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The Wells Fargo Cultural Failure This paper will explore the Wells Fargo miasma which led to the recent $185MM fines levied by Consumer Finance Protection Board (CFPB) ($100 million), the largest in the agency’s short history. Another $85 million was tacked on by paying $35 million to the Office of the Comptroller of the Currency and $50 million to the City and County of Los Angeles. The total fines were assessed based upon the bank’s conduct of opening over 2 million phantom bank and credit card accounts, usually without customers’ knowledge. The fraud was all domestic so there were no Foreign Corrupt Practices Act (FCPA) violations. However, the actions which led to this record breaking fine, the actions of Wells Fargo during the violations and thereafter may well be one of the best teaching moments for any FCPA compliance practitioner around a variety of issues related to FCPA compliance. Initially, I want to look at the sales strategy and compensation structure which led to the scandal. Part I-What is Risk? The sales strategy under which Wells Fargo came to such grief is simple and even benign, cross-selling of products. As noted by Rachel Louise Ensign, writing in a Wall Street Journal (WSJ) article entitled “Banks Simple Strategy Gets Tangled”, “the concept sounds simple enough. If a customer has a checking account, why not sell him a mortgage, wealth management services and credit card as well?” She went on to write, “with banks becoming larger over the past two decades, cross-selling has become a mantra.” You can also think of the cross-selling McDonalds engages in every time you buy a Big Mac when the representative asks you “Would you like french fries with that?” Yet there are other reasons for engaging in this type of business practice. Each and every time a company has a touchpoint, particularly a commercial touchpoint with a business, it strengthens the relationship. According to Gary Silverman, writing in the Financial Times (FT) in an article entitled “John Stumpf, the Labrador of Main Street” , Wells Fargo’s Chief Executive Officer (CEO) “Mr Stumpf’s take on traditional Wells teaching was to promote deeper, more frequent contact with the people it serves. “If there’s one word to describe this company, it’s ‘relationship,’” he told the Financial Times in May. “What we’re trying to do is make sure that every team member, in every interaction with a customer, gets it right. If we don’t get it right, we try to make it right, really quickly.”” So what starts off as a legitimate, legal and beneficial business strategy becomes not only high risk but illegal because of the manner in which Wells Fargo administered its approach to cross-selling. As with any sales initiative, if a company wants to push it, it will set up incentives for the sales team to engage in such behavior. This can be done by increasing commissions around the service or product being emphasized, such as the banks products. Ensign noted, “Banks have tried to create incentives for cross-selling.” At some banks, “Branch employees can get bonuses—

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sometimes 10% or more of their salaries—when they sell additional products.” Companies can also increase sales by making clear that you will be evaluated on how much you sell a product or service. In other words, whether you receive a bonus, pay raise or even keep your job will be evaluated, in some part, on how much you cross-sell. You can even have a hybrid of the above, which may be the worst of all worlds. At Wells Fargo, employees were evaluated for continuing employment by supervisors on cross-selling. Yet they did not receive the same financial incentives to make such cross-selling. Branch managers and supervisors could receive bonuses of up to $10,000 per month for meeting cross-selling quotas when employees who hit their monthly quotas, received, in addition to continued employment, $25 gift cards. Richard Bistrong wrote a piece in the FCPA Blog, entitled “Wells Fargo stretch goals brought out the sandbaggers”, in which he discussed stretch incentives as a process that could lend itself to abuse. While there will always be a dynamic tension between operations, in the form of the sales force, to lower sales projections so that goals set can be more easily met (called: sandbagging) and the corporate office, which wants to set higher goals to generate more overall revenue, I do not think that the Wells Fargo matter is one of such sandbagging. I think the Wells Fargo case is broader with multiple corporate failures. Emily Glazer and Christina Rexrode, in a WSJ article entitled “Wells Boss Says Staff at Fault for Scams”, wrote of one former employee who said, “a former Wells Fargo teller in Pennsylvania, said of responsibility for the sales tactics, “It was all management: their boss, then their boss, then their boss.” Ms. Bhowmick took early retirement from the bank in 2014 at age 58. “They are putting pressure on employees, and it's sad,” Ms. Bhowmick added. “People need their jobs.”” When you put people’s job on the line, they will usually do whatever it takes to keep it. The learning point for this blog post is risk assessment and risk management. If you put a selling system in place that says if you do not meet your quotas, you are history; that is the message your employees will take home. It really does not matter what the CEO says the culture is or what he or she aspires it to be. Do I think CEO Stumpf ordered this draconian a system from on high? Not much chance of that as he was quoted, by Glazer and Rexrode, as saying “the bank doesn’t want a dime of income that’s not properly earned.” This is why a risk assessment must look beyond simply what is being sold to how it is being sold. Part II: Tones at the Tops Tone at the top is the single most ubiquitous phrase in compliance. However, I heard it phrased in a manner last week which not only made sense but explained why it is the most used phrase. It came from Vanessa Rossi, FCPA Due Diligence Compliance Counsel at Baker Hughes Inc. Rossi says the phrase which resonates with her is ‘tones at the tops’ because for every employee, the top is not the company Chief Executive Officer but the supervisor immediately above them and

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it is this immediate ‘top’ which sets the company’s tone for the employee. It is also that supervisor who will set not only the true culture of an employee but will address any complaints that employee has about violations of the company’s self-professed culture. Finally, it may also mean there is more than one ‘tone’ in any organization. Rossi’s insight certainly explains quite a bit about the Wells Fargo scandal. I want to consider the culture at Wells Fargo and how it contributed to the bank creating some 2 million false and fraudulent accounts which led to some 5,300 employees being fired and the CFPB (and others) fine of $185MM. On its public website, Wells Fargo has a Code of Conduct available for inspection and download. The document is entitled Our Code of Ethics & Business Conduct - Living Our Vision & Values. In his cover letter introducing the document, CEO John Stumpf says the following, “We are all responsible for maintaining the highest possible ethical standards in how we conduct our business and serve customers. After all, our culture is centered on relationships, and those relationships are built on trust. Our customers have high expectations of us, and we have even higher expectations of ourselves.” The Code itself has a section entitled Ethics, subtitled “Our ethics are the sum of all the decisions each of us makes every day”, the first sentence reads, “We have a responsibility to always act with honesty and integrity.” In the next section entitled What’s right for customers, subtitled “We want to be approachable and caring, exceed our customers’ expectations, and invest in relationships that last a lifetime”, the first three sentences read, “Our customers are always our priority. Our customer focus is one of the characteristics that distinguishes us from our competitors. We do what’s right for our customers”. The very next section, entitled Making the Right Choice, has a first sentence which reads, “If you’re faced with an ethical dilemma and you’re not sure what to do, ask these questions:

The section ends with the following, “If your answer to any of these questions is “No,” don’t do it.” So it appeared that Wells Fargo said the right things. Indeed, CEO Stumpf, in a Wall Street Journal article by Emily Glazer and Christina Rexrode, entitled “Wells Boss Says Staff at Fault for Scams”, says, “It was the employees’ fault” and “There was no incentive to do bad things.” Wells Fargo did not have a ‘paper Code’ like Enron; sitting there for all to see but never trained on. In a New York Times (NYT) article, entitled “Warned About Excesses, Then Prodded to Sell”, Michael Corkery and Stacy Crowley wrote, “The message to the dozens of Wells Fargo workers

Is it legal?

Does it comply with

our policies?

Is it consistent with our values?

Is it consistent with our

long term goals and interests?

Would I be comfortable

with my decision,

if it’s made public?

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gathered for a two-day ethics workshop in San Diego in mid-2014 was loud and clear: Do not create fake bank accounts in the name of unsuspecting clients. Similar warnings were being relayed from corporate headquarters in San Francisco to regional bankers in Texas, as senior management learned that some Wells employees had been trying to meet exacting sales goals by creating sham bank accounts and credit cards instead of making legitimate sales.” Yet, in spite of this training, statements made by Stumpf to the WSJ and the sections on ethics in the Wells Fargo Code of Conduct point to a clear disconnect between the values articulated in the corporate headquarters with those out in the field, in the branch offices selling consumer banking products across America. This points to a major disconnect between the corporate office and the field. What was important at the corporate office as a cultural value was not so important to those with their jobs on the line out in operations. The WSJ quoted one former Wells Fargo teller who was critical of this corporate message, who was quoted in the piece, said, “It was all management, their boss, then their boss, then their boss. They are putting pressure on employees and it’s sad. People need their jobs.” The reason company employees continued to break the law is seemingly straightforward. The pressure put on employees was to cross-sell, cross-sell and then cross-sell. The NYT piece said, “Wells continued to push sales goals that caused employees to break the rules in the first place.” Moreover, “The biggest problem, the former employees say, has been Wells Fargo’s aggressive sales culture, which was nurtured and honed over decades at the bank’s highest levels.” The pressure to cross-sell was relentless. One former Wells Fargo employee, Sharif Kellogg, was cited stated, ““The branch managers were always asking, ‘How many solutions did you sell today?’ They wanted three to four a day. In my mind, that was crazy — that’s not how people’s financial lives work.”” Wells Fargo apparently noticed something was askance several years ago. The Los Angeles Times first reported on scam allegations coming out of Los Angeles branches back in 2013. The company knew it had a problem and hence the compliance and ethics training. But branch managers (the immediately tops above the consumer sales force) continued to push cross-selling. The NYT piece noted, “former Wells employees swapped grim stories about the dichotomy between their ethics training — where they were formally told not to do anything inappropriate — and the on-the-job reality of a relentless push to meet sales goals that many considered unrealistic.” Another former employee said, “During our training we go through SO much training about ethics and how you CANNOT do that. I got threatened to be fired as a teller with them because I wasn’t meeting my numbers. I told them I didn’t believe in trying to convince someone to spend money they don’t have, get what they don’t need.” The bottom line was that Wells Fargo employees were hounded by the immediate managers to meet clearly unrealistic sales quotas. What was the pressure those branch managers were under? Going in another direction, one former Wells Fargo employee basically said the branch managers were getting rich off the back of their employees when they joked on a YouTube spoof video, ““If

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tellers and bankers make those sales numbers each day, at the end of the month everybody in the branch will get a $5 gift card to McDonald’s. The district manager will get a $10,000 cash bonus.”” Even with a robust and specific Code of Conduct, a CEO allegedly committed to doing business the right way and specific training the ‘tone’ of the organization came from the employees’ immediate bosses. If a branch manager wanted you to cross-sell products to customers who did not want them, did not need them, could not afford them or did even know they had been assigned the products; that is what the employees did. If not, they would be fired. In the corporate world, that is the clearest statement of culture a company can have. Part III - The Bank Knew All Along You know it is going to be a very bad day when, as a company’s CEO, you receive a letter asking the following, “Specifically, the committee should thoroughly examine this issue, including: How it is possible that more than 5,000 employees could bilk customers over the course of five years; the timing, extent and disposition of customer complaints; whether Wells Fargo’s sales and compensation structure incentivized employees to engage in deceptive and abusive practices; and what additional safeguards may be needed to prevent this type of behavior.” That language came out of a letter from Senate Banking Committee Chairman, Richard Shelby, and was quoted in a New York Times Dealb%k column by Andrew Ross Sorkin, entitled “The Brazen Sham No One Noticed”. To Senator Shelby’s questions, Sorkin added a rather obvious one “What, exactly does a risk manager at Wells Fargo do?” For myself, one of the most basic questions was simply how could some 2 million fraudulent accounts, involving both products and services, be opened and no one notice? It turns out that the problem for Wells Fargo is not that no one noticed as the company was well aware that sales representatives had been fraudulently cross-selling for years. The greater problem for the bank was that it was well known within the organization and it was never stopped. In a Wall Street Journal (WSJ) article by Emily Glazer, entitled “Wells Fargo Tripped By Its Sales Culture”, she noted, “Questionable sales tactics persisted, though, and were an open secret in Wells Fargo branches across the country.” She wrote that the bank began asking questions internally about “an uptick in bad behavior” as far back as 2009 when sales spiked during one month’s Jump into January sales program. She noted, “For five years, Wells Fargo conducted investigations into improper practices, hired consultants and tinkered with sales and compensation incentives.”

a. Surveys, Assessments and Internal Investigations In 2010 “employee-satisfaction surveys done for Wells Fargo by research firm Q & A Research Inc. showed that some bank employees felt uncomfortable about what managers had asked

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them to do or when pushing customers to buy products.” In 2012, the “Wells Fargo’s community-banking unit assembled a special task force to look for suspicious patterns in sales practices and examine areas of the U.S. where customer complaints were prevalent, such as Southern California, according to current and former bank executives.” There was an assessment in 2013 after some 200 Wells Fargo employees were fired for fraudulent practices around cross-selling. After some directors and executives wondered if the real problem was the bank’s cross-selling culture and not the terminated employees; it was determined that it was simply ‘rogue employees’. An anonymous source for the WSJ piece said, ““When we first started looking at it, we didn’t think it was anything other than rogue junior players and a few rogue managers””. Even with this finding, the bank’s risk management team “increased its oversight and audit capabilities” over the community banking unit. In 2015, the bank hired Accenture and the venerable law firm Skadden, Arps, Slate, Meagher & Flom “to conduct an internal investigation”. The Board was regularly briefed on the investigation’s progress. As a direct result from this internal investigation “the bank lowered some sales goals and toughened new procedures to ensure that new accounts were legitimate.” After the Los Angeles District Attorney “alleged that Wells Fargo pressured retail employees to commit fraud”, the bank “hired consulting firm PricewaterhouseCoopers to do an in-depth analysis. About a dozen PwC employees worked on the project for about a year, discovering fraudulent sales practices that were prominent in Phoenix, Miami and Newark, N.J.”

b. Compliance and Ethics Training Then there was compliance and ethics training. In another NYT Dealb%k column by Michael Corkery and Stacy Cowley, entitled “Warned About Excesses, Then Prodded to Sell”, they wrote, “The message to the dozens of Wells Fargo workers gathered for a two-day ethics workshop in San Diego in mid-2014 was loud and clear: Do not create fake bank accounts in the name of unsuspecting clients. Similar warnings were being relayed from corporate headquarters in San Francisco to regional bankers in Texas, as senior management learned that some Wells employees had been trying to meet exacting sales goals by creating sham bank accounts and credit cards instead of making legitimate sales.” How seriously was the training taken? In her WSJ piece, Glazer reported the following, “At a sales meeting in Florida in 2014, Wells Fargo & Co. regional executives scolded lower-level managers about an obvious problem that kept cropping up at the bank. Managers were told that their employees should never open accounts for people who don’t exist, people familiar with the meeting recall. One manager in the room saw things differently. In an email peppered with exclamation points and capital letters, she urged her employees to ignore the bosses and get sales up at any cost, says someone who saw the email.”

c. Internal Reporting of Illegal Activity

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Instances where Wells Fargo employees attempted to speak up about unethical or even illegal behavior were met with indifference or outright hostility. Khalid Taha, a former employee was quoted “They warned us about this type of behavior and said, ‘You must report it’ but the reality was people had to meet their goals.” Another former employee, Ruth Landaverde was quoted in the WSJ piece as saying, “If somebody said: ‘This doesn’t make sense. Where are you getting these sales goals?’ then [the response] was: ‘No, you can do it’ or ‘You’re negative’ or ‘Oh, you’re not a team player’. She says she often got the same response whenever she said a customer didn’t need another credit card. “The answer was: ‘Yes, they do,’” she says. She quit after being warned she wasn’t reaching her sales goals, she says.” It does appear that the CEO was made aware of the illegal conduct at Wells Fargo. One Wells Fargo employee reported the unethical conduct in an email directly to CEO Stumpf. As reported from the Senate Banking Committee hearing, in an exchange between Stumpf and Senator Robert Menendez, who read an email that he said was written in 2011 by a Wells Fargo employee reporting concerns about cross-selling pressure directly to the CEO. Mr. Stumpf said “I don’t remember that one.” Mr. Menendez replied: “Well, she was fired.” Yet, in his testimony CEO Stumpf said he was made aware of the problem in 2013 and the Board was informed in 2014.

d. External Reporting of Unethical Conduct Of course, the real losers in all this illegal and unethical activity were the banks customers, who received the unwanted and, in some cases, unknown services and products. Yet these same customers also reported the actions to the bank and nothing came out of this information. Corkley and Cowley reported one former Wells Fargo employee who, “fielded complaints from customers about questionable accounts until shortly before he left the bank this summer. He said bank managers had grown weary of writing up reports on potentially improper sales.” He said that it was “like jaywalking,” and “hard to police.” Other customers interviewed for the piece spoke about the difficulties in cancelling credit and debit cards they “didn’t know about and didn’t want.”

e. Some questions not yet answered If every customer was contacted to obtain or use up to eight product or services, one might wonder about credit risk? Sorkin did when he listed several questions posed to him by Richard Bove a research analyst. The questions included, “What does this indicate about the bank’s underwriting policies? Can anyone have a Wells credit card without any checks being made concerning that person’s ability to make payments for debt created using this card?” And what does this say about the information the company has reported to investors and regulators? The bank also apparently opened 1.5 million false transaction accounts? Does this mean that accounts can be opened with no balances? What does it say about the willingness of the bank to

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operate with accounts on which it makes no money? What policies and procedures at this bank allowed this to occur?”” So, in spite of all the investigations, auditing, assessments, internal and external reporting how could Wells Fargo have allowed this problem to grow? Perhaps the most concise answer came from Glazer who, in another WSJ piece, entitled “On the Way to ‘Great,’ Six Products Per Customer”, wrote that in the bank’s 2010 annual report, CEO Stumpf “said he often was asked why Wells Fargo had set a cross-selling goal of eight [products and services per customer]. The answer is, it rhymed with ‘great’ he wrote. “Perhaps our new cheer should be ‘Let’s go again, for ten!’” Part III - Senior Management, the Board and Corporate Governance Issues At least he fessed up that it was not the (non) rogue 5,300 employees that were responsible for defrauding Wells Fargo customers. At the Senate Banking Committee hearing, held on Tuesday 20th September, Wells Fargo Chief Executive Officer John Stumpf admitted that he was responsible for the failure. (He did, of course, claim he was either misquoted or simply misinterpreted.) As much as I was pleased he owned up to being a leader, I was more than a little bemused when Stumpf admitted that he had known about the scandal since 2013 and the company’s Board of Director’s had known about it since 2014. One might reasonably ask what they did in the intervening two years to stop the illegal activity and remediate? Of course, Wells Fargo has not even suspended the sales compensation plan which led to this fiasco, keeping it open until the end of the year so I guess things move more slowly in the banking sector than in non-financial industries. As I continue to mine the Wells Fargo scandal for lessons to be learned by the compliance professional, today I want to consider the roles of senior management, a Board of Directors and corporate governance. Unfortunately for Stumpf, it appears his cultural leadership of cross-selling; more cross-selling; and then even greater cross-selling of the bank’s products and services to customers, whether wanted or needed, was in large part the reason for the scandal. Of course, with some 255,000 employees, Stumpf can simply claim (and did) that he cannot be responsible for them all. This typical CEO misdirection was answered by Susan M. Ochs, in a New York Times Op-Ed piece, entitled “At Banks, the Buck Stops Short”, when she articulated three reasons why senior management should be held accountable. First, “illicit behavior involving thousands of people and two million fraudulent accounts cannot be dismissed as the work of a few bad apples”. Second, the systemic Wells Fargo’s “problems here stemmed from “cross-selling” — soliciting customers to buy multiple products — which Wells Fargo has promoted as the cornerstone of its retail business model” and what Stumpf was pushing, pushing, pushing. Third, and finally, having been made aware of the problem, it was on senior management to then prevent further illegal activity and remediate the issues.

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Yet the overriding function of senior management is to establish the corporate culture. Even if there were three years of culture and ethics training not to break the law; if an employee’s supervisor was on the back of an employee each afternoon at 3 PM asking about the number of cross-selling calls made that day or your job is on the line, the message is clear. Culture means more than having a robust paper Code of Conduct or even saying we do business the right way; it means you must burn those values into your company. Not that you will be fired for missing your monthly sales quotas. Ochs wrote, “Culture can feel amorphous, and it is always tempting to blame the systems; they are more tangible and easier to deconstruct. But the impact of corporate culture cannot be overstated. For example, sales targets exist in many industries — the key is how they are met. Intimidation, public shaming and micromanagement — as alleged by Wells Fargo employees — will create a culture of fear in which people think they must deliver at any cost.” What about the Board? They are far from blameless in this fiasco as well. It turns out they were informed about the illegal activity back in 2014. Although you might wonder why it took CEO Stumpf one year to inform the Board? What did the Board do when it was informed of this issue? Where were the Board’s actions to protect its shareholders? Where was the Board’s audit committee? These questions have not been answered, as yet, but one thing is certain, the once solid reputation of Wells Fargo now lays in shreds. This reputational risk is the province of the Board and as noted in a Financial Times lead Op-Ed Piece, entitled “The high cost of Wells Fargo’s sales practices”, this matter has demonstrated that “trust is the most precious currency in banking. Without it the system is prone to dry up, with dire consequences for institutions and to the detriment of the public.” The FT piece ended with the following, “Confidence in banking requires boards to accept their responsibilities.” Interestingly, one of the reasons for the seeming Board inertia is that Wells Fargo’s Board of Directors is older and longer-tenured than other US banks. Could this have played into its seeming inertia when it came to this scandal or simply the fact that the monies generated by the fraud were so small and certainly not material to a $50bn plus sized organization? In another FT piece, entitled “Wells scandal stiffens resolve to end board inertia”, reporters Stephen Foley and Alistair Gray noted, “Wells has some of the oldest and long-serving directors among 17 US banks with more than $100bn in assets” with the tenure of director at 9.7 years and an average age of 64.5 years old. Another concern raised in the FT piece was that there is one person in both the CEO role and the Chairman of the Board role. One shareholder activist, Gerald Armstrong, said he planned to “resubmit a proposal for an independent chairman at the bank’s annual meeting next spring.” Armstrong, as quoted in the article, said “How can they argue against my proposal now? Where

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is the board? Where is the audit committee of the board? It appears they go to the meetings, pick up their cheques and they go home.” As CEO Stumpf was also the Chairman of the Board, it might reasonably be asked if the relationship was too cozy and it might well be time to consider Armstrong’s proposal. The most pressing issue will be of clawbacks. In an article in the WSJ, entitled “Wells Fargo Board Comes Under Fire”, Michael Rapoport and Joann S. Lublin reported that Senate Banking Committee members were very critical of the Wells Fargo Board of Directors. But more than the theater of any major Congressional hearing, investors also expressed frustration that the bank has not “moved aggressively” to remediate the problems at issue. The article noted, “In particular, the board’s oversight of the bank’s compensation is under fire because of an incentive-pay structure that fueled the scandal by rewarding employees for selling more products to existing customers. Some think the board should have realized the bank’s pay incentives would lead to misbehavior.” Jill Fisch, a University of Pennsylvania law professor, was quoted for the following, “You might say the board of directors should have been sensitive to how the compensation structure might have induced them to behave that way.” In his Senate testimony, Stumpf demurred on questions relating to salary and compensation clawbacks for executives saying that was for the Board to decide. However, with the now former head of the consumer banking group due to retire with a package estimated to be worth up to $127MM, it is clearly a very large question. It is also one of optics, with, at this point, seemingly low level hourly workers terminated over the scandal and no executives terminated, sanctioned or in any manner disciplined. In this Senate testimony, Stumpf could not name one executive who had been in any way disciplined or terminated over this scandal. Part IV-Clawbacks I thought about criminal history whilst reading about the clawbacks ordered by the Wells Fargo Board of Directors of $41 million from current CEO John Stumpf and $19MM in unvested stock awards from the now retired former head of the consumer banking group, Carrie Tolstedt. Most people wondered why it took the Wells Fargo Board so long to administer this obvious sanction. Indeed, Gillian Tett, writing in the FT in a Comment piece entitled “Clawbacks emerge as a vital weapon in finance”, wrote, “In some respects this seems like too little, too late. The board only imposed this clawback after five Democrat senators wrote a letter to the bank complaining about the issue — and Mr Stumpf delivered a truly dreadful performance in a Congressional committee. It would have been far more commendable if the Wells board had acted before it was pushed.” Gretchen Morgenson, writing in the Fair Game column in the New York Times (NYT) in an article entitled “Executive Pay Clawbacks Are Gratifying, but Not Particularly Effective”, said, “But the move came almost three years after the improprieties came to light — and should serve as Exhibit A for the shortcomings in these pay recovery programs.”

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Other than agreeing that the Wells Fargo Board was a day late (if not a dollar short) in requiring clawbacks, the writers very much diverged on the effect of this action they perceived on banks specifically and in the wider business market in general. Tett said this action may well be seen in the future as a “watershed moment” as it marks “the first time that a board has imposed a tangible clawback of this size, let alone against a chief executive.” Morgenson wrote such actions have been rare and may well continue to be rare in the future. The main reason is that executive compensation “policies are written to cover only a portion of an executive’s pay.” She quoted James F. Reda, managing director of executive compensation consulting at Arthur J. Gallagher & Company, for the following ““Clawbacks extending to all types of compensation are uncommon. They typically only apply to the cash portion and only to the top executives.”” Moreover, she noted, “recoveries are generally restricted to cases in which accounting improprieties are significant enough to force a company to restate its results. Or a company will require clawbacks only if the pay was based on inaccurate financial disclosures. Wells Fargo’s policy contained both of these stipulations, neither of which applied to the account-opening scandal. Instead, the board apparently relied on a third policy” and “That policy covers actions that harm the bank’s reputation.” Morgenson provided a couple of other reasons Boards rarely order clawbacks. The first is the Board has to find there was misconduct and then determine that the misconduct was material. She cited, “Steven A. Bank, a law professor at the University of California, Los Angeles, and an expert on executive pay, said he was unsurprised that clawbacks are so rare. One major reason, he said, is that corporate directors are typically given enormous leeway in deciding when to pursue them. Unless they are forced to do something, they probably won’t.” As to the second “element of discretion inherent in clawback programs relates to the board’s judgment over whether any wrongdoing has a material impact on the company. This concept of materiality is famously subjective, giving directors lots of room to determine that improper activities were not in fact meaningful enough to recover pay”. She cited to George S. Georgiev, an assistant professor at Emory University Law School, who said, “The nebulous nature of materiality is a problem in these matters.” Further, Boards are more accustomed to awarding pay and not taking it away. Finally, there is simply the question of whether the Board members were equipped to perform the job duties of Board member. Morgenson wrote, “corporate directors tend to weigh them in a narrow, rules-based way when they should instead take a broader, more common-sense view.” She quoted Frederick E. Rowe Jr., chairman of Greenbrier Partners, a money management firm in Dallas, for the following, ““directors ought to know bad behavior when they see it. It all comes down to this: Are you doing something to the customer or for the customer?” That seems a pretty simple question. Too bad the Wells Fargo board didn’t think to ask it.”

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Yet changes may well be coming. Tett wrote that the Securities and Exchange Commission has proposed new regulations which would require companies to institute policies requiring senior executives to pay back incentive compensation which was “erroneously awarded” but these regulations are still two years out from taking effect. But with Congressmen from both parties howling at Wells Fargo, it may well be this remedy is made more forceful by the SEC in response to concerns from Congress. Tett also had the fascinating idea which should drive abject fear into the heart of any banker. It was that Deutsche Bank could raise $1.5bn of the amount it needs to settle with the US government by recouping “currently unvested compensation awarded to [its] bankers, and cancelled 2016 bonuses.” Now that might well generate enough fear into bankers’ hearts that they might actually follow the law. It might even be appropriate for this scary month of October. Part V - Compliance is the Answer I end with a review of the Wells Fargo scandal by considering what is at issue and what is at stake in this imbroglio. Unlike a FCPA violation, Wells Fargo paid the relatively paltry amount of only $185 million in this round of fines and penalties. The bank may end up paying much more if other enforcement agencies move to fine the bank for its conduct. Yet here is the kicker, the profits generated by the bank opening some two million fraudulent accounts and products were in the neighborhood of $400,000. It is this final number that I find most stunning. So let’s run the numbers. Here is a company with a market cap of $234 bn, that engages in fraud that generates it $400,000. Now consider the costs of that fraud to date, we have the initial $185 MM, then we have the reported $60 MM Wells Fargo paid in pre-settlement investigative costs, now add a further $50 MM, per their announcement earlier this month, for post-settlement remediation costs. So far the bank is up to $295 million in costs, fines and penalties. Add to that the $6bn in market cap the company lost since the announcement of the fine. This is where it stands now and it is certainly not going to get much better soon for the bank given its pathetic and even abysmal public response to-date. Now consider the underlying cause of this stunning amount. It was simply cross-selling of products and services. There is nothing inherently evil, nefarious, bad or illegal in the cross-selling of financial institution products and services. Indeed, when my banker contacts me to tell me about a new product or service, I am always pleased with the touch of such personal service. I meet annually with her to go over my accounts, products and services my bank offers and at that time I also learn about what is newly available. Is she trying to sell me something or offer me a better banking experience? The answer is of course YES to both. But, that is how business is conducted; a seller has something a buyer wants or needs. It does not get more basic than that. I have never worked in any business where there was not some pressure to perform. As an associate at a law firm, I was expected to bill hours, bill hours, and then bill hours. As a partner

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at a law firm, I was expected to bill hours and generate business for the firm so the associates could bill hours ad naseum. In every other business I have worked there was always pressure to sell. So it is not pressure to sell that is inherently evil, nefarious, bad or illegal. It is only when the pressure to perform, whether to keep one’s job, make a salary or earn a bonus becomes so overarching that people engage in illegal conduct. Does anyone think Wells Fargo Chief Executive Officer John Stumpf told Wells Fargo employees to create false accounts or saddle customers with products they neither needed or wanted to meet the self-styled motto of cross-selling the companies services and products, “Eight is Great!”? Of course he did not. Did Stumpf even say something along the lines of “Will no one rid me of this meddlesome priest”? Probably not. (At least, not that we know about as yet.) There was something else going on at Wells Fargo and the most succinct single sentence on it was written by Duke Law School Professor Samuel W. Buell in an article for the online publication Slate, entitled “Prosecuting Wells Fargo Executives Won’t Solve Anything”. Buell said, “As is almost always true with big corporate scandals, the problem at Wells Fargo was not bad apples but a diseased orchard.” Put another way, the culture at the bank was so driven to cross-sell products and services that employees would do anything to meet that culture, specifically engaging in unethical and illegal conduct. Employees were rewarded for meeting that culture and punished for not meeting it. It was the culture of Wells Fargo that was rotten. That culture always starts at the top and that is what CEO Stumpf is guilty on; if not implementing such a sales culture, certainly facilitating it. (AKA eight is great!) What can or should be done to Wells Fargo? From the regulatory perspective, the company will no doubt pay more fines and penalties. Certainly the bank’s costs in responding to such regulatory efforts will be much greater than its outlay to-date. Yet the current criminal law is not a place that is designed to punish a company that has a rotten culture. As much as Senator Elizabeth Warren may harangue that Stumpf should be criminally prosecuted, it simply is not going to happen. The prosecutions of senior executives in the Enron and WorldCom era involved C-Suite direct involvement in the accounting frauds perpetrated by those organizations. In the financial institution industry, one need only look back further to the savings and loans crisis from the late 1980s to see other types of fraud in the banking industry which did send bank executives to jail but in all those cases the executives engaged directly in the fraud. Professor Buell believes, “the real reason criminal law has not delivered us from corporate troubles is that it does not have the capacity to do so.” Moreover, the very reasons that the corporate form was invented was to diffuse responsibility and liability. These underlying reasons were, of course, very different in the coffeehouses of 16th century London, where the main concerns were around trade across the globe and a structural entity which would limit losses of English shipping companies. Yet it is that structure which is still with us today.

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Does all this mean we should just give up, as some have said, repeal such laws as the FCPA and simply admit that companies will always engage in bribery and corruption? I think the clear answer to repealing the FCPA and not continuing forward with the foremost piece of anti-corruption legislation is that it is not in the interest of the United States to do so. The FCPA was passed, in part, so that foreign purchasers would have confidence that they received the goods and services they contracted for and that US companies would be able to correctly state that bribery and corruption are antithetical to US law. While not foreseen in 1977, it now turns about out that commercial businesses engaging in bribery leads to corruption which has become one of the underlying causes of international terrorism, so for that reason alone aggressive enforcement under the FCPA must continue. How does a company stop from finding itself in shoes of Wells Fargo going forward? The first thing the Board must do is make a clean sweep, as in sweep out the senior management which allowed the culture to come into being, festering until it affected the entire organization and even after being told about it, allowed it to continue. Is the Wells Fargo Board up to the task? Only time will tell on that score. This is where compliance comes in, as compliance is that is the answer. The Chief Compliance Officer (CCO) must be given the resources and real authority in the company to ask questions when it is determined that employees broke the law in routine sales transactions. If the CEO will not concern him or herself with the culture of an organization, the Board of Directors must do. The leader should ask, “Are we doing everything alright?”. Even if a company is doing something wrong which is so financially insignificant to not even raise an eyebrow, if it is left to fester and grow the results can become catastrophic. If the $400,000 profit for the two million fraudulent accounts and services is correct that is just over $60,000 profits annualized. What is $60,000 annually to a $234 bn sized company - it is smaller than nothing. Yet even at a $60 bn company, it turns out that something as simply selling banking products can get an organization into much trouble, cause hundreds of millions of dollars in fines, penalties and related costs and drive multi-billion losses in the capital markets. It was not that the bank was not vigilant as the bank first became aware of the conduct as early as 2009. However, someone at the organization has to care enough to stop illegal conduct before it moves to the scale it did at Wells Fargo. Why no one cared to do so will be something the Board of Directors and the shareholders of Wells Fargo will rue for years to come. When a corporate culture is so toxic that if you do not meet unreasonable sales quotas, it really becomes your money or your (employment) life.

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of the author. The author is not, by means of this publication, rendering business, legal advice, or

other professional advice or services. This publication is not a substitute for such legal advice or

services, nor should it be used as a basis for any decision or action that may affect your business.

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© Thomas R. Fox, 2016