Cutting out a culturally aligned but imperfect remuneration system

In 2011, US bank Wells Fargo was forced to pa $US$85 million for selling higher interest rate mortgages to customers who should have qualified for lower rates, and falsifying loan applications in the process.

Not quite five years later, Well Fargo finds itself faced with a very similar situation causing customer, public and investor distress. Recently the bank announced that it reached an agreement with the Consumer Financial Protection Bureau (CFPB) to the tune of $185 million in fines for opening deposit accounts and transferring funds without customers’ consent. This settlement prompted calls for deeper investigations, increased regulation of the US banking industry and questions around how such unethical behavior might become the norm of acceptable behaviour across an entire organisation.

At a hearing before the US Senate Banking Committee, Wells Fargo CEO John Stumpf disclosed the magnitude of the bank’s governance failure. Stumpf testified that the fraud was first discovered in 2011, when the bank terminated more than 1,000 employees for opening fake accounts. Despite the fact that this represented more than 1% of Wells Fargo’s workforce, neither Stumpf nor the bank’s board of directors were notified of the fraud until 2013. Since then, more than 4,000 additional employees have been terminated. Consequently, the CEO and the head of the Community Banking unit in which the offences occurred have resigned. In addition, the Wells Fargo board has canceled a significant proportion of unvested equity grants outstanding for her and the CEO. The board relied on a policy that covers actions that harm the bank’s reputation when it extracted unvested equity grants with US$41 million from John Stumpf, and $19 million from Carrie Tolstedt, its former head of Community Banking, where the misdeeds took place. That this happened is very unusual in the US, and more difficult as “malus” policies in place throughout Europe and Australia are not practiced by US banks.

Cross selling has been an integral part of Wells Fargo strategy for decades. It has been so successful that retail banks globally benchmark their performance on cross selling to Wells Fargo. It is part of the Wells Fargo DNA. Hence, this issue is a prime example of a much more complicated and systemic culture issue. It was not limited to small group of employees in an isolated branch, or group of desks. It spread across thousands of people. Over several years, Wells Fargo has terminated 5,300 employees (so far) who were implicated in the scandal.

There have been several articles over the years describing the aggressive sales demands placed on Wells Fargo employees, and examples the unintended consequences in terms of unacceptable behavior associated with this.

Remuneration is one such process that informs people as to what an organisation truly values. At its core, this is not a bad thing. However, these remuneration models can be a driving force for undesirable behaviour if not designed with care. They need to be supported with appropriate compliance and supervisory safeguards to ensure undesirable behaviour does not occur in the first place, or if it does, it is nipped in the bud before it becomes systemic, and therefore “cultural”.

It is almost unimaginable that the Wells Fargo board or senior executives, would condone unethical behavior in any form. The same is true for ASX 100 companies. When employees change from working within the system to behaving unethically, it is often limited to a small number, however, it will, and does, occur. It is perhaps not so much the remuneration system, which was effective at conveying what was valued (i.e. product sales to existing customers), but compliance and supervision systems to ensure that these were “real” sales accepted by willing and informed customers undertaking profitable bank transactions.

The bank has announced that it would eliminate product sales goals by 2017 in an effort to begin to change the way they incentivize employee behaviour.

The concept of cross-selling has been a centerpiece of the Wells Fargo culture for decades. The elimination of cross sales incentives that have been an integral part of that culture, and contributed to the bank’s outstanding success, must be a wrench. One wonders if it reflects an acknowledgement that the bank cannot provide appropriate supervisory and governance controls alongside the incentive plan to ensure it works as it should, or if it was just a response to intense external pressures and the associated reputational damage, or both.

© Guerdon Associates 2024
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