On Feb. 2, 2018, the Federal Reserve published a letter it had sent to the former lead director of Wells Fargo, Stephen Sanger. In the letter, the Fed reviewed Mr. Sanger’s performance as lead independent director of the financial institution and deemed it “ineffective.”
The recent Wells Fargo scandal is a cautionary tale of a corporation’s culture gone bad; the letter is a rare instance of a regulator publicly shaming an independent director.
The Wells Fargo scandal itself reads like the pages of the script for a bad TV drama. It began with millions of fake, unauthorized bank and credit card accounts to boost the appearance of sales, and is ending with thousands of employees fired, four members of the board of directors ousted by the Fed, millions in fines and settlements, DOJ and SEC investigations, and a lot of embarrassing, public shaming of executives along the way.
On Sept. 8, 2016, news broke that for years, Wells Fargo employees had been secretly creating fake accounts without customers knowing it, to boost sales figures and qualify for bonuses.
From a CNN report (linked to above):
The way it worked was that employees moved funds from customers’ existing accounts into newly-created ones without their knowledge or consent, regulators say. The CFPB described this practice as “widespread.” Customers were being charged for insufficient funds or overdraft fees — because there wasn’t enough money in their original accounts.
Additionally, Wells Fargo employees also submitted applications for 565,443 credit card accounts without their customers’ knowledge or consent. Roughly 14,000 of those accounts incurred over $400,000 in fees, including annual fees, interest charges and overdraft-protection fees.
The Consumer Financial Protection Bureau (CFPB) charged Wells Fargo with the largest fine the CFPB had ever levied—$185 million.
Soon after news of the scandal broke, the US Department of Justice began an investigation into Wells Fargo. Within a week, the Senate banking committee would hold a hearing for Wells Fargo where its CEO John Stumpf and Senator Elizabeth Warren would go head to head in what would turn out to be a humiliating dressing down of Mr. Stumpf that went viral across the media.
In early September 2016, Stumpf said he had no plans to step down. Though he was apologetic, he said the best thing for him to do was lead the company. By the end of the month, Stumpf stated he would forfeit his 2016 salary, including his bonus and $41 million in stock awards. (When all was said and done, the board ultimately clawed back $69 million in compensation from Stumpf. )
That same month, the first executive stepped down: Carrie Tolstedt, who was in charge of the division that created the fake accounts. Although it took a while, the board of Wells Fargo ultimately clawed back from her approximately $67 million (some of which was in the form of taking back unexercised stock options).
In front of the House Financial Services Committee at the end of September, Stumpf again testified and was met with more disapproval with lawmakers calling Wells Fargo a criminal enterprise and comparing Stumpf to a common bank robber.
On October 12, the tide had officially turned for Stumpf. He stepped down from his role as CEO:
While the bank CEO said he was “deeply sorry” and insisted there was no “scheme” to scam customers, he struggled at times to answer lawmakers’ questions. He often gave the impression he wasn’t fully in charge of the company.
Jeffrey Sonnenfeld, an authority on corporate governance at Yale, said Stumpf proved to be a “deer caught in the headlights with a tin ear in understanding, addressing, and communicating the problem.”
The Securities and Exchange Commission launched an investigation into Wells Fargo next. Additional investigations uncovered retaliation by Wells Fargo against whistleblower employees attempting to surface illegal activities.
In March 2017, a top federal banking regulator severely downgraded Wells Fargo’s community lending rating.
In April, Wells Fargo asked for $75 million more back from Mr. Stumpf and Ms. Tolstedt. Class action suits mounted, and totaled $142 million in settlements to include customers who had unauthorized accounts opened in their name as early as May 2002.
In August, more fake accounts were discovered, which brought the total amount of fake accounts to 3.5 million.
(During this debacle, Wells Fargo was separately investigated for its wealth management business selling services that weren’t in the best interest of customers, and the anti-money-laundering unit failing to file timely suspicious activity reports. This is just a sampling of many other issues that came to surface about Wells Fargo’s practices since the original scandal broke.)
In early 2018, the Federal Reserve referred to Wells Fargo’s practices as “widespread consumer abuses.” The strongly worded letter addressed Mr. Stumpf not as the CEO of the firm, but as the chair of the board of directors:
As Chair, it was your responsibility to lead the WFC board in its oversight of the firm’s business and operations. With respect to that responsibility, it was incumbent upon you as leader of the WFC board to ensure that the business strategies approved by the board were consistent with the risk management capabilities of the firm. It was also incumbent on you to ensure that the WFC board had sufficient information to carry out its responsibilities.
The Federal Reserve also took the harsh step of imposing constraints on the bank as it works to get its house in order:
Due to the scope and severity of these compliance and conduct failures, the Federal Reserve Board has also issued a cease-and-desist order (“Order”) against WFC requiring, among other things, that WFC strengthen board oversight of the firm and senior management. The Order also imposes limits on WFC’s growth until substantial progress on implementing the requirements of the Order has been achieved.
That meant that Wells Fargo wouldn’t be allowed to expand until the Fed sees that the institution was on the right path. And, the Fed wants four of Wells Fargo’s board members out by the end of 2018.
This post is focused on the subject of the Fed investigation, but it’s worth noting that the Office of the Comptroller with the Bureau of Consumer Financial Protection just fined Wells Fargo $1 billion for an unrelated scandal concerning Wells Fargo auto loans and mortgage credit rate extensions.
Where Were the Independent Directors?
In the middle of this scandal is the board of directors at Wells Fargo.
When the scandal broke, the Office of the Comptroller of the Currency (OCC) launched an investigation. According to CNN Money, the OCC investigation report revealed that the board was informed as early as 2005 that “most of the bank’s internal ethics hotline complaints and firings were linked to sales violations.”
However, apparently the OCC itself had received something like 700 whistleblower complaints as early as 2010, but never informed the board of Wells Fargo.
The Wells Fargo board also launched its own independent investigation. The investigative report “pinned most of the blame on senior management, it also found that Wells Fargo directors should have moved faster to fix the flawed ‘decentralized structure’ that allowed for the scandal to fester largely unchecked at the sprawling bank,” according to a CNN report (linked to above).
The board’s independent investigative report also noted, according to CNN, that “Wells Fargo’s directors were not alerted by management until 2014 that the sales practice issues were a ‘noteworthy’ risk. But the report also concluded that Wells Fargo’s directors should have pushed immediately for ‘more detailed and concrete plans’ to fix the problem and have been more aggressive about holding Tolstedt accountable.”
In its letter to lead director Sanger (linked to at the intro of this article), the Federal Reserve was unsparing in its criticism, first by highlighting a lead director’s responsibility (emphasis added):
The Federal Reserve Board is issuing this letter to you with respect to your tenure as lead independent director of the board of directors of Wells Fargo & Company (WFC) from 2012 to 2016. As lead independent director, you had a responsibility to lead other non-executive directors in forming and providing an independent view of the state of the firm and its management.
Then, the criticism turned towards the responsibility of a lead director to obtain the right information (emphasis added):
To fulfill that role, you needed to have sufficient information from firm management to understand and assess problems at the firm. This would require robust inquiry and demand for further information about the serious compliance problems that were occurring at the firm … you did not appear to lead the independent directors in pressing firm management for more information …
Finally, the Fed turned towards Mr. Sanger’s duty to serve as a check on management (emphasis added):
A lead independent director is appointed to serve the interests of the firm and, to that end, provide an alternative view of, and (when necessary) check on, executive directors of the board and the management of the firm. Your performance in that role is an example of ineffective oversight …
As an aside, in 2017, proxy advisory firm ISS recommended shareholders vote no on 12 of the 15 members of the Wells Fargo board. Surprisingly, despite the scandal, all 15 board members were re-elected (though by the skin of their teeth).
What’s the Takeaway for Public Company Board Members?
It’s true that independent directors rarely face personal liability as a result of corporate scandals. However, in the case of Wells Fargo, personal financial liability may have been more comfortable than the public shaming that some of the bank’s top executives and its lead director faced.
The Wells Fargo scandal illustrates how high the stakes can be when it comes to the oversight of a company by board members and executives.
This can be difficult—no doubt. The things that went wrong at Wells Fargo involved one of many functional areas of a large corporation. According to Mr. Stumpf, the fraud only involved 1 percent of Wells Fargo employees.
This leads to a concerning question: For directors to do their job well, do they need to be aware of happenings at all levels of a corporation?
In the case of Wells Fargo, it was sales targets and compensation plans at the level of individual bank branches that drove much of the fraudulent behavior; it’s not obvious (or at least it wasn’t before the Wells Fargo scandal) that a board would consider the compensation plans of employees at the level of a bank branch to be within their direct purview.
In striking the right balance of operating at the director level but still knowing what’s going on in management, public company directors first need to be aware of what their regulators expect.
Also relevant is the extent to which a company’s business directly impacts consumers, especially in what consumers would typically regard as a relationship of trust (read: Wells Fargo wasn’t just selling widgets to faceless companies).
In some cases, this might mean that, in the face of signs that something may be wrong, independent directors—particularly of highly regulated and highly visible companies—will need to get much closer to the company’s day-to-day business than directors typically do in their normal oversight role.
At first this level of being “in the weeds” may feel uncomfortable to some directors. However, most directors will quickly realize that, in the face of strange signals and management resistance to providing clear answers to pressing questions (especially related to compliance issues), directors have a duty to ensure that management is operating within the four corners of the law.