- On October 23, 2017
Just over a year ago, the Wells Fargo fake account scandal hit the press. At that time, we wrote about the 4 takeaways for compensation committees. Now that we’ve had a year to chew on the scandal, we thought we would revisit the implications for compensation committees.
Here’s a recap: over 2 million accounts were opened without customer consent, eventually leading to a fine of $185M for widespread illegal practices. Wells Fargo had known about the gaming of incentive programs for some time, and had terminated over 5,000 employees for this behavior over a number of years. And it wasn’t just bankers who were watching, the scandal caught the public imagination – the grilling of former CEO John Stumpf by Senator Elizabeth Warren has garnered nearly a million views on YouTube.
The issues at Wells Fargo prompted banks across the globe to review their compensation practices, particularly incentive compensation arrangements. Where once Compensation Committees were most concerned with executive rewards, Directors are now asking management questions about front line sales incentives, the associated risks and, attempting to ensure that no similar issues exist in their organizations.
So, 12 months on what, if anything, has changed?
What has been happening at Wells Fargo?
Wells Fargo has been reasonably transparent, at least at a high-level, about the steps they have taken and changes they have made over the last 12 months. The Board completed a comprehensive and independent investigation of community banking sales practices, and the April 2017 key findings from the Director’s independent report and action plan as well as a more recent update to “strengthen operations and governance”, published in September 2017, provide insight into some key changes that are being made in light of the scandal.
- Redesigning incentive plans to have a greater focus on customer outcomes;
- Changing leadership structures, so senior leaders are closer to the customer; and
- Improving risk management and control.
Let’s take a look at each of these changes.
Redesigning incentive plans
In our experience, management often views incentive programs as a “silver bullet.” We’ve observed many conversations around the leadership table about changing a measure or a goal specifically to increase performance in a particular area. You want to increase the sales of a particular product? Then ratchet up the quotas for that product, make minimum achievement a gate-opener to incentive plan participation, or increase the weighting in the scorecards and voila! — performance improves.
Wells’ incentive compensation programs were highlighted as a major contributing factor to the unethical behaviours that led to the opening of accounts without customer consent. Their incentive programs required change. Wells Fargo implemented a new incentive compensation plan for community bank employees, removing product sales goals and replacing them with customer service, risk management, and team performance measures.
Importantly, they didn’t stop there.
The investigation into sales practices showed that there was extreme pressure placed on employees to meet sales goals, with some employees fearing they would lose their jobs if they didn’t meet sales quotas. On the flip side, the top sellers received all the reward and the recognition. The community bank of Wells Fargo demonstrated the typical hallmarks of a sales culture, with sales performance lauded above all else, even customer outcomes.
To address the need to change this deeply rooted sales culture, Wells Fargo also put in place a number of training and coaching programs specifically related to articulating acceptable sales practices and improving the customer experience. These additional programs should help to shift the culture from one of focussing on sales outcomes above all else, to a service culture that considers customer outcomes paramount.
Changing leadership structures
To understand the need to change leadership structures, we highlight the example of employee turnover associated with the unethical sales practices and unauthorised accounts.
During the period where these unauthorized accounts were opened (2011 to 2016), over 5,300 employees were terminated for unethical behaviour. Why didn’t management see this as a significant issue, or move to address it more quickly?
Part of the answer lies perhaps in the need for large organisations to manage by quantitative metrics. An organization like Wells Fargo has 269,000 employees. Employee performance metrics like turnover would be tracked monthly. While quantitative turnover metrics are easy to observe and interpret, the reasons for why employees leave the company may not have been visible.
In the case of Wells Fargo, approximately 900 employees left the company each year due to unethical behaviour (5,300 over 6 years). But while 900 employees seems like a huge number, it represented less than half of 1% of the entire employee population. When senior executives or Board members review employee metrics, numbers like this are unlikely to receive any attention or be perceived as an issue.
Using a qualitative lens to employee metrics is critical. While the absolute numbers may not be material, qualitative reporting can highlight the behavioral causes behind quantitative trends. The Wells Fargo Director’s report highlighted a “disinclination of senior leadership … to see the problem as systemic” which resulted in a failure of management to appropriately escalate the issues related to inappropriate sales practices.
This again reflects a cultural issue. It is likely some sales leaders (and senior management) were personally benefiting from the account growth that came from the unauthorized accounts, another potential reason these employee terminations were not called out as a specific concern. Perhaps Wells Fargo had a “good news culture”, where good news travels more quickly than bad (which may not escalate at all).
To address these leadership issues, Well Fargo decided to remove a layer of management so senior leaders were closer to the customer and the employees serving them.
The Wells Fargo Board also took a number of actions to clearly reinforce executive accountability. At the highest level, there was a forfeiting of equity awards for both John Stumpf and Carrie Tolstedt (whose employment was deemed to be terminated for cause) of approximately $60m. The Wells Fargo Board also determined in April 2017 to claw back approximately $28 million of Mr. Stumpf’s incentive compensation paid in 2016.
In addition, no 2016 bonuses were paid to eight members of the operating committee to reflect the Board’s decision that these executives held the collective accountability for the overall operational and reputational risk of the Company.
Wells Fargo also terminated four senior managers of the Community Bank for cause. None of these individuals received a 2016 bonus and all unvested equity awards and vested outstanding stock options were forfeited.
These actions send a strong message to leaders throughout the organization about what behavior is acceptable and how important it is to lead ethically, reinforcing the desired cultural change to be a more customer focussed organisation.
Improving risk management
Wells Fargo also took action to change the control environment, including operational and risk management practices in the Community Banking division.
Control functions at Wells Fargo (such as risk, compliance, finance and human resources) were operating on a decentralised model where the hard reporting line was to the business unit leader rather than a functional executive. This organizational structure has a very real potential for significant conflicts of interest, as reporting on risks or compliance breaches is made to the very leaders who are responsible for the breaches. These business leaders are also responsible for determining, for example, the compensation outcomes of these control function employees.
To address this, Wells Fargo changed the reporting relationships of these teams directly to a centralized functional group, eliminating the potential conflict.
Well Fargo has also increased its focus on the customer experience and improved monitoring of sales practices risk. Wells Fargo has leveraged technology to improve protection measures such as sending an automated email to customers every time a new account is opened. They have also increased their focus on quality assurance through a mystery shopper program, which will help determine if the new customer focussed approach is being appropriately embedded and demonstrated in employee interactions with customers.
In a move we have also seen in other companies, the focus on conduct risk has increased significantly. Wells Fargo established a Conduct Management Office reporting through to the Chief Risk Officer. At Wells Fargo, the conduct management team handles internal investigations, whistleblowing (through their EthicsLine), and complaints management. By centralizing these functions, it should be easier to identify trends and initiate remediation where appropriate.
Yet more inappropriate sales practices were also identified
Wells Fargo has clearly taken action and invested to improve their customer focus and culture, so we can only imagine the disappointment of the Board, executive team and employees when over the past 12 months another 1 million unauthorized accounts were identified, which lead to an additional in $2.8m in customer refunds.
In a separate issue – but related from a cultural perspective – in July it was reported that Wells Fargo charged hundreds of thousands of customers for auto insurance they didn’t want. In a practice commonly referred to as “product bundling”, customers who took out a car loan they were also charged for auto insurance – the Wells Fargo insurance product was often quite a bit more expensive than similar insurance the customer could obtain elsewhere.
It seems customers may not have fully understood the implications and cost of the insurance product, and in some cases the insurance charge led to customers defaulting on their loans. An independent review estimated that Wells Fargo should compensate customers to the tune of $73m to customers to make them whole as a result of these inappropriate sales.
What can we learn from Wells Fargo?
We believe the takeaways for compensation committees that we wrote about last year are still very relevant, and worth revisiting:
- Remember: you get what you pay for
- Unreasonable incentive goals are dangerous
- Clawbacks: use them
- Governance and culture matter too
In addition, reflecting on the Wells Fargo experience over the last 12 months has given us three further observations for executives and leaders. We believe these have application to any customer-facing organization, not just banks.
- Your reputation is important, and needs to be actively managed. CEOs can be called to account by Senate Committees at any time and for almost any reason. Customers frequently take to social media about poor customer experiences. Your company is always in the public eye. It is critical for organizations to consider the reputational implications of their strategies and operating procedures. Scandals can seldom be kept internal, and leaders must address them decisively and quickly. In another recent scandal, Equifax were criticized for taking too long to disclose their security breach, and some executives even sold stock between when the breach was known internally and when it was disclosed. Ensure corporate reputation is considered when discussing not only compensation strategy, programs and decisions but also your broader business strategy, operations and employee communications.
- Culture underpins your operations, and it doesn’t change quickly. If you do identify systemic issues in your operations, particularly where it may be linked to a poor customer outcome or unethical behaviours – this is a big red flag. Organizations need to act decisively to address cultural concerns. At Wells Fargo, this included training for both management and employees, clearly articulating and reinforcing behavioural standards, and sending strong messages with compensation clawbacks and forfeitures. Know your leaders, and be sure they are reinforcing the desired culture. If you are looking to create a customer-centric culture, you need to ensure that someone is taking the perspective of the customer when making key strategic and operational decisions. Culture needs to be consistently reinforced, and monitored to ensure change is sticking. Remember Peter Drucker’s sage words: “Culture eats strategy for breakfast.”
- Regularly review for conflicts of interest, and ensure checks and balances are in place. The Wells Fargo Board identified that the control functions, particularly risk and HR, required greater independence. While decentralised models may seem more nimble or responsive, they can compromise important checks and balances, particularly where “line of business risk managers [are] answerable principally to the heads of their businesses” (Key Findings from Board Investigation, Action Plan Update, and Our Path Forward, April 2017). An increased focus on reviewing risks and incidents to identify trends in employee behaviour and related customer complaints is another way to ensure appropriate oversight of what’s happening in the business. Finally, it’s important to review executive performance goals – is there an appropriate independence for control functions. You should also consider an explicit link to customer outcomes and other non-financial measures (for example conduct and behaviours) to reinforce their importance.
While we never want to see scandals of this magnitude in any organization – they present a valuable opportunity to review what could be done better, and shine the light on our own organisations. We can learn from the mistakes of others and determine if there are things we can do better, to serve our customers, communities and shareholders.
Sheffield Barry is an Executive Compensation and HR Consulting firm, providing customized advice to clients at an affordable price. We leverage technology to deliver data and analysis as efficiently as possible, so we can invest more time understanding our clients’ unique business issues to develop custom solutions and advice. For more information, please visit us at SheffieldBarry.com or email us at info@SheffieldBarry.com.