Two new reports concerning the Wells Fargo scandal suggest that the bank’s senior management, its board of directors, and the regulators all knew about the bank’s toxic practices, yet for years did nothing to stop them.
In September 2013, on the fifth anniversary of the peak of the 2008 financial crisis,The Economist decided that one of the interesting ways to revisit the crisis was by focusing on its “winner”: Wells Fargo, the bank that wasn’t bailed out and came out stronger than ever.The Economist spared the bank no compliments, arguing that it weathered the crisis “[s]imply by remaining solvent, a tribute to years of careful management.”
The prestigious weekly also highlighted Wells Fargo’s winning formula: “[t]o increase the success of its desultory credit-card operations, it need only entice more customers already using its multiple other services.” It also cited an analyst who said the bank was really good at “managing its employees well, providing the right incentives to enthuse them about pushing what the bank has to offer.”
Fast-forward to April 2017, to another report concerning Wells Fargo’s way of managing and incentivizing its employees: “Aided by a culture of strong deference to management of the lines of business (embodied in the oft-repeated ‘run it like you own it’ mantra), the Community Bank’s senior leaders distorted the sales model and performance management system, fostering an atmosphere that prompted low quality sales and improper and unethical behavior.”
The report goes further, detailing the damage created by this culture: “Trends in the data show, perhaps not surprisingly, that as sales goals became harder to achieve, the number of allegations and terminations increased and the quality of accounts declined.” It also describes the failure of control mechanisms: “Several common themes—again, substantially related to Wells Fargo’s culture and structure—hampered the ability of [corporate control] organizations to effectively analyze, size and escalate sales practice issues.” And it explains how the culture turned personal: “These [sales goals] reports were ultimately discontinued in 2014 after the Community Bank hosted ‘Leadership Summits’ in which regional leaders recommended changing or eliminating Motivators [the sales goals reports] due to the culture of shaming and sales pressure they perpetuated.”
Who is the author of the 2017 report? Wells Fargo itself, of course. More accurately, four Wells Fargo directors who investigated what became, in the summer of 2016, one of the biggest and best known retail banking scandals in recent years, culminating in the resignation of CEO John Stumpf.
The amazing, abrupt change in the way that Wells Fargo is represented and perceived by the financial industry, the regulators, and the press—from a bank once hailed as prudent and a leader in motivating employees to a reckless financial institution that suffers from endemic cultural problems—is the result of a bigger story: the failure of Wells Fargo’s board of directors and the regulators.1
Let’s start with the board. The failure of Wells Fargo’s board of directors was evident long before the latest report was published. University of Chicago Booth School of Business professor Luigi Zingales raised it in this blog and in Bloomberg back in October. The harsh and critical special report that the four-member committee issued three weeks ago is quite remarkable, considering that until last summer this very board backed Wells Fargo’s CEO. In a congressional committee, Stumpf appeared defiant and looked perplexed and surprised when Senator Elizabeth Warren asked him why he did not resign, give back his bonuses, or fire any of the bank’s managers. Stumpf, no doubt, had the complete backing of the board at the time. He stepped down only after being publicly grilled by Warren (the hearing later went viral and was watched over 800,000 times).
Scholars of law and economics have studied the dynamics in the boards of public companies, offering many explanations for the way that directors supervise management. Wells Fargo could serve as a great case study to support the theory that boards can be captured by CEOs. As long as Stumpf was the CEO, the board did not see any reason to claw back his multimillion-dollar compensation packages or thoroughly examine the bank’s culture and practices. As soon as he was out, the same board of directors conducted an investigation that led to very concrete and severe conclusions, painting management as reckless, at best.
The only way to explain this sudden change is the ousting of the CEO. Once he was ousted, the board “saw the light.”
The board’s report also reveals that most of the information regarding Wells Fargo’s culture—the fraudulent activities and the perverse incentives and procedures—were all known internally for years. The first event described in the report occurred 15 years ago: “In summer 2002, Internal Investigations determined that almost an entire branch in Colorado engaged in a form of ‘gaming’ in connection with a promotional campaign in the second quarter of 2002. Although most within Wells Fargo recall this incident as involving improper teller referral credits, it also involved employees issuing debit cards without customer consent.”
2002 is also the year in which, according to the report, Wells Fargo took action against such behavior: “Starting in at least 2002, Community Bank HR participated in efforts to stem sales practice issues.” In other words, had the board wanted to deal with these issues and investigate them, it had all the reasons in the world to do so many years ago.
To be sure, the report does address the board.
The higher up the chain of command it goes, however, the less blame it attributes to senior management. The board itself is absolved.
The report laid most of the responsibility on Carrie Tolstedt, the bank’s former head of community banking: “The root cause of sales practice failures was the distortion of the Community Bank’s sales culture and performance management system, which, when combined with aggressive sales management, created pressure on employees to sell unwanted or unneeded products to customers and, in some cases, to open unauthorized accounts.”
Stumpf was criticized as well, to a lesser degree. The bank’s “decentralized corporate structure” and “run it like you own it” culture, according to the report, gave Tolstedt a free hand, and so Stumpf was only to blame for being “too slow to investigate or critically challenge sales practices in the Community Bank” and for failing “to appreciate the seriousness of the problem and the substantial reputational risk to Wells Fargo.”
Before getting to the report’s discussion of Wells Fargo’s board of directors, it is worth looking at the board’s composition. Currently, Wells Fargo’s board has 16 members, 11 of which were appointed prior to a December 2013 investigative report in the Los Angeles Times. The LA Times report brought the problems within the bank into the public domain but also, by Wells Fargo’s own admission, triggered the chain of events that eventually stopped the problematic practices three years later.
Tasked with conducting the investigation, the independent directors of Wells Fargo created an “oversight committee” composed of four members. Of the four, three were appointed as directors before the LA Times article: Enrique Hernandez (appointed in 2003), Stephen Sanger (appointed in 2003; chairman of the board since October 2016), and Donald James (appointed in 2009). The fourth member, Elizabeth Duke, was appointed in 2015—after the publication of the initial LA Times story, but while the toxic practices were still going on.
In its report, the oversight committee did mention the board, but largely exonerated its members, saying that reports regarding the problematic practices were late to arrive and that management reported that it was addressing the issue: “Sales practices were not identified to the Board as a noteworthy risk until 2014. By early 2015, management reported that corrective action was working. Throughout 2015 and 2016, the Board was regularly engaged on the issue; however, management reports did not accurately convey the scope of the problem.”
The board’s report attributes many of the bank’s toxic practices to decentralization—a legitimate managerial approach that has its supporters. Nevertheless, the report is dotted with analyses and examples that, when connected, suggest that the bank’s executive management has effectively neutralized many control mechanisms, especially the board. Executive management was not decentralized—it went rogue. Out of control. And for many years. Which begs the question: what about the regulators?
A new report, leaked last week, suggests that the behavior of the regulators resembled that of the board. That report was written by the regulator itself: the Office of the Comptroller of the Currency (OCC), a bureau within the Treasury Department that regulates all national banks, including Wells Fargo. The OCC made the report public after it was leaked.
The 15-page report, issued by the OCC’s Office of Enterprise Governance and its ombudsman, is very critical of the OCC. After acknowledging that the OCC knew of the issues within Wells Fargo as far back as 2010, it stated that “The OCC did not take timely and effective supervisory actions after the bank and the OCC identified significant issues with complaint management and sales practices.” The report also said that the team in charge of Wells Fargo “focused too heavily on bank processes versus what those processes were actually reporting” and “reached conclusions without testing or determining the root causes of complaints despite the existence of red flags.”
The Wells Fargo report does mention the OCC (the OCC was one of the agencies the bank settled with in September 2016). It does not mention, however, that the OCC was aware of the sales practices before the settlement.
In November, soon after the scandal reached national and international audiences, several large investors in Wells Fargo called for changes in the board. One of the issues that some shareholders who pushed for change brought up is the other commitments that many Wells Fargo board members have. For example, John Chen is the Executive Chairman and CEO of BlackBerry; Federico Peña is a Senior Advisor to VC fund Colorado Impact Fund; and John Baker is also the Executive Chairman of real estate company FRP Holdings, which has been doing business with Wells Fargo. Another possible explanation for the board members’ adherence to their posts is compensation. Since 2005, for instance, board member Lloyd Dean earned about $3 million for his role on the board. As of a year ago, he also held Wells Fargo shares worth $4.2 million.
Following the events and the subsequent report, the board has made three notable changes: forcing out Stumpf, the CEO and chairman; separating the role of CEO and chairman of the board; and declaring an “acceleration” of the centralization of control functions. Yet it still resists calls for change within the board itself.
Wells Fargo’s scandal is outstanding and unique in many ways, the most important of which, perhaps, is the exceptional opportunity it offers to answer many hot-button questions on the roles of executive management, boards, and regulators in the banking industry: How effective are banks’ executives in spotting and stopping rogue behavior? How effective are banks’ boards in supervising executives’ handling of such situations? How effective are regulators in unearthing and putting an end to such behavior? And can stakeholders—from shareholders to employees to customers—rely on all three institutions to tackle these issues?
Wells Fargo’s report and the OCC report provide worrisome answers. The bank’s executives knowingly set unrealistic sales goals and pushed employees to set up fake accounts for customers without t
heir authorization and without their knowledge. Even though these dubious practices were not isolated—it is estimated that about two million such accounts were opened in many locations over the span of about 15 years—they were stopped only in late 2016. Executives knew, board members knew (or should have known), and regulators knew almost all along, yet failed to do anything about it.