Tone at the Bottom: Governance Lessons from Wells Fargo
That was the advertised title for the program co-sponsored by the Rock Center for Corporate Governance and the Silicon Valley Directors Exchange. (Sign up to be on the SVDX mailing list.) After the program, I am still not convinced the real governance lesson from Wells Fargo (ticker: WFC) is not more about lack of oversight from the top, rather than the tone at the bottom.
It was another great panel of corporate governance, legal, and public relations experts for the deep dive into what went wrong. As usual, it was Chatham House Rule, so I’m mostly providing a little more background and some commentary on the presentations. I am sure others drew different conclusions than I did. The panel focused on issues ranging from public disclosure requirements, whistleblower policies and mechanics, compensation policies (including the board’s use of claw-back provisions), company policies regulating employee conduct, and the negative publicity suffered by the bank. Here were some of the advertised questions:
What happens when you have a well-meaning and talented board and a CEO who was regarded within the industry as one of the best managers with a stellar reputation? Was it inevitable that the CEO would be forced to step down by an outraged Congress and populist sentiment? What governance lessons from Wells Fargo are applicable to the non-banking industry, with special attention to Silicon Valley-based tech companies?
Governance Lessons from Wells Fargo: The Panel
From the promised program:
Adjunct Lecturer in Law
Santa Clara University Law School
Gordon Yamate serves on the boards of a number of cultural philanthropic organizations. As a former general counsel of two Silicon Valley-based public companies, he teaches a seminar level corporate governance course at Santa Clara University Law School that bridges ongoing legal developments with practical strategies for management and boards in critical and challenging governance matters.
Executive Vice President and Co-Founder
G.F. Bunting & Co.
Dave is a skilled strategist and writer with a large number of contacts in the media world. He has worked closely with technology, investment, land development and hospitality clients, in addition to providing strategic guidance on reputation management and media outreach. With both journalism and newspaper management experience, Dave is an experienced advisor to our corporate clients. He has worked on executive transitions, layoff planning and thorny personnel matters. Like his colleagues at G.F.BUNTING+CO, Dave works closely with in-house and outside attorneys on litigation and other legal matters. Dave is a 27-year veteran of the news industry. He served as managing editor of the San Jose Mercury News from 2003 to 2008. He joined the Mercury News as business editor in 2001 at the height of the Internet technology boom. Previously, he was a reporter and editor for 17 years at the Miami Herald, where he participated in two projects that won Pulitzer Prizes.
He is a graduate of the University of Notre Dame and has an MA in journalism from Northwestern University. Prior to G.F.BUNTING+CO., Dave worked as the Silicon Valley-based executive for a Los Angeles crisis communications firm.
Researcher, Corporate Governance Research Initiative
Stanford Graduate School of Business
Brian’s work focuses primarily on corporate governance, although he has also written cases in the areas of financial accounting, human resource management, operations, and strategy. He has co-authored two books, Corporate Governance Matters and A Real Look at Real World Corporate Governance, in collaboration with Professor David F. Larcker.
Former CEO and Executive Chairman
Director, Costco Wholesale Corporation, DreamWorks Animation, Hewlett Packard Enterprise, and Juno Therapeutics, Inc.
Maggie Wilderotter was Chief Executive Officer of Frontier Communications from November 2004 to April 2015, and then Executive Chairman of the company until April, 2016. During her tenure with Frontier, the company grew from a regional telephone company with customer revenues of less than $1 billion to a national broadband, voice and video provider with operations in 29 states and annualized revenues in excess of $10 billion.
Mrs. Wilderotter is a member of the Board of Directors of The Conference Board; a member of the Executive Committee of the Catalyst Board of Directors; a member of the Board of Women in America; and a member of the Business Council and the Committee of 200. In 2014, she chaired the Blue Ribbon Committee on Board Strategy for NACD and is a member of WomenCorporateDirectors (WCD).
Governance Lessons from Wells Fargo: Background
“People invariably will do what you pay them to do even when you’re saying something different.” …American Banker called Wells Fargo “the big bank least tarnished by the scandals and reputational crises.”
The company’s operating philosophy includes the following elements:
- Vision and values.
- Conservative, stable management.
In 2013, rumors circulated that Wells Fargo employees in Southern California were engaging in aggressive tactics to meet their daily cross-selling targets. According to the Los Angeles Times, approximately 30 employees were fired for opening new accounts and issuing debit or credit cards without customer knowledge, in some cases by forging signatures… Branch employees were provided financial incentive to meet cross-sell and customer service targets, with personal bankers receiving bonuses up to 15 to 20 percent of their salary and tellers receiving up to 3 percent…
The company maintained an ethics program to instruct bank employees on spotting and addressing conflicts of interest. It also maintained a whistleblower hotline to notify senior management of violations…
In September 2016, Wells Fargo announced that it would pay $185 million to settle a lawsuit filed by regulators and the city and county of Los Angeles, admitting that employees had opened as many as 2 million accounts without customer authorization over a five-year period…
Of the 2 million potentially unauthorized accounts, only 115,000 incurred fees; those fees totaled $2.6 million, or an average of $25 per account, which the bank had refunded…
Stumpf resigned without explanation. He received no severance and reiterated a commitment not to sell shares during the investigation. The company announced that it would separate the chairman and CEO roles…
Customer visits to branches declined 10 percent year-over-year in the month following the scandal. Credit card and debit card applications also fell.
The Panel Discussion
SEC concern: was there adequate disclosure on a timely basis? Sept 8th they announced a settlement with regulatory agencies of $185M. Review by 3rd party going back to 2011. Refunded $2.6M to customers. They disciplined and terminated employees but didn’t disclose how many.
It appears the Board primarily wanted to avoid reputational damage.
Summary of some of the facts (I have not been following case and type too slowly to get them all down). Wells Fargo had five primary values:
- People as a competitive Advantage
- What’s right for customers
- Diversity and inclusion
They were not living the values all the way though the organization. Incentive structure – how did that impact? Senior executives did not have cross-selling metric in their own compensation plan… although other statements lead me to believe the positive results from cross-selling did cascade into executive pay because some monies were clawed back.
Wells Fargo clawed back executive pay related to cross-selling incentives. John Stump resigned. The board split the chair and CEO positions. It was a very messy data situation. Accounts are opening and closing all the time. Only 115,000 out of 2M accounts incurred fees. That is important from a trust standpoint but not from a financial standpoint. Senate testimony was prepared.
Senate accusations included: You’re putting pressure on your employees. Not paying them enough. Firing them for buckling under pressure. Firing 5,000 people turned out to be bad when Senator Warren wanted one person fired.
Governance lessons from Wells Fargo include the fact that companies and boards need to look at their process first, before looking at the people. This is especially true in this case given the problems around abuse of cross-selling were so widespread. Unfortunately, the Company assumed it was the people, not the process. In 2013 they should have investigated the process and change them.
JPMorgan’s London Whale debacle provided an example to Wells Fargo to see what happens. (Although many believe that problem was handled well, new information continues to surface (See ‘London Whale’ Breaks Silence. In the opinion of most observers, Dimon got ahead of it, in part, by being active with the media. He apparently called Stump and offered advice.
Our panelists appear to believe splitting chair and CEO was smart to do at this time. It gives new CEO more time and leeway in learning the new job.
Another of the governance lessons from Wells Fargo: There are real differences between the executive officer and board perspectives. Boards should not just overlook quantitative issues because they impact only 1% of customer. Banks need to be trusted advisors. Reputation was paramount. As the crisis developed, Wells Fargo apparently had almost 50 law firms representing them. They first thought it would be business as usual. The chief officers and some board members had been there for decades. Instead of challenging each other, they were supporting each other. Trust but verify.
Its what you do when you discover a problem that makes the difference. Wells Fargo’s situation snowballed after Stump’s appearance in Washington. We don’t know when the board foundnd out.
No one on the board stood solidly with Stump. They seem to have fired Stump before the facts were known. The board reacted to a firestorm. If Stump was retiring in a year, perhaps he was a sacrificial lamb.
Pay incentives should have been for the right behaviors. The customer needs to want the product. Wells Fargo could have built in validation that customers were consciously accepting an upgrade or cross-selling. Was it a board tenure problem? The board did include people with financial backgrounds. The problems seem to stem more from a poor process.
Another of the governance lessons from Wells Fargo, Jamie Dimon had relationships with members of the Senate Banking Committee – John Stump did not.
The clawback terms at Wells Fargo were broad and were enabled by a policy that deferred a lot of pay until retirement. They typically get a large payout upon leaving. At Wells, they clawed back before the independent investigation completed. CEOs and boards have to be active in employee engagement. They must be plugged into a network so they employees tell you the truth. You must visit them, not have them always come to you.
Watch a video clip, shot after the event with the moderator and two panelists.
CorpGov.net: As a former ethics officer, I used to get frequent whistle-blowing reports, which I would bring to the attention of our executive staff. (I worked for a government agency without a board.) There is no way the Wells Fargo board would not have known of the problem unless basic systems were not in place. Apparently, the SEC will be focusing on this in further investigations. Although the title of the program seems to imply the tone at the bottom was problematic, to me it seems it came from the top. They set or approved the incentive and reporting systems.
Lisa Servon offers some more consumer-friendly observations Wells Fargo could adopt in chapter eight of her book, The Unbanking of America: How the New Middle Class Survives.
Wells Fargo: TheCorporateCounsel.net
As I was writing this post on Governance Lessons From Wells Fargo, Broc Romanek posted the following, which I am cutting and pasting in its entirety because I think he is always among the most insightful observers.
Over on “The Accounting Onion,” Tom Sellers blogs that Wells Fargo could be the next major MD&A enforcement case for the SEC. He notes that Wells Fargo’s former CEO told Congress that the board was aware of the bank’s unauthorized account issues in 2014. Tom focuses on MD&A’s “known trends” requirement, & says that the bank ran afoul of it here:
Companies often produce lengthy MD&A disclosures from core requirements that boil down to two criteria:
– As of the time of filing, what management knows.
– Whether a transaction, event or uncertainty that management does know about had, or is reasonably likely to have, a material effect on profitability, liquidity or capital resources.
As indicated by the following from Francine McKenna’s article, the first criteria would have been met more than a year ago:
“Stumpf testified management and the board was informed of the issues in 2014. The Los Angeles City Attorney filed a lawsuit against the bank in 2015 after Los Angeles Times first published reports of the problems in 2013.” [italics supplied]
Even so, no disclosure was made in an SEC filing through the second quarter of 2016. And just in case you are wondering, the MD&A rules do not permit a company to omit required MD&A disclosures out of concern for their effect on future litigation, creating a competitive disadvantage, or resulting in a self-fulfilling prophesy.
Tom goes on to suggest that while the financial impact of the $185 million settlement itself may not have been material to Wells Fargo, the collateral damage to the bank’s reputation & business was much larger – and should have been taken into account in management’s materiality assessment.
I admit that when I first read this, I was a little skeptical about the argument – hey, I’m a petite bourgeois corporate tool, so I have my biases. Wells Fargo’s flat-footed response suggests that management viewed this situation primarily as a regulatory matter, and assessed its downside by reference to what the expected settlement with the CFPB and other regulators would be. Should they have anticipated the firestorm that followed, and factored that into the materiality assessment?
My first inclination was to say no – that kind of speculation is beyond what’s required by MD&A. I still think that’s the case in most situations. But the more I thought about it, the more troubled I became by the bank’s failure of imagination. Two million unauthorized accounts? More than 5,000 employees terminated because of this mess? Under those circumstances, was it reasonable for Wells Fargo to think that a $185 million settlement with regulators would be the end of it?
There’s still at least one aspect of the case that makes me think this isn’t really a slam dunk – we’re talking about management’s subjective opinion about the downside risk, & that means Virginia Bankshares may come into play. Wells Fargo could argue that while management’s opinion about the downside may have been wrong, it’s only actionable if management didn’t really believe it. Fait v. Regions Financial is the leading case when it comes to the applicability of Virginia Bankshares to accounting & financial judgments – and Omnicare doesn’t seem to have put much of a dent in it.
Wells Fargo: Shareholder Proposals
Of course, the scandal at Wells Fargo led to a flurry of shareholder proposals and no-action requests. “The six so-called no-action request letters filed with the SEC are the most by the bank since the agency began posting such requests in 2007.” See Wells Fargo Locks Horns With Some Shareholders Over Proxy Proposals.
Governance Lessons from Wells Fargo: The Audience
As a commercial endeavor, I know that cute pets drive clicks on the internet. Of course, to be effective, they probably should be at the top. This little Sheba Inu was so well behaved, especially for a breed known for independence, I thought he/she deserved to be included in the photos.
Maybe I will have more audience shots next time. I should be over my dog envy by then. That one is so much more dignified than our little guy on the left who hasn’t made it to any of the programs. He would probably be too much of a distraction. At least 10% of the people who see him remark, “oh how cute,” even though he is trying to look serious, trying to get me to go for a walk.