Wells Fargo’s fraudulent account openings: What are the (initial) risk management lessons?

It is intriguing that the intense level of media attention and Congressional furor over Wells Fargo’s fraudulent account opening scandal may equal or exceed that involving the LIBOR and Forex rigging scandals that resulted in billions of dollars of fines. The financial institutions that settled the LIBOR cases had allegedly manipulated the benchmark interbank interest rate that sets short-term interest rates all over the world. Financial institutions similarly settled cases involving alleged manipulation of the foreign exchange market. These LIBOR and Forex cases of wrongdoing struck directly at the integrity of the U.S. financial system but involved complex, somewhat abstract financial crimes.

Wells Fargo’s settlement involved alleged violations of consumer protection laws whose systemic impact is not direct but whose import is immediately obvious to the average American. The scandal may reflect industry-wide practices that can have a highly negative impact on a bank’s franchise value. Over two million accounts were opened without customer authorization. Wells Fargo fired 5,300 employees implicated in the improper sales practices and paid $185 million in civil fines to regulators, including $100 million to the Consumer Financial Protection Bureau. California and Illinois have suspended certain business ties with the bank. The Justice Department is reportedly now investigating the matter. Former employees said the sales targets, involving cross-selling of products, were unreasonable and the root cause of the improper practices. Managers allegedly threatened employees to do whatever it took to meet the sales quotas.

Wells Fargo obviously had not reckoned on the reputational damage that a consumer protection issue could cause. The question is why didn’t it see this coming? An initial possibility is that the board of directors and senior management did not adequately assess the risk that high sales quotas might incite improper practices among low-level employees. More seriously, when they apparently learned of the first cases of wrongdoing a few years ago, they appear to have done little other than order additional compliance training consisting mainly of warnings not to open fraudulent accounts, a cosmetic rather than root-and-branch approach to the fraud.

It was only after the first Congressional testimony of the CEO and chairman, John Stumpf, in which he said the scandal was only a matter of “rogue employees,” that the board woke into action. Among other things it revoked $41 million of his stock and salary and $19 million in unvested stock grants of the executive who had been in charge of the division responsible for cross-selling. The fallout over the scandal showed no sign of abating as Stumpf resigned as CEO and chairman on October 13. 

Several media accounts offer incisive commentary on the Wells Fargo scandal. These include Matt Levine of Bloomberg on clawbacks and the bank’s compliance efforts to stamp out the fraud in 2014 while continuing to impose unreasonable sales targets, and the Wall Street Journal on the board’s inaction despite the presence of directors with special expertise in the financial markets. Lessons on good corporate governance and risk management practices will undoubtedly emerge as more details are reported about the scandal. 

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