Published earlier in Oct 2016 in my earlier Blog – Ported here in Aug 2017:

As we have all read in the news recently, Wells Fargo & Co is currently embroiled in a fake accounts creation scandal. It is understood that this was a multiyear “scam” where millions of unrequested, fee-generating customer accounts were unearthed at Wells Fargo (WFC), a bank traditionally considered “old school” and “conservative”. The alleged misconduct was revealed when the Consumer Financial Protection Bureau (CFPB), the Los Angeles City Attorney and the Office of the Comptroller of the Currency (OCC) fined the bank $185 million, alleging that more than 2 million bank accounts or credit cards were opened or applied for without customers’ knowledge or permission between May 2011 and July 2015.

Consequently, a bank official acknowledged that it had terminated some 5,300 employees, roughly 1 percent of the workforce, in relation to the allegations, and the bank issued a statement saying, “We regret and take responsibility for any instances where customers may have received a product that they did not request“. Initially, despite the scandal pointing to bank’s leadership, no one in leadership position was found accountable and fired for their roles in the scam. However, after widespread outrage and Congress’s timely action including hearings and “dress down” before the House and Senate the Then-CEO John Stumpf stepped down weeks later, taking more than $130 million in compensation with him along with Carrie Tolstedt, was the head of Wells Fargo’s community banking division.

This scandal is another instance of short term expediency bordering on greed, circumventing established internal controls, as in previous banking crises in advanced economies, and may be attributed to the following reasons:

1. Unrealistic Financial Targets / Incentives: We understand that Wells Fargo placed unrealistic Financial Targets in the form of very high number of accounts to be opened by each of their employees on behalf of their customers. This was revealed in a “class action” lawsuit filed by a few of their ex-employees  who worked for the bank during the last 10 years and who, as the suit alleges, were “either demoted, forced to resign, or terminated,” for not meeting “impossible” quotas the bank set as goals for employees to open accounts on behalf of customers. This resulted in employees opening unrequested, fee-generating customer accounts to meet their “quotas”.
2. Use of Arbitration primarily for dispute resolution: We believe that the Financial Industry’s established practice to use Arbitration to resolve disputes with Customers concealed the true nature and magnitude of this problem of fake accounts. Consequently, Arbitration, mandated in some if not all basic agreements that customers sign when they open accounts at the bank, helped hide this fraudulent schemes from the Justice system, News media, and the general public.
3. Executive Compensation: After the global financial crisis of 2008, Government Regulations (rightly) prevented them from engaging in participating in high risk activities like sub-prime mortgages etc. which had “high reward” potential and consequently higher executive compensation. However, since these avenues were not available, fee-generating customer accounts were seen as an alternative to generate higher profitability, and the bank decided to focus on this area of business. Consequently, aggressive targets were handed down the “chain of command” in order to generate higher profits and greater executive stock-based and other compensation. Hence, we submit that Executive Compensation tied to fee-generating customer accounts contributed to this scandal.

This scandal has presented us with a number of lessons to be learned and we believe that some of the steps to prevent future scandals of this nature are as follows”

1. Provide more realistic Financial Targets: Banks should provide more realistic financial targets to their employees so that there is less incentive for risky behavior. We believe the Board of Directors need to monitor this closely and the Independent directors exercise their “independence” and be involved in setting and commenting on targets.
2. Reduced use of Arbitration: Financial institutions should make the dispute resolution process more transparent and reduce the use of arbitration. Also, there should be a “watchdog” established to monitor the the nature of disputes so that these sorts of frauds are detected much earlier.
3. Executive Compensation with Claw-back Provisions: This is an area where Bank Regulators need to play a significant part and will not be viewed favorably by other “free market” proponents beside myself. It is my view that Banking Regulators exercise more control and push the Board and Justice Department to “claw-back” compensation when Executives have materially profited by fraudulent activities. During Congressional hearings, Sen. Bob Corker, R-Tennessee, very appropriately said that Ex-CEO Stumpf would be engaging in “malpractice” if the bank didn’t “claw back” money that it had paid to executives during the period that the accounts were being opened without customers’ permission.
4. Congressional Oversight: One of the reasons for the Financial Crisis (circa 2008) was the result of inadequate regulation of real estate and financial markets. This resulted in widespread contagion of crisis across Financial Markets and the “Too Big to Fail” doctrine was used to bailout the Financial Industry with no accountability. Hence, it is our view hat Congress has the sacrosanct duty to protect the American Public and prevent crises of this nature by updating / modifying / strengthening appropriate provisions of statues like Sarbanes-Oxley, Dodd-Frank etc. We feel that House of Representative’s Financial Services Committee hearings to investigate into the bank’s alleged misconduct as well as “the role of Washington regulators in monitoring and investigating” the alleged misconduct was a step in the right direction and went a great way in restoring confidence in the Banking System.

Financial crises occur, in part, because trust is suddenly lost. However, this crisis was contained without far-reaching impact to the Financial Systems because trust was regained because of widespread outcry and swift Congressional Action, which prompted the Bank to accept responsibility, and change the regime.

We were lucky this time and dodged the proverbial “bullet” so it is urged that some of the steps mentioned here considered and implemented by Financial Institution Leadership and Banking Regulators.