Wells Fargo Fake Accounts Investigation Whitewashes Glaring Risk Management Failures

Sherman & Sterling, engaged by Wells Fargo’s board to investigate its “fake accounts” scandal, issued a 113 page report which includes more ugly details about the California bank’s abusive sales practices. In connection with the release of this document, Wells announced that it was clawing back $28 million more from former CEO John Stumpf, who had already voluntarily given up $41 million, and $47 million from the former head of the community bank, Carrie Tolstedt.

The chairman of the board was also making the media rounds trying to persuade skeptical newscasters that having Stumpf retain 3/4 of the pay he’d earned when the abuses were underway (they now are acknowledged to have been visible as early as 2002) was adequate.

The New York Times depicted the report as “scathing”. In fact, it is a carefully crafted document to dump all responsibility on Stumpf and Toldstedt, both of whom clearly are culpable, and shield the board and the new CEO. Anyone who knows much about banking will see clear footprints that the board ignored basic risk management failures and poor governance structures. Ironically, the only part of the cover-up that might be plausible is that the new CEO, Tim Sloan, as having been head of a completely unrelated business until he was elevated to Chief Operating Office in 2015, does appear to have been organizationally removed enough to be blameless. He also appears to have tried taking action against Tolstedt fairly quickly given how loyal Stumpf was to her (as in Sloan would have been forced to proceed carefully).

First, we’ll go through how Sherman & Sterling covered up for the board. Then we’ll discuss other issues, such as what the new developments say regarding legal liability and the possibility of prosecution.

The Coverup

Effort to hide fundamental risk management failure in plain sight. The report describes the glaring risk management failures we had mentioned before, ones that were obvious, and others our retail banking/IT expert Clive had correctly identified were in play. But the report tries to normalize them as being unfortunate features of how Wells did business that worked out badly rather than glaringly obvious control failures where not only top executives but ultimately the Board is responsible.

Even worse, the report proves the board’s negligence by indicating it had noticed a major deficiency, that control functions were reporting to unit/profit center managers like Tolstedt, in 2013, yet was leisurely about addressing it. Keep in mind that is exactly the same kind of deficient structure that led to the JP Morgan London Whale scandal. It is a basic risk management failure to have control staff report to profit center managers. In fact, they are designed to be for show only. Does anyone with an operating brain cell think someone would make their boss look bad?

Even though there were corporate level control staff too, the report makes clear that corporate control functions were “culture of substantial deference” to the business line managers like Tolstedt. Translation: they were toothless. Get a load of this:

As events were unfolding, his [the Chief Risk Officer’s] visibility into risk issues at the Community Bank was hampered by his dependence on its group risk officer and he was essentially confined to attempting to cajole and persuade Tolstedt and the Community Bank to be more responsive to sales practice-related risks.

Yet a plan to fix it was still incomplete as of 2016…worse, even after the Los Angeles Times first reported on the fake account abuses in 2013. From the report:

The Risk Committee of the Board, consisting of the chairs of all the Board’s
standing committees, was created in 2011 to oversee risk across the enterprise. This involved a multi-year plan starting in 2013 to substantially grow Corporate Risk, to move toward centralization of more risk functions and to enhance Corporate Risk’s ability to oversee the management of risk in the lines of business. Consistent with this plan, the Board supported major funding increases for Corporate Risk for 2014-2016. But, as problems with sales practices in the Community Bank became more apparent in 2013-2015, Corporate Risk was still a work in progress and the Chief Risk Officer had limited authority with respect to the Community Bank.

Note that the report points to something even worse than simply limited scope of the Chief Risk Officer (as well, as the report points out, of the legal department and human resources). Despite being corporate level functions, as in theoretically senior to business units, they were also de facto subordinate. This is not uncommon in unregulated business, but even so, the norm there should be that the control function, particularly the legal department, can escalate matters to the CEO and board. Here, it doesn’t simply appear that that was not a viable option due to Tolstedt’s tight personal relationship with Stupf. It appears that this could never have happened with any business unit. That means supervision across the bank was fundamentally defective. Deficiencies of that magnitude mean not only was the CEO asleep at the wheel or an active enabler. The board was culpable too.

No mention of clearly deficient financial controls. Regular readers will remember how FTI Consulting helped CalPERS perpetrate a sham investigation of private equity compliance because the questions FTI was asked to investigate could not be answered with the methodology they employed. Even with private equity being fabulously secretive, we were still able to find significant errors in FTI’s report.

Here, we have FTI apparently not digging deep enough, again by design, as well as the report failing to mention that a big chunk of the work was to compensate for the absence of basic financial controls. From the report:

The firm analyzed various metrics to assist in determining the impact of the Community Bank’s sales culture. First, it examined Wells Fargo’s investigations data for allegations of sales integrity violations and associated terminations and resignations. And second, it analyzed information relating to the rate at which the Community Bank’s customers were funding — that is, making initial deposits into — new checking and savings accounts. While there can be many reasons a customer might not fund an account, lower funding rates (the proportion of new accounts with more than de minimis deposits) suggest that some customers were sold accounts that they may not have wanted or needed. …

The pressure associated with the campaign manifested itself in higher rates of low quality accounts, as confirmed by the “Rolling Funding Rate,” a quality metric used by the Community Bank to track the rate at which its customers “fund” (place more than a de minimis amount into) new checking or savings accounts.

And this was in a footnote:

To determine whether these trends in Los Angeles were affected by simulated funding — the phenomenon in which bankers used customer funds from one account to surreptitiously fund another account, identified in Wells Fargo’s settlement with the CFPB on September 8, 2016 — FTI Consulting conducted an analysis backing out all potentially simulated funding accounts identified by Wells Fargo’s consultant, PricewaterhouseCoopers.

What were the corporate risk officers doing? This section makes clear that metrics that should have been reviewed on a corporate wide basis were instead not merely prepared by Tolstedt’s unit but not shared with anyone at the corporate level. This is utterly inexcusable.

As Clive pointed out earlier:

Opening up fake products to claim a sale is a trick which goes back to when a TBTF tried to sell Noah Ark insurance. When I started in retail at a TBTF nearly 30 years ago, senior management (as a minimum the VP or equivalent in charge of a geographical area) would get reporting from the internal compliance or risk function about the number of accounts opened which had low turnover. A low turnover account is a serious red flag for either mis-selling or even (as was the case that has been exposed at Wells’) the salesforce boosting their figures by robo-applications….

Of course, it all comes out in the wash eventually — the customer didn’t want the product in the first place and if they didn’t want it, they almost certainly won’t use it. This will result in a low (or no) activity account.

Simplistic attempts are generally made in the bank’s operations to prevent this kind of sales practice. The most common is that if within in a certain timeframe (a month or 6 weeks is usual) there hasn’t been a transaction on the account or the card hasn’t been activated, the account will be closed and this low activity account sale will be clawed back from the salesforce. But of course, this is widely known in the bank employees, so the standard ruse is to diarise a follow-up customer service call, tell the customer some cock-and-bull story about how the bank employee has noticed a potential security issue with one of their cards and could they phone the security team just to confirm the card is still in their possession. Or another variation is to tell the customer If they want to call into the branch, they can sort the “problem” out, while in the branch they get the customer to phone the activation line, then “check” everything is okay by doing a cash advance at the counter on the card (they’ll even refund the fee, how kind!).

These are just some tricks, readers can get the gist of how it works and probably even think of their own alternatives.

But there’s still a trail of evidence which the bank should be following — accounts which are very light in transactions after 6 months or dormant in a year. These are always investigated, not for the customer’s benefit but because it costs the bank money to maintain the account. They are invariably force-closed due to low activity (this will be in the product’s standard Terms and Conditions, to give the bank the ability to do this). This management information is collated and picked over endlessly by the P&L accountants. Too many customers attracted to the brand, sold product to, but who then walk away are value-destructive. Senior management (one part of the senior management team, anyway) are all over this metric like a rash.

Not at Wells, needless to say.

We skipped over FTI’s overly cursory personnel review. FTI was tasked to look into “Wells Fargo’s investigations data for allegations of sales integrity violations and associated terminations and resignations.” In other words, all FTI did was review Wells’ data. Notice this also:

Shearman & Sterling has conducted 100 interviews of current and former employees, members of Wells Fargo’s Board of Directors and other relevant parties. Shearman & Sterling’s interviews focused primarily on senior members of management across all of the areas that had significant contact with sales practice issues. In addition, Shearman & Sterling reviewed the product of hundreds of interviews of more junior employees conducted by or on behalf of Wells Fargo. Shearman & Sterling also reviewed information concerning more than 1,000 investigations of lower level employees terminated for sales integrity violations, which Wells Fargo’s Internal Investigations group conducted.

This is inadequate to get at the question of to what degree these “sales integrity violations” were actually trumped up to punish employees who refused to engage in aggressive sales practices, or as others allege, they were terminated on thin and unrelated grounds when they started complaining. Interviews by Wells Fargo are worthless for lack of confidentiality; even ones conducted by third parties are suspect by virtue of how keen Stumpf was to blame the fake accounts scandal on low-level workers.

And other experts were not impressed either. From the Financial Times:

Dennis Kelleher, chief executive of the advocacy group Better Markets, said that Wells directors had failed to take responsibility. He called on shareholders to vote against all of them at the bank’s annual meeting this month. 

“Consistent with their past too-little, too-late cosmetic actions, blaming and punishing two previously fired executives are little more than standard moves in a PR playbook,” Mr Kelleher said. 

Can We Hope for Criminal Prosecutions and Other Issues

The Wells board and Stumpf thought penny-ante stealing was not stealing. The fact that the total hard dollar customer losses were small despite the brazenness and scale of the fraud was the big reason the former CEO thought he could brazen this out. And given that sanctimonious Wells had taken vastly more from customers via foreclosure abuses, this lackadasical might have otherwise seem reasonable. After all, the traditional check on this kind of nickel and dime grifting, class action lawsuits, have become almost as rare as the dodo bird thanks to the successful efforts of Corporate America to cut them back.

Several prosecutors are supposedly still looking into further action. The most promising legal theory would appear to be Sarbanes Oxley. False certifications of the integrity of controls, which are made by at a minimum the CEO and CFO, which would include the adequacy of risk management, are Sarbox violations. And Sarbanes Oxley is designed to allow prosecutors to readily turn civil charges into criminal ones if discovery turns up solid evidence of severe misconduct. But no one has every use Sarbox, so this idea seems remote.

Another wee problem is that the Department of Justice under Jeff Sessions is likely to sit this one out. But the Los Angeles City prosecutor was the one that developed this case and got $35 million of the original $180 million settlement, so they seem the most likely to try to take this sordid matter further.

Another source of more legal shoes dropping is whistleblower retaliation claims and other types of wrongful termination suits. Enough employees could be affected to add up to more serious payouts, and even more important, continued media focus on Wells’ bad conduct.

Wells is not out of the woods, but sadly it is more likely to suffer the drip drip drip of individual cases than a prosecution or even a nice juicy civil suit against Stumpf or board members derelict in their duties. And I would be delighted to be proven wrong.

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  1. Larry

    Financial crimes are not crimes, they’re misunderstandings or mistakes. Because of course our better classes cannot possibly go to jail for conduct that would put the average citizen in jail for years. Honestly, my non-profit pre- and post- school cooperative daycare had a director that over the course of 7 years embezzled about $250k out of the organization. She’s going to jail for between 3-7 years and ordered to pay back what she can (not much) over time. But run a bank as if it’s a mob shake down organization and you get some of your millions clawed back and still retire in greater comfort than most of the rest of the world.

  2. shinola

    If I read it correctly, Stumpf has had $69 million clawed back but retained 3/4 of the compensation he made while the scam was ongoing. So, he “only” made $207m. while heading up a criminal operation…

    The word that keeps popping into my head is “obscene”.

    1. Yves Smith Post author

      The figure is based on a CNBC interview, which I trust is accurate. I haven’t independently tried to verify it. I rechecked just now and the reporter said Stumpf kept 76% of his pay over the last 6 years. If you instead view the scandal as starting between 2002 and 2004, he retained an even higher percentage of his total comp.

  3. Kokuanani

    On initially reading the headline, I didn’t know if “fake” described the accounts, or the “investigation” into those accounts.

    Looks like both. :-)

  4. jfleni

    Clawbacks are OK, but something like paying a speeding ticket at a huge discount; where are the perp-walks and heavy fines for the big criminal wheels of Wells-f***off?

    Nowhere, because our betters (please use the royal ‘we’!) cannot be even slightly inconvenienced.

  5. Toshiro_Mifune

    I am not a lawyer, but….. Shouldn’t this really be investigated for violations of the RICO Act with a look to charge large swathes of the C level and board who approved it since they profited from it?
    I know that wont happen, but isn’t that what should be happening?

    1. JTMcPhee

      Maybe some enterprising attorney, who does not fear personal and professional death, might be persuaded to bring a civil RICO action on behalf of all the people WF has defrauded. Here’s a nice primer for the cause of action, http://www.lanzasmith.com/RICO-page/index.html. I have no relation to or interest in the law firm that created that link. And if one searches for “civil RICO attorneys,” you get lots of hits.

      The son of a long time acquaintance, who works for a large international environmental and anti-corporation organization, is a named defendant in a SLAPP suit, http://www.dmlp.org/legal-guide/responding-strategic-lawsuits-against-public-participation-slapps, brought by an “energy company.” Fortunately, the organization is able to fund the defense and the prosecution of counterclaims.

      The (snort) Justice Department (smirk) has its own hornbook, emphasizing the manifest “difficulties,” largely of bureaucratic creation and evidencing those hidden politics that govern such things, of undertaking such an action if it’s to be done by the government, at least… https://www.justice.gov/sites/default/files/usam/legacy/2014/10/17/civrico.pdf

      Sort the wheat from the chaff, and burn the chaff… It says that in the Bible somewhere, doesn’t it?

    2. Yves Smith Post author

      Over my pay grade, but I understand RICO is rarely used because it has tougher requirements (evidentiary? not sure) than many other legal theories of action.

      1. JTMcPhee

        Yes, hard cases to make. That’s what one can find in the linked primer and the DoJ manual. Here’s another fairly short laydown of what it takes to make a civil RICO claim fly: http://www.lectlaw.com/files/lit08.htm

        As with so much of what is supposed to be the “rule of law,” under statutes that our Overlords and their lobbyists have had so strong a hand in drafting, and gutting, and under court rules that likewise grow out of whining by the white-shoe specialists in corporate defense, the deck is stacked heavily against the poor mope with limited or no resources. At least contingency=fee arrangements, for lawyers willing and able to front the costs (often from prior litigation-lottery recoveries), are not yet outlawed, though that’s under pressure too. And of course mandatory arbitration, without recourse to judicial remedies (though so many judges are in their robes thanks to “connections” and in on the game), because “fine print contract terms” in adhesion contracts say so.

        The Fokkers leave what in aviation is called a “sucker hole,” a small gap in the otherwise totally obscuring undercast, that non-instrument-capable pilots, incautious enough to get caught above a thick cloud deck, will dive towards and into, after seeing a flash of the ground beneath, hoping they can circle down to a safe landing through the open patch that so often closes out beneath them, leaving them disoriented and in the fog and in a spiral dive into terrain. So that us folks, up in the air, running out of fuel, have at least a fleeting sensation that we can “recover.”

        Here’s a few cases where settlements were forced. Judgments and treble damages plus attorney fees are rarer: https://www.lawyersandsettlements.com/search.html?keywords=racketeer

  6. justanotherprogressive

    “Sherman & Sterling, engaged by Wells Fargo’s board to investigate its “fake accounts” scandal, issued a 113 page report which includes more ugly details about the California bank’s abusive sales practices. In connection with the release of this document, Wells announced that it was clawing back $28 million more from former CEO John Stumpf, who had already voluntarily given up $41 million, and $47 million from the former head of the community bank, Carrie Tolstedt. ”

    Well, since Sherman &Sterling were engaged by Wells Fargo’s board (i.e, engaging the fox to investigate the security at the henhouse), I’m surprised that the report is as comprehensive as it it……
    Where is the federal investigation? Or should I not ask that question……

  7. Sluggeaux

    The corruption of prosecutors offices by political money, from the U.S. DOJ on down to the local level, is why this sort of bad behavior will continue. A tax system that our corrupt Congress has designed to facilitate obscene accumulations of wealth is at the heart of the problem.

  8. Tim

    In my experience the ground shifted in the early 00’s with the implementation of huge overdraft charges and an effort by the banks to get people to overdraw their accounts by hook or crook. It took me a while to understand why banks changed from bouncing checks and disallowing withdrawals in excess of funds available. Screwing people became the name of the game and from then on banks became as sleazy as used car lots.

    I had a checking and savings account at Bank of America for many years where the savings would automatically replenish the checking account to cover checks. One day I noticed that the bank had opened a “personal line of credit” for me without permission or notice. At the same time, they stopped transferring funds from my savings account to checking and instead charged me an overdraft fee and drew down my new personal line of credit to the extent my checks exceeded the checking account balance.

    I must have called a dozen times to reinstate the prior arrangement and cancel the line of credit and on each call I was told the bank would do so which, of course, it never did. I finally withdrew all funds and tried to close the accounts – again unsuccessfully – and opened up accounts at a local bank. Better for a while but the sleaze eventually filtered down through the tech providers they all use.

    There was nothing new at Wells Fargo. They just remained more brazen after the financial crisis because they managed to appear less sullied than the other big banks. It’s a business full of sleazy unprincipled people who dress and pretend to be otherwise.

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