For nearly two years, Wells Fargo has made headlines—for all the wrong reasons.

The latest prolonged moment of bad press came on April 20, when the Office of the Comptroller of the Currency, in a coordinated action with the Consumer Financial Protection Bureau, assessed Wells Fargo Bank with a civil penalty of $1 billion as a punitive action for overcharging customers in its mortgage and auto loan businesses.

Among the consumer abuses cited by regulators was convincing customers to pay for car insurance they didn’t need (leading to repossessions of said cars upon non-payment) and misleading borrowers on mortgage interest rates, even when they were already committed to an interest rate-lock.

The OCC assessed a $500 million civil penalty against Wells Fargo and ordered the bank to make restitution to customers harmed by its “unsafe or unsound practices.” Separately, the CFPB assessed a $1 billion penalty against the bank, but credited the OCC’s $500 million against the total.

The bank’s record-setting fines add to what has been a very expensive pattern of government enforcement. Wells Fargo’s troubles began in September 2016, when the CFPB announced that Wells Fargo Bank was fined $100 million for “the widespread illegal practice of secretly opening unauthorized deposit and credit card accounts.”

More bad news: The banking giant also faces multiple lawsuits from employees, customers, and investors, and there is an ongoing investigation into its wealth management division and allegations it ignored fiduciary standards (although not the yet-to-be enacted fiduciary rule under consideration by the Securities and Exchange Commission) by pushing clients into investments that were not in their best interest, yet benefitted the bank and its bottom line.

For its part, Wells Fargo is claiming, yet again, that it learned its lesson.

“For more than a year and a half, we have made progress on strengthening operational processes, internal controls, compliance, and oversight and delivering on our promise to review all of our practices and make things right for our customers,” President and CEO Timothy Sloan said in a statement.

Current enforcement actions may, even in an indirect way, influence the near future of federal bank regulation and build upon the already expanding power base of the Federal Reserve.

Since the financial crisis of 2008, the Fed’s Board of Governors has bolstered its role among one of several bank regulators. Under the Trump administration, it is poised to further expand its role as the lead regulator over large, systematically important financial institutions.

In July 2017, Randall Quarles was nominated by President Donald Trump to serve as vice chairman for bank supervision on the Federal Reserve’s Board of Governors. The position was created by the Dodd-Frank Act and directed to “develop policy recommendations for the Board regarding supervision and regulation of depository institution holding companies and other financial firms supervised by the Board and shall oversee the supervision and regulation of such firms.’’

Quarles took over the role during the Trump administration because the previous Obama administration failed to formally nominate anyone. He has started to exercise that authority, with a stated goal of tailoring compliance burdens to an institution’s size and assets.

A key challenge will be balancing “safety and soundness” concerns with the White House’s deregulatory zeal. Although the Fed was not involved in the latest round of Wells Fargo fines, the bank’s troubles may feed into his agency’s future direction and actions.

Shrinking a giant

One tool in the regulatory arsenal, although one that will likely be used sparingly, is either breaking up big banks or limiting their operations if they grow to be perceived as unmanageable.

In February, responding to compliance breakdowns by Wells Fargo, the Federal Reserve Board announced that it would restrict the growth of the firm until it sufficiently improves its governance and controls.

“For more than a year and a half, we have made progress on strengthening operational processes, internal controls, compliance, and oversight and delivering on our promise to review all of our practices and make things right for our customers.”
Timothy Sloan, President & CEO, Wells Fargo

Wells Fargo was banned from doing anything that would increase its total consolidated assets past their December 2017 levels, while it takes measures to bolster its compliance with federal banking laws. The bank will still be able to issue loans and take deposits.

Using Wells Fargo as a test case, expect critics in Congress to urge this sort of enforcement tool for other bank failures. Already, such a growth limit is among the punishments for failing a Dodd-Frank mandated “stress test.”

As for those stress tests, Quarles says he wants those annual assessments to be better tailored to specific institutions, be more transparent, and to allow banks themselves to provide additional commentary to regulators when they fail.

A continuing focus on pay and incentives

Prior to its 2016 enforcement actions, Wells Fargo had compensation incentive programs in place for employees that encouraged them to sign up existing clients for additional accounts, credit cards, and online banking. As sales numbers spiked, management kept quiet and senior leadership boasted of the resulting revenue increases and cross-selling prowess to shareholders, the government alleged.

Regulators, including the Federal Reserve, have considered easing the punitive effect on shareholders for this sort of bad behavior by targeting punishments to executive pay.

It is an idea that even Wells Fargo has had to consider following an independent investigation into sales practices by the law firm Shearman & Sterling.

 “Bank leaders were unwilling to change the sales model or recognize it as the root cause of the problem, resisted and impeded scrutiny or oversight from corporate risk management and the Board and, when forced to report, minimized the scale and nature of problems,” Shearman & Sterling wrote in the resulting report.

Amid criticisms of what some say is the treatment of big bank executives as “too big to jail,” record-setting fines are likely to continue as the go-to move for the Federal Reserve and other bank regulators.

State regulators are also escalating their criticism of incentive practices. Among them is New York State Comptroller Thomas DiNapoli.

On April 17—amid rumors, but prior to confirmation of the government’s $1 billion fine—DiNapoli, trustee of the New York State Common Retirement Fund, wrote to fellow Wells Fargo shareholders urging them to support his call for the bank to provide a report on whether incentive pay practices exposed it to financial losses.

DiNapoli is head of New York State Common Retirement Fund, the third -largest public pension fund in the United States, with an estimated $209 billion in assets under management. His shareholder proposal will be put to a vote of fellow investors at the bank’s annual meeting on April 24.

The proposal specifically asks the bank to disclose whether it has identified employees or positions eligible to receive incentive-based compensation tied to performance or sales metrics that could motivate them to take excessive risks and expose the company to possible material losses.

Senate Democrats are also calling on federal financial regulators to strengthen a proposed “clawback” rule pursuant to the Dodd-Frank Act that aims to prohibit executive pay arrangements that promote excessive risk-taking or misconduct in the financial services industry.

Citing Wells Fargo’s failure to properly align sales goals with customers’ interests, Democrats have asked regulators to strengthen requirements so major financial institutions are required to enforce policies that reclaim executive’s compensation connected to misconduct and fraudulent activities. The Federal Reserve, as the primary regulator for big banks, will continue to face pressures to mandate those post-malfeasance pay actions.

That the $1 billion Wells Fargo fine gained the support and praise of Mick Mulvaney, President Trump’s penalty-averse acting director of the CFPB, may indicate that we can expect a continued reliance on big bank fines in the absence of criminal pursuits.

This may be tied to scorn heaped upon the CFPB for its previous $100 million penalty against the bank. Among the accusations against the pre-Mulvaney CFPB is that it “rushed to settle with Wells Fargo for less than 1 percent of the Bureau’s own estimate of the bank’s statutory civil monetary penalty.”

Overhauling the board of directors

A powerful tool in the Federal Reserve’s arsenal is its seldom-used authority to demand the termination of banks’ board members.

In February, as part of the Board’s consent cease-and-desist order with Wells Fargo, it emphasized the need for improved director oversight of the firm.

Amid the Fed’s threat to force out directors, Wells Fargo took the step on its own, electing six new independent directors as phased retirements began.

During Quarles’ testimony earlier this month as part of a semi-annual update to Congress, House Financial Services Chairman Jeb Hensarling (R-Texas) questioned whether the Fed’s interference with bank directors conflicted with traditional state oversight.

“Typically, corporate governance is determined by state laws. There is, frankly, hundreds of years of case law,” he said, “I am somewhat concerned that the Fed is trying to supplant itself over state corporate governance law. The line drawn between supervision and corporate governance is getting rather murky.”

Quarles said his goal and intention was to “de-murkify” the situation by evaluating public comments. He made no assurances, however, that the Fed had any inclination to surrender its authority over bank directors.

Lawyers, guns, and money

Aside from consumer abuses, Wells Fargo is creating controversy with its decision to continue business with gun manufacturers.

Wells Fargo Chief Financial Officer John Shrewsberry has also said that his bank will not agree to the gun control demands of the American Federation of Teachers, according to The Washington Post.

American Federation of Teachers President Randi Weingarten this month announced that her union would cut ties with Wells Fargo after executives failed to follow up on a meeting with the union to discuss the bank’s relationship with the National Rifle Association and gun manufacturers.

In contrast, Citigroup and Bank of America have announced new firearm-related policies and will sever services with businesses that sell firearms to anyone who hasn’t passed a background check.

Don’t expect the Federal Reserve or other regulators to want anything to do with these sorts of restrictions.

Senate Banking Committee Chairman Mike Crapo (R-Idaho) and Sen. John Kennedy (R-La.), however, quizzed Quarles on the issue during his testimony before them. He, in turn, called pro-gun punitive actions, “outside of our remit.”

 “This is no different than the big banks refusing to do business with someone because they oppose abortion,” Kennedy said. “We don’t need red banks or blue banks. Banks shouldn’t make decisions based on which button a small-business owner pushed in the voting booth, especially when taxpayers, Republicans and Democrats alike, bailed them out after the 2008 financial crisis.”

Staying the course

Soon-to-depart Fed Governor Lael Brainard, in a speech last week, said her agency should not maintain status quo with its policies. This includes a focus on strengthening capital and liquidity buffers at large banking institutions, despite pressures and proposals to reduce those requirements.

She warned, “There is a risk that regulators and banking institutions end up spending too much time looking in the rear-view mirror and not enough time looking ahead for emerging risks.”

Brainard explained her vision for future regulatory actions. Among them, finalizing the net stable funding ratio, a “significant liquidity regulation” that is “important to ensure that large banking firms maintain a stable funding profile over a one-year horizon.”

The Fed also needs to finalize Dodd-Frank Act limits on large counterparty exposures. “These limits will reduce the chances that outsized exposures, particularly between large financial institutions, could spread financial distress and undermine financial stability as we witnessed during the last financial crisis,” she said.

Brainard also supported “improving the efficacy of the Volcker rule while preserving its underlying goal of prohibiting banking firms from engaging in speculative activities for which federal deposit insurance and other safeguards were never intended.” Quarles is among those who supports easing the rule for small- and medium-sized community banks and will oversee legislative demands to do so.