Risk Management

What Did Wells Fargo’s CEO Know?

One cause of the alleged improprieties of Wells Fargo’s incentive programs may have been clogged communications.
John Bugalla and Kristina NarvaezSeptember 16, 2016

Too often, companies get into trouble when their employee-performance incentive programs aren’t in sync with sound risk-governance practices. Employee fraud can be the result when an organization’s incentive program is stretched too far. Further, low-performing employees can end up taking drastic measures in order to look good during their employee-performance reviews.

John Bugalla

John Bugalla

Wells Fargo’s current problems are a potent case in point of how an apparent lack of risk communication among line management, senior management, and the board set the stage for potentially illegal incentives on a large scale. Yesterday, the bank was hit with three subpoenas by three different U.S. attorneys in an escalating investigation into “how thousands of bank employees came to secretly issue more than a million sham accounts without customers’ consent,” according to The New York Times.

That followed  on the heels of the bank’s $185 million settlement agreement with the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency, and the Office of the Los Angeles City Attorney, “regarding allegations that some of its retail customers received products and services they did not request,” according to Wells Fargo’s press release.

Kristina Narvaez

Kristina Narvaez Narvaez

The amount of the settlements totaled $185 million, plus $5 million in customer remediation. Of that total, Wells Fargo will  pay $50 million in civil penalties to Los Angeles.

The alleged improprieties in the bank’s sales practices were driven by unachieveable incentive goals, Los Angeles city attorney Michael Feuer charged in his part of the litigation. “In order to achieve its goal of selling a high number of ‘solutions’ to each customer, Wells Fargo imposes unrealistic sales quotas on its [California] employees, and has adopted policies that have, predictably and naturally, driven its bankers to engage in fraudulent behavior to meet those unreachable goals,” Feuer argued.

The Los Angeles lawsuit brought by Feuer claimed that some Wells Fargo employees even pressured their own family members and friends to sign up for accounts to the extent that they “tapped out” their customer network.

But such behavior is contrary to what Wells Fargo’s CEO, John Stumpf, told Thomas Stanton, a staff member of the Financial Crisis Inquiry Commission, back in 2010. “Our culture puts the customer at the center of what we do. If it’s good for the customer, it will ultimately be good for us,” he contended.

Stumpf further asserted that Wells Fargo links this vision to its corporate strategy of cross-selling products to its customers. The strategy enables customers to have a good experience with the company by putting them in a position to purchase more useful products and services, he argued.

Stumpf also stated in this same interview that Wells Fargo’s “culture eats strategy for breakfast every morning.” Putting culture first would indeed be the best priority for an organization if their corporate culture mirrored sound risk governance practices. Using such practices, the company would not only monitor an employee’s performance in terms of sound judgement and ethical behavior, but make them accountable for their decisions. And Wells Fargo doesn’t appear to have done that. Maybe it was because its culture had eaten its strategy, leaving only the hunger for near-term revenue in its wake.

Wells Fargo’s strategic failure is somewhat remarkable, given the regulatory guidance banks have had since the end of the financial crisis. Indeed, Securities and Exchange Commission rule 33-9089 and the Dodd-Frank Act have been in force since 2010. One of the major goals of 33-9089 is to prevent incentive compensation schemes that reward employees for taking excessive risks.

Further, Dodd-Frank requires banks the size of Wells to have a Chief Risk Officer (CRO) who reports directly to CEOs like Stumpf. On Wednesday, The Wall Street Journal reported that Stumpf defended the firm and its efforts to stop its allegedly illegal sales practices, claiming that it was the employees who did it on their own.

“There was no incentive to do bad things,”  Stumpf told the Journal.

The obvious questions, then, begin with: If the incentives didn’t start at the top, why weren’t Stumpf and his team eventually informed of them? What kinds of information are Stumpf and the board of directors receiving from the company’s chief risk officer, Michael J. Laughlin? Is the board merely receiving information that management is pushing up to them, instead of the board pulling the information that it needs to perform its responsibility of risk oversight, which, again, is required by the SEC?

One cause of the alleged improprieties of the bank’s incentive programs may well have been clogged communications between senior management and employees. Given the facts to date, we recommend that the Wells Fargo board engage an independent third-party expert to completely review the bank’s enterprise risk management program, focusing on the flow and quality of information going to the board.

John Bugalla is a principal with ermINSIGHTS and Kristina Narvaez is president and CEO of ERM Strategies LLC.