The evidence the article presented was far from anecdotal. There had been several lawsuits filed, some from customers alleging that Wells Fargo employees opened accounts or credit lines without their authorization, and others by employees of the bank alleging they had been forced to work unpaid overtime, in some cases to meet sales targets.
Various named sources at Wells Fargo were quoted as denying any wrongdoing and emphasizing the bank’s commitment to ethics. One of them was Timothy Sloan, the bank's CFO at that time, and now the COO.
So it seems odd that three years later, when the same story broke again in September – this time with the firm conducting an internal investigation into whether, between 2011 and 2015, its employees had opened accounts without customer authorization – that senior executives appeared shocked to learn that, yes, they had.
And not just in isolated cases. As many as 1.5 million debit accounts may have been opened without customer consent and as many as 565,000 credit cards issued. The malpractice was carried out by at least 5,000 employees – around one in 50 of Wells Fargo’s total workforce.
It is also incongruous that as recently as July 31 Carrie Tolstedt, the senior executive who oversaw the retail banking business at Wells Fargo during that period, was described by CEO John Stumpf “as the standard bearer of our culture” in the announcement that she would retire at the end of the year – taking with her a tidy sum of $93 million. (A sum that is coincidentally half the $185 million penalty just imposed on the bank by the Consumer Finance Protection Bureau, the Office of the Comptroller of the Currency and the City and the County of Los Angeles.)
The bank's board subsequently said she will forfeit unvested equity awards, valued at $19 million. Stumpf is to forfeit $41 million.
When there are incentives that drive unethical outcomes, then research shows that even the most ethical people may falter
- Azish Filabi, Ethical Systems
Stumpf attempted to defend his institution to the Wall Street Journal by pointing out those 5,300 employees had been fired over the issue, and claiming they were “not incentivized to do bad things”.
But even if there were not plenty of reports from fired employees revealing the intense pressure they were under to make sales at any cost, then common sense would say, as Jeremy Willinger, communications director at Ethical Systems points out: “If you’re going to claim to have 5,300 bad apples, you may as well admit what you really have is a bad barrel.”
The scandal at Wells Fargo has put bank ethics (or lack thereof) front and centre once again. The timing could not be worse for the majority of banks in the US.
In August the White House’s Council of Economic Advisers put out a report on regulatory impact on smaller banks – the community banks – that concluded by saying that the administration supported the move to tailor regulatory requirements because those smaller banks are closing due to compliance costs. The Wells Fargo scandal may now have blown the chances of that happening.
Dick Bove, senior analyst at Rafferty Capital, says: “Any discussions about easing up on the onerous regulation post-crisis are out the window. No Democrat or Republican in their right mind would look to put that bill through now that Wells Fargo has proved that banks are crooks.”
But there is a deeper issue here. Regulation does not equate to good ethics. So how can banks clean up their act?
Since the financial crisis, a growing and eclectic community has formed to address ethics in banking. Behavioural scientists, moral psychologists, meditation teachers and religious leaders are telling heads of finance how to solve a problem like bad ethics.
They are being taken seriously. Last year, speaking at the Bank of England, Thomas Baxter, executive vice-president and general counsel for the New York Federal Reserve, gave a rousing speech on the rewards of an ethical culture that stressed the need for reform.
He said: “A bank’s goal should be to provide service to its customers through financial intermediation... [IMF chief] Christine Lagarde sees this as a question of animating purpose – and I agree."
Even the Archbishop of Canterbury, Justin Welby, has called for financial institutions to reset to the first principle of service, playing a role in the world that contributes to “human flourishing”.
Among many salient points made by Baxter, he emphasizes the obvious, that punitive action is good, but too late to really resolve the issue.
One problem with punitive action is that while fines are necessary to demonstrate that the SEC and its counterparts have control over banks, those such as Wells Fargo’s $185 million are minuscule, given that its quarterly earnings are typically around $5.5 billion. The fine has already been provisioned for.
There have been much larger fines – most recently the $14 billion claim against Deutsche Bank for mis-selling mortgage backed securities, for example – but even big fines are paid and then quickly forgotten, even by the shareholders that must take the brunt of them.
A second problem is that the punitive action is always at a corporate level. Individuals are rarely held responsible. Worse still, there have been many cases where people who might be thought to carry some responsibility for the wrong-doing have walked away without punishment.
“If managers in the financial sector were held professionally responsible for the actions of their reports, they might be more careful about how they instructed and incentivized them,” says John Hendry, a professor at Cambridge University, who writes about bank ethics.
The case of Tolstedt at Wells Fargo seems particularly offensive. Even if she had no knowledge of what was happening in the 6,000 branches she oversaw, walking away with even a reduced $74 million hardly sends a signal to employees that ethics are important. It makes Barclays’ £2 million pay-out to Bob Diamond, who resigned in the wake of the Libor scandal, look virtuous.
Stumpf says the board is considering clawing back some of Tolstedt’s stock pay out, but cannot disclose the terms publicly.
What tends to happen in most of these cases is that junior employees are the ones who are most severely punished. In the case of Wells Fargo, many of the 5,300 employees shown the door were on $17-an-hour salaries. Hanging junior staff out to dry does not get rid of the problem. So what can?
Many would say that it comes down to 'culture', which is an unfortunately vague term; but with the help of behavioural scientists and researchers it is being fleshed out.
In March last year social psychologist and author Jonathan Haidt and a group of academics set up non-profit Ethical Systems, an organization that highlights and conducts research into ethics, applying that research not just to banks, but the corporate world in general. It looks at the systemic causes of unethical behaviour and how businesses benefit from good ethics. Haidt is also writing a book called ‘Three stories about capitalism’, a moral psychology of economic life.
Azish Filabi is chief executive of Ethical Systems. She says one of the challenges with the culture of most corporations is that the issue of ethics simply is not given deep enough consideration. Self-regard is an issue here. If you were to poll the CEOs of 100 companies, or even 100 random people on the street, and ask them if they believe themselves to be ethical, how many would say they are not?
Furthermore, ask those CEOs how they address ethics within their organization and they will likely talk about their investments in CSR, point to their huge compliance teams and mention their code of conduct, says Filabi. The discussion just does not go much further. When asked if they would like to talk about their ethics training, all the large US banks contacted for this article, with the exception of Citi, declined to comment.
Research makes it clear that ethics is a highly complex subject. For example, the 5,300 people at Wells Fargo cannot possibly have all been unethical. People who knew Tolstedt outside Wells always talked highly of her and remarked on her commitment to customers.
Rather, says Filabi: “When there are incentives that drive unethical outcomes – such as in the case of Wells Fargo employees being pressured to hit targets – then research shows that even the most ethical people may falter.”
No amount of psychological testing during the hiring process or referring people to the code of conduct (as Stumpf does in his post-scandal memo to employees) is going to help.
As Ethical System’s Willinger points out, compliance does not create ethics: “We think of it like having to keep on top of weeding a garden. It needs constant assessment and evaluation of what is working.”
While there are no easy answers, there are some things that every bank can look at. Leadership behaviour is key, says Willinger. If the CEO talks about ethics but is not firing managers over the lack of it, poor oversight or failure in responsibility, then that will send a signal to the rest of the firm about how seriously ethics are taken.
An ethical culture can also be instilled through incentive and compensation systems. In the case of Wells Fargo, compensation and incentives were directly linked to the number of new accounts opened. It is clear, at least with hindsight, that such a target at a bank could cause problems. There are only so many customers out there and bank sales teams, unable to find new customers but fearful of being fired, would be tempted to resort to unethical sales tactics under such pressure.
Rafferty Capital’s Bove points out that some banks have introduced compensation plans that reward employees based on customer satisfaction. None of Citi, Bank of America Merrill Lynch, Goldman Sachs, Morgan Stanley and JPMorgan would comment on the introduction of compensation on customer satisfaction rather than sales, although Fifth Third Bank says it “balances customer service goals with a sales approach”.
Firms that consider their operational model as service provider tend to have a better culture than those firms that consider their operational model as money maker
- Thomas Baxter, New York Federal Reserve
In order to tackle what seems to be a systemic problem, banks could be forced to adopt entirely foreign ways of working. The New York Fed’s Baxter, for example, points out that changing the language used by banks might be helpful. Using the word ‘counterparty’ rather than ‘client’ only strengthens the idea that customers are profit opportunities: they come to be regarded as something to be exploited.
“In my experience, firms that consider their operational model as service provider tend to have a better culture than those firms that consider their operational model as money maker,” says Baxter.
Filabi says research also suggests that highlighting ethical wins better inspires good ethics rather than negative discussion around ethics. Some banks are already employing this method of addressing ethics. Citi, for example, released a 12-part ethics and culture video series highlighting challenges senior leaders faced in their careers and the decisions they made. To increase engagement, Citi employees then could submit their own videos describing how one of the videos had inspired them.
More foreign still are practices such as meditation, but it is becoming part of the conversation. The CFA Institute of investment professionals is piloting a four-part meditation programme for its members. Jason Voss, who helped develop the programme over the last three years, says one practice has been found to have a positive impact on ethics. In several controlled tests it was shown that practicing a compassion meditation results in more ethical decisions being made, not only immediately after, but for a period of several months.
From loved to loathed
Changing the language, quoting archbishops, compassion meditation and making videos about the good ethics of our peers may sound too hokey for Wall Street, but as Baxter points out: “To those who are sceptical about the benefits of a strong ethical culture; if this is not a suitable method to prevent bad behaviour by bankers, what alternative proposal do you advocate? The status quo is not acceptable.”
Thomas Baxter, New
Not only is it not acceptable, it is not smart. Surely the greatest business case for ethics is simply the impact of a scandal on stock price. For example, Wells Fargo’s stock price was down year-to-date almost 16% on September 22, compared with Citigroup’s loss of 9%, Bank of America’s loss of 7.3% and JPMorgan’s increase of 2%.
It has gone from loved to loathed in a matter of weeks. Wells Fargo was the one big US bank to have largely avoided the fall-out from the financial crisis. Its stock had not just been trading higher because of its consistent and impressive earnings; potential shareholders would have been encouraged to hold the stock because it had not fallen foul of regulators in the same way as Bank of America or Citi. In effect, there was a CSR-related premium in the stock price. That is now surely gone.
In a gloomy assessment of Wells Fargo, Bove points to further investigations and the unravelling of a reputation that was built on being the safe pair of hands. Certainly it seems likely that Stumpf will be pressured to step down.
And recovery is a long road. Look at Volkswagen. Before the news broke last September that Volkswagen had cheated emissions tests its stock price was €165, now it is €118, having recovered from a low of €92.36. Ethical Systems points to studies that show not only is the stock price negatively affected by unethical behaviour, but financial performance in general is impacted for as much as five years if that behaviour results in a conviction.
This was highlighted in a Deutsche Bank-sponsored report last December stating that 62.6% of studies show a positive correlation between looking at environmental, social and governance (ESG) factors and financial performance. Increasingly analysts are taking ethics into account in their valuations. Morgan Stanley includes financial penalties and the reputational damage on future volumes in its ESG overlay on bank stocks.
If people lose trust in the financial companies that serve them, then what use are banks?
- Jason Voss, CFA Institute
Among the questions it asks bank management is: 'How do you define your company’s culture?' Those questions are likely to become more probing as banks ask researchers on ethics to provide guidance. As Voss points out, rethinking the questions themselves is part of the collective effort to address lack of ethics.
There is also evidence that ethical reputation impacts hiring. Although 12 years old, a study by Stanford University of 800 MBA graduates from 11 leading European and North American business schools found an overwhelming 94% of the students said they would be willing to forgo financial benefits to work for an organization with a better reputation for ethics and corporate social responsibility.
It is a similar case with clients. In Linda Treviño and Katherine Nelson's book ‘Managing business ethics’, the pair state that punishment for bad ethics comes from business partners as well: “When illegal or unethical conduct is revealed via the media, firms lose legitimacy with business partners such that, after the illegal conduct is revealed, their executives are more likely to serve on the boards of firms with lower reputations and profitability than before, and the company’s own board members are more likely to come from firms with lower reputations and profitability.”
Several commentators have been bold in stating that Wells Fargo is being unfairly lambasted for what is a routine issue for banks – the mis-selling of products. But ethical experts argue that it is that such actions are regarded as routine that is the problem, and it must change. For Voss, who in addition to being a meditation researcher, is also a successful trader and investment manager, good ethics are imperative if a financial system that is perilously fragile is going to survive.
“If people lose trust in the financial companies that serve them, then what use are banks?” he asks.
Solving the bank ethics problem will have a greater impact that many realize, says Baxter. “From the perspective of the supervisory community, an industry comprising personnel who have a strong ethical culture will be a safer and sounder industry, certainly safer and sounder than an industry full of miscreants. And this could be a powerful factor toward financial stability.”