investigations remains to be seen; however, the bank is also responding other requests for information on the sales practices and circumstances of the original settlement and the bank’s lawyers are busy defending a number of lawsuits have been filed by non-governmental parties seeking damages or other remedies related to these sales practices. In addition, leaders in several states, including California, Illinois and Ohio, announced that Wells Fargo had been banned from doing business with state agencies in those states, as well as participating in any state bond offerings, and similar bans were announced by leaders in various cities including Chicago and Seattle.
The scandal initially had a devastating impact on investors and others who depend on the value of the bank’s stock, such as low- and mid-level employees, who had received stock options as part of their compensation arrangements. From early September 2016, when news of the settlement was released, until mid-October 2016 the market value of the bank’s stock fell by almost $28 billion. When earnings for the third quarter were announced they had slipped to $5.6 billion from $5.8 billion for the same period a year earlier; however, there were signs of even more alarming problems for the future. For example, in presentations to investors the bank reported that banker and teller “interactions” had dropped from the previous year and from August 2016, the month before news of the scandal broke, and that consumer checking account openings and applications for the bank’s credit cards had also fallen off sharply. Similar softening of demand was occurring with respect to mortgage referrals from retail branches.
The announcement of results for the fourth quarter included word that new credit card applications were down 43%, new checking account openings had fallen by 40% and both teller transactions and customer interactions with the bankers in the branches had also declined when compared to the fourth quarter of 2015. The bank’s expense ratio—the bank’s expenses divided by revenue—had climbed outside of its typical range owing in part to the legal bills and advertising expenses associated with dealing with the scandal and attempt to regain the trust of customers. However, in spite of all this, Wells Fargo stock enjoyed the surge that other banks and financial institutions experienced in the wake of the election results of November 2016 and the share price, which had fallen to $45 in early November, had risen to $55 in mid-January of 2017.
Has the bank weathered the storm? Macroeconomic conditions looked promising: rising interest rates, robust job market, strong “credit quality” among potential borrowers and the real possibility of reduction of banking regulations. At the same time, Wells Fargo faced stiff competition from traditional banks and new players in the financial services industry offering innovative products and services without the large expense of maintaining a “brick-and-mortar” infrastructure. Whatever the future held, it was clear that Wells Fargo had failed several stakeholders: the employees who were fired; the customers who were bilked; the investors who believed in the board and saw the bank’s reputation plummet; and the trust of the communities in which the bank operates.
Commentators have correctly pointed out that the Wells Fargo scandal sheds a harsh light on the shortcomings of the bank’s board of directors in exercising several of its key dues and obligations to the shareholders and other stakeholders of the bank.
The entire board, as well as the committee of the board tasked with focusing on risk management, has a duty to continuously assess risks that are inherent in the company’s business and take prompt action to mitigate those risks before they explode into a crisis like the Wells Fargo situation. In this case, the evidence seems to be clear that top officials of the bank knew of the practices well before the dates that were originally stated but obviously did little or nothing to address the issue. In fact, many former employees have come forward with stories about how it was well-known throughout the bank that fraud was going on and that anyone who spoke out would be punished. Whistleblower systems were failing and while the bank employs a large number of people—over 264,000 as of 2015–certainly terminating 5,000 employees for alleged fraudulent practices would be a systematic problem that should be picked up by the bank’s risk management and governance systems and questioned by board members.
The board, as a whole as well as through the actions of its compensation committee, also has a duty not to enter into compensation arrangements that encourage bad behavior. Since the board acted fairly quickly to rescind previously approved bonuses and other compensation to senior executives who either knew or should have known about the fake accounts, which bonuses and compensation were originally awarded based in part on the enthusiastic recommendation of Stumpf as the chairperson of the board, it would seem that the board conceded that it failed to do sufficient due diligence in this situation. Interestingly, the bank’s proxy materials used prior to public disclosure of the scandal indicated that the board understood that compensation practices could create risks for the bank if they rewarded improper behavior and that the human resources committee met each year with the company’s chief risk officer “to review and assess any risks posed by our enterprise incentive compensation programs”. However, later reports indicated that the risk and human resources committee of the board actually failed to communicate and that the risk committee was likely never briefed on compensation practices and issues. Eventually, the board did take action to reduce executive compensation in response to the scandals. In March 2017, it was announced that Sloan and seven other top executives would not receive a cash bonus for 2016 and have their vested equity awards from 2015 cut by up to 50% “based on the accountability of all those in senior management for the overall operational and reputation risk of the company, and not on any findings of improper behavior in the board’s ongoing independent investigation.” According to bank estimates, the total amount of the compensation cuts was about $32 million.
In addition to their duties with respect to risk management and compensation, directors, especially the independent directors who are not involved in the day-to-day business activities of the company, should continuously monitor the organizational culture of the company, starting at the top with the employee members of the board and then continuing with the other members of the executive team and farther down to the bottom of the organizational hierarchy. The immediate response of the bank when news of the fraudulent accounts and mass firings emerged was to view it as an issue of employee misconduct, in spite of its being so widespread, and to willfully ignore the possibility that there were serious flaws in the organizational culture and the supervisory chain. What made the response even more puzzling and troubling was that industry watchers had been characterizing the bank’s culture as aggressive and intense—cross-selling has been a preferred sales strategy for years–long before these sales practices came to light and it apparently it was well known among bank employees that promotions and bonuses came to those who opened as many different types of accounts as possible, regardless of whether customers really needed them, and that employees who could not or would not keep up with the push for new accounts would be punished.
The reaction of the bank’s board to the scandal was also interesting given its composition and apparent experience in bank regulatory and operational issues. It was reported that the board, which was composed of fifteen members, included top corporate executives, former high-ranking United States government officials, an accounting expert and an academic and was impressively diverse (40% of the members were women and 2/3 of the members were either female, Asian, African-American or Hispanic). Moreover, two of the members were former financial regulators with extensive experience in consumer banking. In spite of all of this, and the hefty compensation that board members received ($279,000 to $402,000 in 2015), the board appeared to be clueless about a situation that was bubbling throughout the bank’s extensive branch network in thousands of communities.
The Wells Fargo situation and the apparent ethical missteps of Stumpf as he served as both chairperson of the board and the CEO brought up the continuously discussed question of whether those roles should be separated. In the past, the bank’s board has argued against separating the roles of the chairperson of the board and the CEO on the grounds that the existing structure was providing effective independent oversight of management and board accountability and that the bank’s strong financial performance was sufficient evidence that its governance structure was working effectively. Until the scandal came to light, the shareholders apparently agreed and resoundingly rejected insurgent proposals for an independent chairman. However, one of the notable responses to the scandal was the board’s reversal on this issue and voluntary decision to separate the two positions once Stumpf left. Stephen W. Sanger, the new chairperson of the board selected by his colleagues, previously served as chief executive and chairman of General Mills and was no newcomer to the situation at the bank. He had been a director of the bank since 2003 and the “lead independent director” since 2012. It seems fair to ask, as some critics have done, what he has been doing during all that time to further independent oversight of the senior management team. If, as some have claimed, he was unable to comprehend the risks that the bank was taken on because the CEO was controlling the information that was provided to the board, then one of his first jobs as the chairperson should be to find out who else was involved in that deception and purge them and then move on to creating a whole new reporting structure that empowers independent directors to fulfill their obligations to shareholders and the other bank stakeholders who have been injured by the scandal.
Sources: G. Morgenson, “Wells Fargo Board, Now in Spotlight, Recalls Its Role”, The New York Times (September 28, 2016), B1; M. Corkery and S. Cowley, “Bank’s Leader Exists Abruptly Amid Scandal”, The New York Times (October 13, 2016), A1; J. Stewart, “Justifiably, This Buck Stopped with the Chief Executive”, The New York Times (October 13, 2016), B3; M. Corkery and S. Cowley, “Shake-up at Wells Fargo Fails to Dispel Skepticism From Lawmakers”, The New York Times (October 14, 2016), B1; K. Sweet, “Wells Fargo earnings fall after scandal”, San Francisco Chronicle (October 15, 2016), B1; K. Pender, “Wells board is also to be blamed for fiasco”, San Francisco Chronicle (October 16, 2016), D1; G. Morgenson, “Wells Fargo Must Make Clean Break”, The New York Times (October 16, 2016), Sunday Business 1; M. Corkery “Wells Fargo Struggling in Wake of Fraud Scandal, Quarterly Data Show”, The New York Times (January 14, 2017), B2.