- On October 14, 2016
The Wells Fargo (WFC) scandal seemed to have died down last week, or at least had seemed to have been overtaken by the election season news cycle. Until yesterday, when CEO John Stumpf “retired”. And this morning new WFC CEO Timothy Sloan is appearing on the TV behind me on various morning business shows. While that scandal seems over now for this news cycle, I expect that we will see a new round of outrage when WFC publishes their proxy statement next spring, and potentially again a few weeks later around the time of their annual shareholder meeting (though Stumpf’s retirement may mute some of the public anger).
To be sure, this is not the first — nor will it be the last — scandal over big bank pay. So, what are some of the takeaways and key learnings from this episode for Compensation Committees and other Board members?
Here are four important lessons from the Wells Fargo scandal:
- Remember: You get what you pay for.
- Unreasonable incentive goals are dangerous.
- Clawbacks: Use them.
- Governance and culture matter too.
1. Remember: You get what you pay for.
I heard a discussion of the WFC fraud on the radio earlier this week that summed up this issue well: “They paid for opening more accounts. They got more accounts.” Which reminds us of the primary principle of compensation and incentives: you will almost always get what you pay for.
Core to the Wells Fargo scandal is the bonus program implemented for retail bankers that rewarded them for selling additional products and services to their customers. We have learned through the journalistic and legislative investigations that more than a handful of bankers found an easy (and illegal) workaround for meeting their sales quotas: they signed up customers for new accounts without their knowledge.
Through my review of the various research and reporting on the scandal, it appears that not only was the bonus program for bankers to blame, but perhaps more importantly, the alignment of interests up and down the chain of management encouraged a culture of aggressive sales among all levels of the retail bank. Particularly disturbing was a recent episode of NPR’s Planet Money, #728: the Wells Fargo Hustle, in which former WFC retail bankers described the pressure of working at the bank and how aggressively they were expected to push new accounts. Even more disturbing was how their managers treated them if they failed to meet their quotas, including black marks on their records and blackballing them from other jobs in banking. Is it any wonder that employees looked for ways to meet their quotas (both legal and potentially illegal) to avoid having their future careers in the banking industry destroyed by overly-aggressive managers?
The Wells Fargo new account bonus program did exactly what it was designed to do, and achieved precisely what its designers intended.
2. Unreasonable incentive goals are dangerous.
I have not found much detail about the goals for new account incentive bonuses. However, from what has been written about all behaviors and the type of culture encouraged, the goals for opening new accounts must have been extremely aggressive. And others have reported about the aggressiveness of performance goals for Wells Fargo retail bankers in the past. Also, certain participants in the banker new account bonus program suggested that each banker needed to average SIX new accounts opened each DAY. And the mantra used by CEO Stumpf when talking with his retail bankers was “Eight is great.” In other words, he expected each household to have eight different Wells products.
WFC bankers were expected to encourage all walk-in customers to open new accounts, and when not assisting walk-in customers, were expected to call new and existing customers to open additional accounts. Those bankers who failed to meet their quotas were expected to come into their offices over the weekend to continue selling new accounts to customers. (For a very vivid discussion of banker experiences, listen to the Planet Money episode referenced earlier.)
While it is challenging to understand exactly how aggressive these goals were, it is indicative that so many participants felt the only way to achieve such goals was to “cheat” and find alternative ways to meet their goals. Wells CEO John Stumpf attributed the entire scandal to the misbehavior of a few rotten apples. However, WFC has confirmed that 5,300 bankers were fired for opening 2 million accounts that were never requested by customers. To me, that counts as more that a “few”. It suggests that goals were so aggressive that thousands of bankers felt they needed to find alternative ways to meet their goals.
3. Clawbacks: Use them.
To their credit, Wells Fargo had a clawback policy in place. To their discredit, the Board’s delay in clawing back compensation attributed to the scandal led to the appearance that the Board was unwilling to claw back compensation. Only after their arms were twisted after CEO Stumpf’s testimony in front of the House and Senate banking committees and after significant excoriation from the journalistic community did the Board finally relent. In fact, the new accounts fraud was disclosed to the public on September 8, while the Board did not reveal the clawback of Stumpf’s bonus until September 20. Almost three weeks. And evidence suggests that the Board was notified of the fraud as early as 2011. (A good timeline of the recent events can be found here.)
If a company has a clawback policy in place and is facing a scandal of this magnitude, one of the priorities of the Board should be to assure shareholders and the public that all compensation “earned” through inappropriate means will be returned to its rightful owner. Quickly. By dragging their feet on clawing back CEO compensation, the Board communicated to the public the perception that they were doing everything in their power to protect the most senior executives from taking any responsibility for the scandal.
4. Governance and Culture Matter too.
This scandal could have been avoided, and the fraud prevented, had Wells Fargo cultivated a different organizational culture. Or if the Board had different governance practices in place, particularly the process for sharing information communicated by whistleblowers.
Instead, WFC cultivated a culture of aggressive performance at any cost. The penalty for not meeting performance goals was not just termination, but unreasonable punishment via blackballing employees from the entire banking industry. (Question: this seems counterintuitive. Shouldn’t you retain your best performers and allow your weaker performers to join your competitors?) The aggressive expectations and penalties for non-achievement provided an even greater incentive to look for alternative methods for meeting goals.
A culture emphasizing customer satisfaction and ethical practices could have possibly avoided the fraudulent behavior of the retail bankers and their managers. True, the WFC Code of Ethics included this line:
but printed words on a poster in the break room does not an organizational culture make. It is clear that the culture of the bank was one of aggressive sales. Ethics came second. Or fourth. Or not really at all.
Finally, and perhaps most importantly, Governance and oversight by the WFC Board of Directors was lacking on several dimensions:
- Compensation Risk Review: The Compensation Committee failed in their oversight of the risk review associated with compensation programs. Or perhaps just accepted the risk involved with the design of the new accounts bonus program. At the very least, this risk should have been monitored carefully and brought to the attention of the Committee when the fraudulent behavior was uncovered.
- Whistleblower process: Whistleblowers apparently notified the CFPB of the new accounts fraud in October 2013 (CEO Stumpf sold $13 million of stock on October 31, 2013, shortly after learning of the incidents). And we now know that “Dennis Hambek, a former branch manager in West Yakima, Washington, sent a certified letter in January 2006 to Carrie Tolstedt, then Wells Fargo’s head of regional banking, outlining unethical “gaming” activity at area branches. In 2007, Tolstedt was made the company’s head of community banking, the division where many of the unethical practices occurred.” This was five years earlier than the bank had said its board first learned of the fake accounts. [You may recognize Tolstedt’s name as the alleged head of the entire fraud. WFC initially announced that she would resign her position as head of community banking (with no other consequences), then later announced she would retire at the end of 2016 (with no other consequences), then finally at the end of September announced that she had already terminated employment and forfeited equity worth $19 million. Read the sordid details here.]
Sadly, the bank’s ethics hotline allegedly resulted in whistleblowers losing their jobs. If such allegations are true, WFC’s whistleblower process is not just broken, but among the most counterproductive ethics hotlines in the history of business. Bloomberg sums it up like this:
The Code of Ethics goal of “Maintaining the highest possible ethical standards,” does not appear to have any relation to the WFC ethics hotline, their governance processes, nor was it anywhere near the top priorities of Tolstedt, Stumpf, or the WFC Board of Directors.
CEO Stumpf announced his retirement on October 13, 2016. In early October, the Board announced that it would claw back $41 million of Stumpf’s compensation. However, he’s not exactly required to write a check in that amount back to the company, he’s giving up unvested performance-based stock awards that might never vest anyway.
It remains to be seen if there will be any fallout for Board members next spring during the annual shareholders meeting. At minimum, I would expect that Director re-election voting will be far weaker than it otherwise would have been. And probably rightly so.
At minimum, Wells Fargo is a broken company. Many systems and processes like compensation, governance, and cultural priorities need to be completely torn apart and rebuilt. More than likely, several Board members contributed to such a culture of looking the other way and need to “voluntarily retire.” I don’t envy new CEO Timothy Sloan. He’s got a huge task ahead of him.
What Compensation Committees and Boards should learn from the Wells Fargo Scandal
So what should public company Board members take away from the WFC events?
- Pay attention to the potential risks involved in your incentive programs. Your incentive program risk review should identify potential risks associated with each key program (not just your executive incentive programs), along with the potential ways that participants could achieve the key goals for each incentive program (both legal ways that may not align with the Company’s long-term strategic goals [for example, trading margin to achieve volume], as well as illegal and/or unethical ways). For the riskiest elements, ensure that HR or Risk is providing periodic updates to the board on how those risks are being managed.
- Test the reasonableness of your incentive plan performance goals. Test your goals: (a) both internally against historical performance and externally against peer or industry benchmarks, (b) on an aggregate basis overall for each geography, department, line of business, etc. as well as on an individual basis (is opening six new accounts every day a reasonable goal for each retail banker?), and (c) both relative to historical benchmarks as well as proactively against future expectations (including economic expectations, stock price expectations, etc.)
- If you have clawbacks in place, use them when circumstances dictate. In a timely fashion. Delaying action suggests to your internal (employees) and external (public, media, customers, etc.) audience that the Board will protect executives, even if employees suffer termination or customers suffer fraud.
- Review your processes for whistleblowers. Make sure your process provides safeguards for whistleblowers and that they won’t suffer from retaliation from their managers or others in the chain of management. Ideally, the communication process should be overseen directly by the Board of Directors or someone who reports directly to the Board.
Events such as this generate significant anger among internal stakeholders like employees and external stakeholders like customers. The business risks are significant and real. However, scandals such as the Wells Fargo incident offer an opportunity for Boards and Management teams to learn. A teaching moment, if you will. Compensation Committees should pay close attention to the explicit and implicit risks associated with your compensation programs, especially how participants might be able to “game” the achievement of performance goals. If you have clawbacks in place — and every company should — the Board should have a plan to take action in a timely fashion once fraud is uncovered. And finally, Boards should be actively involved and updated on any issues brought to light by whistleblowers.
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