You are having a bad week when, as a CEO, you are called before Congress to testify. You are having a horrible week when the complaints against you unite Democrats and Republicans.

That daunting display of unity took place last week when Wells Fargo CEO John Stumpf was called before the Senate Banking Committee to answer questions about recent revelations that his bank’s employees opened 2 million accounts and credit cards in the names of customers without their knowledge.

The offenses, dating back to 2011, resulted in the termination of 5,300 employees and netted $185 million in fines from the Consumer Financial Protection Bureau, Office of the Comptroller of the Currency, and City of Los Angeles.

The root of the problem, according to regulators, were unreasonable sales targets that led the bank’s sales team to both protect their jobs and earn incentives.

The grab-your-popcorn moment of the hearing came from Sen. Elizabeth Warren (D-Mass.), who was expected to give Stumpf an earful, and she most certainly did.

“You haven’t resigned,” she told Stumpf. “You haven’t returned a single nickel of your personal earnings. You haven’t fired a single senior executive. Instead, your definition of ‘accountable’ is to push the blame to your low-level employees who don’t have money for a fancy PR firm to defend themselves. It’s gutless leadership.”

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While other banks average fewer than three accounts per customer, Wells Fargo set its target at eight accounts, Warren said, adding that Stumpf repeatedly referenced Wells Fargo’s success at cross-selling during earning calls as one of the main reasons to buy stock. The value of that stock personally held by Stumpf increased by more than $200 million during the time the scandal unfolded.

“If one of your tellers took a handful of $20s from the cash drawer, they’d probably be looking at criminal charges for theft,” Warren said. “They could end up in prison. But you squeezed your employees to the breaking point so they would cheat customers and you could drive up the value of your stock and put hundreds of millions of dollars in your own pocket.”

Warren threw Stumpf’s own words back at him, quoting from the bank’s “Vision and Values Statement”: “We believe in values lived, not phrases memorized. If you want to find out how strong a company’s ethics are, don’t listen to what its people say, watch what they do.”

When asked, Stumpf declined to say whether he would support a clawback of bonus money received by soon-to-retire (with a $145 million golden parachute) Senior Executive Vice President of Community Banking Carrie Tolstedt. That decision was in the hands of the board of directors.

Warren blasted Stumpf for not firing a single senior executive, or anyone connected to the compliance division “that was in charge of making sure that the bank complied with the law.”

“First off, it was not a scam,” Stumpf responded, later hedging on whether or not the illicit accounts and charge cards constituted fraud. In his view, sales targets were intended as “a way to build deepening customer relationships.”

There was no encouragement for employees to break from company policy, he added. “I have never said go out there and do these things. We try to do the right thing.”

Warren was not persuaded. “This is about accountability,” she said. “You should resign. You should give back the money you took while this scam was going on, and you should be criminally investigated by both the Department of Justice and the Securities and Exchange Commission.”

“You haven’t returned a single nickel of your personal earnings. You haven’t fired a single senior executive. Instead, your definition of ‘accountable’ is to push the blame to your low-level employees who don’t have money for a fancy PR firm to defend themselves. It’s gutless leadership.”
Senator Elizabeth Warren (speaking to John Stumpf)

Earlier in the hearing, Stumpf had an opportunity to present his case without the cross-examination to follow. “I do want to make very clear that there was no orchestrated effort, or scheme as some have called it, by the company,” he said. “We never directed nor wanted our employees … to provide products and services to customers they did not want or need.”

“It is important to understand that when an employee provides a customer with a product or service that she did not request or authorize, that employee has done something flat wrong,” he added. “It costs us satisfied customers, and we lose money on these accounts. Wrongful sales practice behavior goes entirely against our values, ethics, and culture and runs counter to our business strategy of helping our customers succeed financially and deepening our relationship with those customers.”

That said, Stumpf said he accepts “full responsibility for all unethical sales practices.”

Stumpf detailed internal responses to the illegal sales practices as they were uncovered (and made public in a 2013 story by the Los Angeles Times). “Efforts to detect and deter unethical conduct have progressively evolved over the last five years,” he said.

In 2011, the bank launched its Quality-of-Sale Report Card in California, and it was implemented in 2012 across retail banking. They were designed to, among other things, deter and detect misconduct through monitoring of sales patterns that may correlate with unethical behavior.

In 2011, a Sales and Service Conduct Oversight Team began to engage in proactive monitoring of data analytics, specifically for the purpose of rooting out sales practice violations. In 2013, it began its first proactive analysis of “simulated funding” across the retail banking business, reviewing employee-level data around account openings.

In 2013, a cross-functional oversight team for retail banking sales integrity issues was formed to identify suspicious sales trends. In 2015, the bank continued to enhance training materials and practices, make changes to incentive plans, and lower incentive compensation goals for employees.

As allegations emerged, PwC was retained to identify the population of customers that may have suffered financial harm. Beginning in September 2015 and continuing into 2016, PwC conducted data analysis of the more than 82 million deposit accounts and nearly 11 million credit card accounts, Stumpf said. It focused on identifying transaction patterns that might be consistent with improper conduct and identified approximately 1.5 million such accounts that could have been unauthorized. PwC also identified credit cards that had never been activated by the customer nor had other customer transaction activity. Approximately 565,000 consumer cards, or 5.8 percent of all credit cards opened, fell into that category (not all of which were unauthorized).

THE POLITICAL BACKDROP

The Wells Fargo revelations may be terrible news for those who seek to do away with the Consumer Financial Protection Bureau in its current form.
How’s this for bad timing: The story broke the same week that the CHOICE Act, a legislative package birthed by Financial Services Committee Chairman Jeb Hensarling (R-TX), advanced from committee with a 30-26.
Hensarling describes the bill as a Republican plan “to replace the Dodd-Frank Act and promote economic growth.” Among its many overhauls to the post-financial crisis regulatory landscape is to change the name of the CFPB to the “Consumer Financial Opportunity Commission” and task it with the dual mission of consumer protection and competitive markets. The bill would also replace the CFPB’s single director with a bipartisan, five-member commission subject to congressional oversight and appropriations. Last, but not least, it would repeal its authority to ban bank products or services it deems “abusive” (as it did with Wells Fargo) and its authority to prohibit arbitration.
The Wells Fargo news was welcome ammunition for House Democrats. “I am more than disappointed. I am amazed that we are considering a highly partisan, damaging piece of legislation to kill Dodd-Frank and harm consumers,” Representative Maxine Waters (D-Calif.) said at the markup hearing. “We saw more than two million fraudulent accounts were opened by Wells Fargo. Enough for every resident of the state of New Mexico.”
An added bonus for Democrats: With thousands of aggrieved Wells Fargo customers pondering litigation, and soon learning they are stuck with fine print agreements to binding arbitration instead of redress in a courthouse, efforts to repeal CFPB rules prohibiting binding arbitration may go over like a lead balloon.
The lesson for House Speaker Paul Ryan: Always check your Twitter queue after a crisis. “Dodd-Frank's regulations have not helped the American people,” he tweeted the same week the Wells Fargo fines were announced. “They've hurt our small businesses.” A related tweet: “The CFPB supposedly exists to protect you, but instead it tries to micromanage your everyday life. That’s NOT a #BetterWay.”
The Twitterverse responded:
“When Wells Fargo ripped off millions from its customers #GOP yawned, did nothing. #CFPB did something.”
“So that tweet was sponsored by Wells Fargo, right? Consumers you should just get ripped off and take it like a man!”
“LOL ... dude, you seriously have to work on both your timing and message considering the recent win against Wells Fargo. Wow.”
Don’t, however, completely count out the CFPB’s critics as the Wells Fargo scandal evolves.
Iain Murray of the Competitive Enterprise Institute, a conservative think tank, has a unique perspective on the bank’s headline-grabbing woes. What’s missing amid the hand-wringing, he suggests, is “an appreciation of the biggest victim in this fiasco,” namely the bank itself.
“What happened was not a deliberate attempt to sandbag customers by the bank’s owners, but a conspiracy to game the bank’s compensation program, which rewarded big sellers of its products, by the bank’s own employees,” he says.
In economics, the phenomenon has a name—the principal-agent problem. It arises when the agent (in this case an employee) of the principal (the bank’s owners and investors like Warren Buffet, who lost $1.4 billion as a result of the scandal) “acts opportunistically in self-interest against the interests of the principal,” Murray explains. Owners, customers (who will likely see increased fees as a result), and employees who did not engage in shady, sales-inflating tactics all suffer.
A problem with the corporation, Murray says, is that the nature of the employment contract hides information that is present in a commercial contract. If Wells Fargo had employed internal markets, for instance, there could have been warning signs that certain branches were far out-performing others in a way that would have raised eyebrows and prompted quicker internal investigation.
“If firms are to police against opportunistic employee behavior, they need a full range of information-gathering strategies at their disposal, including disaggregating the corporation,” he says. “Yet all the regulatory pressure, particularly in the world of banking, has been towards greater agglomeration in corporate structures, which intensifies the lack of information that allows opportunistic behavior.”
This, Murray concludes, is why the Wells Fargo scandal “shouldn’t lead us automatically to assume that regulation is helping out the little guy, even though prima facie it seems that it did its job here.” In general, “if regulation could exacerbate the principal-agent problem, it is probably a bad regulation.”
—Joe Mont

The bank, Stumpf said, is working with the Office of the Comptroller of the Currency (OCC) to strengthen oversight of sales conduct risk and has established a Sales Conduct Risk Oversight Office that reports to the chief risk officer. It is also “creating a new, enhanced branch compliance program that will be dedicated to monitoring for sales practice violations by conducting data analytics and frequent branch visits.”

The rundown of compliance initiatives wasn’t enough to keep lawmakers at bay.

Sen. Sherrod Brown (D-Ohio) pushed back against Stumpf’s hesitation to describe recent events as fraud. “I call it fraud because I got tired of the euphemisms a long time ago,” he said. “This is not a matter of customers who received products or services they did not want or need, as Wells Fargo puts it. That makes it sound like there was a mix up under the Christmas tree and I got the right-handed baseball glove that was meant for my brother Charlie.”

“The impression that emerges is that the company might have been whispering about ethical standards and treating the customer right, but they were shouting ‘this is the way you make money, sell more of these,’ ” said Sen. Jack Reed (D-R.I.)

Sen. Bob Corker (R-Tenn.) was surprised at Stumpf’s failure to commit to clawbacks, describing it as “committing malpractice from the standpoint of public relations alone. “

Corker also questioned the efficacy of the bank’s compliance program. “There is a compliance officer. All banks have these because you are regulated to death. This is something you would think would be flagged and jump out at someone who was in that job.”

Citing a lack, thus far, of SEC disclosures on the illegal accounts and subsequent fines, Sen. Pat Toomey questioned how the bank could maintain that neither rise to the level of “materiality.”

“The reputational damage to the bank clearly is material,” he said. “When thousands of people conduct the same kind of fraudulent activity, it’s a stretch to believe that every one of them individually conjured up this idea of how they would commit this fraud. Isn’t it very probable that there was some orchestration that happened at some level?”

Senator Richard Shelby (R-Ala.), demanded answers from regulators: “If the OCC and the CFPB were aware of these issues before the L.A. City Attorney’s lawsuit, why did they wait until 2016 to bring an enforcement action? Why did it take an L.A. Times reporter to uncover what should have been uncovered by Wells Fargo’s regulators?

“If there were ever a textbook case where consumers needed protecting, this was it,” he added. “How many millions of unauthorized accounts does it take before the CFPB notices? While the Bureau is billing this as the largest settlement in its history, it is unclear whether it had any significant role in discovering or investigating the bank’s conduct.”

“The unsafe and unsound sales practices at the Bank, including the opening and manipulation of fee-generating customer accounts without the customer’s authorization, are completely unacceptable and have no place in the federal banking system,” Comptroller of the Currency Thomas Curry said. “They reflect a lack of effective risk management, a breakdown in controls, and an inappropriate incentive structure.”

He reiterated that the investigation and subsequent enforcement actions were tightly coordinated between all three of the participating agencies.

As far as his agency’s response, beginning in 2013, after receiving information from whistleblowers, it issued a Supervisory Letter requiring the bank to develop its operational risk compliance program. In early 2014, it directed the Bank to address weaknesses in compliance risk through the establishment of a comprehensive compliance risk management program related to unfair and deceptive practices.

In March 2015, OCC examiners completed a multiyear assessment of the Bank’s compliance management systems, applying the OCC’s rule on heightened standards for large banks. Examinations in 2015 found that the bank lacked a formalized governance framework to oversee sales practices.

The OCC concluded its 2016 examination work in July, finding that the bank’s sales practices were unethical; caused harm to consumers; and that management had not responded promptly to address these issues, Curry said.

The OCC is now conducting a review to identify gaps in its supervision and assess lessons it can learn from the investigation. “At the same time, I have directed our examiners to review the sales practices of all the large and midsize banks the OCC supervises and assess the sufficiency of controls with respect to these practices,” Curry said.

“This action should serve notice to the entire industry,” CFPB Director Richard Cordray said. “If sales targets and incentive compensation schemes are implemented in ways that threaten to harm consumers across the entire financial sector … any such initiatives should be carefully monitored as a basic element of a company’s compliance program.”