Wells Fargo Incentives Lead to Fraud

Wells Fargo, one of the largest banks in America, was fined $185 million for the company’s fraudulent selling practices. A Wall Street Journal article¹ reports, “Federal regulators announced that Wells Fargo opened as many as two million deposit and credit-card accounts without customers’ knowledge.” Many former employees of the bank attribute the widespread fraud to the incentive structure and the pressure received from managers to reach the company’s ambitious sales targets.

Wells Fargo has been envied by its competitors for its high return on equity, with greater relative profits than other leading financial institutions such as J.P. Morgan. This success is a result of the focus on cross-selling more products (i.e. different financial services) per customer, a strategy it has faithfully followed since 1999.

However, some managers’ fierce dedication to this strategy led many lower level employees to create dummy accounts. Sales progress was closely monitored, requiring updated reports several times a day. Not meeting your targets was not something to be taken lightly, as many lower and mid-level managers lost their jobs due to their inability to consistently achieve their goals.

The account representatives and account managers also felt immense personal pressure to achieve sales goals due to the monetary incentives attached to their targets. With low base salaries those bonuses became very significant and highly desirable. A Harvard Business Review article³ explains how this type of incentive structure entices employees to make minor ethical compromises which then escalate and spread from there. The article reads:

“Consider the following sequence: A bank account manager, under pressure to make a sales goal to receive his bonus, pushes a customer to add a credit card, even though the account manager knows it’s not in the customer’s interest. Still short of the goal, the account manager asks his friends and family to open accounts. (The accounts are to be closed shortly thereafter.) With the goal still not achieved, the account manager opens accounts without asking customers and transfers a small amount of money. (The accounts are closed shortly thereafter and the money is transferred back.) As soon as the account manager gets away with the first unethical act, it’s not a big step to the fraudulent ones. The justification moves from ‘it’s legal’ to ‘no one is harmed’ to ‘no one will notice.’ When such practices are tolerated, they escalate in severity and spread throughout the organization.”

Wells Fargo’s CEO, John Stumpf, accepted full responsibility in his congressional hearing last week.² Over the past five years the bank has fired 5,300 employees for their involvement in fraudulent practices and has hired consultants from PriceWaterhouseCoopers and Accenture as well as several law firms to investigate the situation. However, it seems as though all that effort was too little, too late. 

Mr. Stumpf has received a lot of heat for this scandal, including requests for his resignation and calls for top executive’s compensation to be paid back to those negatively affected. Some have even questioned his competency as the CEO of such a large bank. The WSJ article¹ previously mentioned goes on to state, “In the 2010 annual report, Mr. Stumpf said he often was asked why Wells Fargo had set a cross-selling goal of eight retail banking products per customer. “The answer is, it rhymed with ‘great,’ he wrote. ‘Perhaps our new cheer should be: ‘Let’s go again, for ten!’” 

The bank said it will “scrap all product-based sales goals in its retail branches starting January 1.”¹  It is unclear why they are waiting until next year to implement this change aimed to alleviate the pressure experienced by employees that led them to these illegal practices.  Hopefully this scandal will help other companies see more clearly that extreme commitments to aggressive goals can potentially lead to fraud.

1.     http://www.wsj.com/articles/how-wells-fargos-high-pressure-sales-culture-spiraled-out-of-control-1474053044

2.   http://www.wsj.com/articles/wells-fargo-ceo-stumpf-i-accept-full-responsibility-for-unethical-sales-practices-1474326173

3.   https://hbr.org/2016/09/wells-fargo-and-the-slippery-slope-of-sales-incentives

Fraud Prevention in the Banking Industry

According to a recent article on Bloomberg, banks are considering using blockchain technology, the same platform used in bitcoin transactions. This change could prevent losses that are due to one particular type of fraud. Some companies are applying for and receiving financing from multiple banks, but are using the same invoice as proof of collateral for all of the banks. This allows the company to receive much more financing than they should be able to receive, and the banks lose a lot of money if the company defaults on their loan. This fraud is similar to if an individual were to receive several mortgages from various banks for a single house. If the individual were to default on their mortgage, they would keep a lot of cash, and the banks would each be left with only a portion of a house as collateral. The losses due to this financing fraud have been close to $700 million for banks such as Standard Chartered Plc and JPMorgan Chase.

Individuals Causing the 2008 Housing Crisis Receive No More Than a Slap on the Wrist

Following the 2008 housing crisis, several of the banks involved paid large settlement fines. JPMorgan Chase was one of those banks. The Justice Department used evidence from an anonymous whistleblower in the prosecution, but until recently the whistleblower remained anonymous. Matt Taibbi recently released an article in Rolling Stone describing why the whistleblower, Alayne Fleischmann, has gone public with what she knows. Ironically, the Justice Department wasn’t committed to bringing “justice” to those individuals who contributed to the fall of the economy through fraudulent activities. In fact, Attorney General Eric Holder said the following:

“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy, and I think that is a function of the fact that some of these institutions have become too large.”

What is the Justice Department doing if they aren’t bringing justice to those responsible for major crimes? When Fleischmann realized that much of what she reported to the SEC and the Justice Department was not being fully pursued, she decided she had to go public with what she knew.

Research Study Suggests That the Culture in the Banking Industry Leads to Dishonesty

Financial Times recently printed an article about a study done by researchers at the University of Zurich which suggested that bankers have a tendency to lie for financial gain. The study used a control group and treatment group of bankers. The bankers in the control group were asked questions about their everyday life (for example, “How many hours of television do you watch per week?”). The bankers in the treatment group were asked questions relating to what they did at work as a banker. They then gave each group a coin, had them toss it ten times, and then had them self-report their results. The participants were told beforehand whether heads or tails would count as a success. If no cheating took place, the average amount of heads compared to tails should have been very close to 50/50 for each group. In the control group this was the case, but the group who had been primed with thinking about their profession as bankers reported 58.2% winning tosses. From these results, the researchers estimate that 26% of the bankers in the treatment group cheated.