Excerpted with permission of the publisher, Cambridge University Press, from Seeking Virtue in Finance: Contributing to Society in a Conflicted Industry by JC de Swaan.
Customer Mandate: Serving Customers' Interest Faithfully - The Wells Fargo & Co Case
In my research for this book, I spent many months trying to identify ethical role models in finance. One name that repeatedly came up in the context of the US banking industry was John Stumpf.
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One of eleven children, he was raised on a dairy and poultry farm in Pierz, Minnesota. He first worked in a local bakery before enrolling in college and becoming a community banker. Industry analysts I interviewed in 2013-2014 were uniformly impressed by his civility and no-nonsense approach. Articles on Stumpf consistently highlighted his Mid-Western rural upbringing and values. In its 2013 Banker of the Year profile of Stumpf, industry publication American Banker noted the frugality of his office and the pervasive folksiness of his senior managers as the self-conscious marks of a values-based bank.
After many years in senior management roles, Stumpf became CEO of Wells Fargo & Co (NYSE:WFC) in 2007. Wells Fargo was a trusted, community-oriented bank, founded in 1852 in San Francisco as a bank and express delivery service. It had deftly navigated the real estate bubble of the 2000s, largely eschewing the sirens of subprime mortgages. Stumpf’s steady leadership enabled Wells Fargo & Co to emerge stronger from the financial crisis than most other large US commercial banks. He was widely praised for his ability to implement one of the largest bank mergers in history, integrating Charlotte-based Wachovia, the fourth largest bank in the United States, on the verge of collapse at the time of its acquisition. Under Stumpf’s watch, Wells Fargo became the largest US bank by market capitalization and the largest bank employer in the country. By 2015, it reached number seven in Barron’s “World’s Most Respected Companies” list. Stumpf could do no wrong. I was pleased to have found a titan of the banking industry to portray as an ethical role model.
Wells Fargo's Colossal Scandal And Stumpf's Stance On It
And of course, a colossal scandal surfaced in September 2016. It emerged that 5,300 Wells Fargo & Co brokers had created 2.1million checking and credit card bank accounts - a number later re-appraised at 3.5million, without the consent of their customers. An investigative report dating back to 2013 had already uncovered evidence of this fraud, but few would have anticipated its magnitude. Besides, it didn’t fit the prevailing narrative on Wells Fargo.
This scandal was all the more confounding because it came out of a commercial bank that was portraying itself as having deep roots in its communities - not from your typical aggressive New York- or London-based investment bank. And it wasn’t a case of complex finance which required industry specialists to parse out whether a true breach of trust had taken place between finance professionals dealing in esoteric capital markets instruments. Employees had created fake accounts for their unsuspecting retail customers. For some of the duped customers, this represented no more than a nuisance. For others, the fraud had real implications. Unsolicited credit card accounts could negatively affect credit ratings or even place customers into collections when unauthorized fees went unpaid.
While Stumpf initially tried to frame the breach of trust as the work of rogue employees, it quickly became apparent that it spawned from deep inside the company’s culture. For years, intense pressure had been put on employees to sell as many products as possible to their existing clients. In Wells Fargo & Co’s 2015 annual report, Stumpf wrote that cross-selling enabled the bank to develop “deep and long-lasting relationships“ with customers. It is also more profitable to sell additional products to existing customers than to acquire new customers. The emphasis on cross-selling was initiated by Dick Kovacevich, Stumpf’s widely admired predecessor. Kovacevich perceived financial products as being no different than consumer products, calling Wells Fargo branches “stores.”
On the surface, Stumpf accepted responsibility for the scandal but effectively directed the blame toward low-level employees. He resigned in the face of overwhelming criticism in October 2016. Wells Fargo & Co paid $185million for the fraud to regulators, including the US Consumer Financial Protection Bureau (CFPB), and another $575 million in a settlement with attorney generals of all fifty US states. It also paid hundreds of millions of dollars in refunds, settlements, and legal fees related to the fraud (and a $ billion fine in late 2018 related to its auto and mortgage lending practices). In an unprecedented move, Janet Yellen imposed an unusual penalty on Wells Fargo on her last working day as Fed Chairwoman, capping the bank’s assets at their 2017 year-end level, until the bank shows sufficient improvement in its governance. The bank has struggled to regain its footing with retail customers as the scandal has eroded the perception of its value proposition, although its valuation is consistent with that of other large US banks as of early 2020, albeit no longer at a premium.
How could such a cancer be allowed to spread within an organization that touts itself as a main-street bank dedicated to consumer and small businesses? The factors at play all reflect industry-wide challenges. The first is that over the last decades, the finance industry has increasingly become a minefield of conflicts of interest. The fact that most large banks such as Wells Fargo & Co are publicly listed creates a tension. The relentless pressure to deliver short-term results to boost shareholder value can too easily divert management away from the patient, solicitous handling of customers that is necessary to foster long-term relationships. Maximizing shareholder value, the mantra of listed companies for the past few decades in the United States and many other advanced economies, conflicts with putting customers’ interest first if shareholder value is constantly measured on a short-term basis. The internal goals at Wells Fargo had little to do with its customers’ interests and everything to do with shareholder value. These goals were pursued via an unforgiving incentive system, or punishment system depending on how one looks at it, that fetishized target numbers, to the exclusion of other considerations.
The Goal Of Selling Multiple Financial Products
In theory, the goal of selling multiple financial products to existing customers was not nefarious in and of itself. Underlying that goal is the desire to create deeper relationships and a more loyal, stickier customer base, which is encouraged to source most, if not all, of its financial products from one trusted bank. As Stumpf insisted, “there was no incentive to do bad things.” In fact, the disciplined use of targets has become standard across the finance industry. Since the 1990s, management consulting firms have converted their clients to “value-based management.” Accordingly, all resources should be channeled toward increasing the value of the firm and its share price. Discipline toward that overarching goal is imposed by tying incentives to departmental-level targets on metrics that management deems to have the greatest potential impact on the firm’s value. Where Wells Fargo & Co stood out was in its uniquely aggressive cross-selling targets, and the relentless pressure on low-level employees to achieve these often unrealistic, short-term goals, no matter how they got there. Prior to the scandal erupting, a petition signed by 5,000 employees had called on management to lower sales quotas, to no avail.
As of 2013, employees were reportedly asked to sell at least four financial products to 80% of their customers, while the stretch goal was the “Gr-Eight,” meaning eight financial products per retail banking household. That practice had been carried over by Kovacevich from his days as CEO of Norwest Corporation, prior to its merger with Wells Fargo & Co. The intensity of Wells Fargo’s targets was an outlier in the industry. For instance, a former Chase employee reported that she was given daily sales goals at Wells Fargo versus monthly ones at Chase. Wells Fargo managers met with employees several times a day to report on their progress.
These unrealistic goals spurred a culture of permissiveness -results at all costs, that led to fraud. Former bankers reported being pressured by their managers to invoke spurious reasons to convince customers to open new accounts - for instance, stating that it was unsafe to travel without separate checking and debit cards - or opening and closing new accounts for customers by claiming there had been fraud in the existing account. Managers encouraged employees to order credit cards for pre-approved customers without their knowledge, filling forms using their name and contact information, and at times moving money away from existing accounts. Specific directives to open unrequested accounts came from branch as well as district managers, the very people who would have been expected to exercise oversight over the integrity of customer interactions. In a staggering display of cynicism, Wells Fargo & Co fired employees who reported abuses via the bank’s formal internal whistleblower channel. When it fired employees prior to the scandal becoming public, Wells Fargo would not inform its customers of the fraud or refund fees that had been illegally extracted from them.
A culture of results at all costs - and results not being inherently defined in ways that are consistent with serving the customer’s best interest - necessarily stems from the top of the organization. As Stumpf stated during congressional testimonies, “I care about outcomes, not process.”
The fraud could be interpreted as the unintended consequence of poorly designed incentives - unintended because these fake accounts created no tangible value to the bank. Wells Fargo & Co extracted approximately $2million in fees from 85,000 of the more than 1.5million unauthorized deposit accounts opened, and a bit above $400,000 in fees from 14,000 credit card accounts of the more than 565,000 that may have been unauthorized - a pittance in the context of a bank that generated revenues of over $88 billion in 2016. It is implausible to think that Stumpf would have wanted these results to occur.