When you buy a shirt and the shopkeeper tries to sell you a necktie, that's cross-selling. When you pick up your to-eat-at-the-desk sandwich and the guy at the register persuades you that you need some potato chips, that's cross-selling. When thousands of Wells Fargo employees respond to pressure and the bonus system by opening two million deposit and credit-card accounts for customers without telling them, or in fictitious names, that's fraud. When the practice continues for at least five years with the knowledge of the CEO, it calls into question whether the America's largest bank by market capitalization, our number-one mortgage issuer, number-one auto and small business lender, second largest debit-card issuer, and third largest bank by assets is merely managed by incompetents, or is simply too big to manage.
All of this occurred under the nose of one Carrie Tolstedt, the executive responsible for the Wells Fargo's 6,000 branches. Tolstedt, known as "the watchmaker" because of her obsessive attention to detail, "retired" from her supervisory role in July, to use the euphemism favored in the industry, but will remain with the bank until year-end. At the time of her retirement announcement, the bank was discussing its cross-selling practices with regulators. Unlike the 5,300 Wells employees who have been fired, sans severance, and are probably in dire financial straits, Ms. Tolstedt, who has been awarded some $20 million in annual bonuses from 2010-to-2015 according to Richard Selby, chairman of the Senate Banking Committee, in part because of the earnings growth from fraudulent cross-selling, will return to her native Nebraska with a goodbye gift of $125 million in stock options. CEO John Stumpf called her a "standard-bearer of our culture, a champion for our customers, and a role model for responsible, principled and inclusive leadership."
That was before the scandal broke, and Wells paid a $185 million fine. Last week, Stumpf appeared before the inevitable congressional inquiry and did himself no favors. He said he regrets all of this, takes responsibility, but gave no indication that he plans to return the bonuses he received when Wells Fargo shares soared in response to the high level of reported earnings. That, he said, is up to the bank's board, chaired by, er, John Stumpf. He denied that cross-selling was all about raising the bank's share price, only to be confronted with his repeated statements to Wall Street analysts citing the success of cross-selling as a reason for the high share price.
Asked how much his own shares had risen in value during the period of phantom cross-selling, Stumpf ducked, saying that is publicly available information. And so it was, enabling Massachusetts Democratic senator and bank-basher Elizabeth Warren to compute that his 6.75 million shares had increased in value by $30 per share, for a total take of "more than $200 million in gains, all for you personally". Stumpf could not address some questions because he claimed at various points that he is not a lawyer, not a compensation expert able to comment on the bank's bonus scheme, not a credit consultant able to comment on the effect of unrequested credit cards on the credit rating and the interest rates Wells' customers have had to pay. Nevertheless, surely well worth his 2015 compensation of $19.3 million, third only to Jamie Dimon at JPMorgan Chase ($27 million), and Lloyd Blankfein at Goldman Sachs ($23 million).
Congressional inquisitors were driven to the conclusion that Stumpf was either complicit in this scam, which he neglected to report to the board for at least a year after he discovered it, or incompetent to supervise a bank of Wells' size. Senator Warren told Stumpf, "you should resign… and you should be criminally investigated…. It's gutless leadership." A far cry from 2013 when four events coincided. Stumpf was named Banker of the Year by the American Banker; he became America's highest paid banker; he took leadership of the charge against regulations that "have gone too far"; and sham cross-selling reached its peak. Now, Stumpf's future tenure is likely in the hands of Warren Buffett, whose Berkshire Hathaway is the bank's largest shareholder, with a $20 billion, 10 percent stake in the bank. Buffett, not usually shy of publicity, says he won't comment on this or anything else until after the presidential elections "because it will lead down too many paths."
Enter Larry Summers with a study prepared long before the Wells scandal cast doubt on the ability of humans to manage big banks, even one that does not deal in the complex financial instruments sold by its big-bank brethren, Goldman Sachs and JPMorgan Chase. Summers and his Harvard colleague, Natasha Sarin, say in a paper presented last Thursday, "We find that financial market information provides little support for the view that major institutions are significantly safer than they were before the crisis and some support for the notion that risks have actually increased." It seems that increased regulation, and the prospect of still more to come, have driven down the value of bank shares, requiring banks to raise more capital—the "unmet challenge in financial regulation and supervision".
If Summers and Sarin are right, more regulation might not prevent Wells-style shenanigans. Three steps might. The first would be reform of the existing rules of corporate governance just might. Those rules produced a management team insensitive to consumers' interests, and to the political perils of responding to a crisis by firing $12-per-hour employees for conduct that earned multi-million bonuses for their bosses, just might
Currently accepted corporate governance standards permit Mr. Stumpf to be both chairman and CEO of Wells Fargo. The chairman is supposed to see to it that the CEO and other employees of Wells Fargo operate in the long-term interests of shareholders. Chairman Stumpf seems satisfied that CEO Stumpf did just that. Faced with a shareholder request to separate the two functions, the board responded, that it has sufficient oversight of the chairman, and that the proposal "would unnecessarily restrict the board's ability" to select the best chairman candidate. Only Stumpf would do.
Current rules also require the board committee responsible for making certain that customers are fairly treated to meet just three times each year. Even after an article in the Los Angeles Times in 2013 prompted the City Attorney's office and the Consumer Financial Protection Board to begin their investigations, the committee held to the minimal schedule. Its chair resigned earlier this year.
Failing reform of corporate governance, a second solution might be that being offered by Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. A Republican who served as a top Treasury official overseeing the bank bailouts that followed the financial crisis, Kashkari says we have not solved the "too big to fail" problem, and should consider "breaking up large banks into smaller, less connected, less important entities …. The time has come to move past parochial interests." It won't take more than a misstep by some other bank, and a Stumpf-like performance by a heavily bonused chairman/CEO, for Mr. Kashkari to get the attention his proposal merits.
Finally, criminal prosecution of the top executives might serve as a deterrent to others. In most cases such prosecutions are difficult to mount successfully: too many layers of bureaucracy between the "rogue" employees and the top brass, the financial machinations too complex to explain to a jury. But the Wells Fargo case involves 5,300 employees, not a rogue or two. The driver of the fraud was the system, not the greed of some one or two individuals. Top management knew of the frauds but did not sufficiently revise the system that was driving it: Even now, elimination of sales goals for retail bankers will not occur until next year, according to New York Times analyst James B. Stewart.
And forging signatures, opening accounts of which customers are unaware, charging them for services they did not request, damaging their credit ratings are the sorts of things juries can understand. It is more than likely that such juries would sympathize with the cheated customers. Indeed, it might be difficult to find the requisite number of impartial jurors who bear no animus towards bankers.
The Justice Department has had little success in pursuing top executives until now. Which is increasing the pressure on it to demonstrate that this time is different, that the little fish have already been penalized with job losses, and that it is time to fry bigger fish—and not just a loner like the London Whale.