> Posted by Nadia van de Walle, Lead, Africa Partnerships and Programs, the Smart Campaign

The following is part of the Smart Campaign’s #FintechProtects mini campaign. We’re raising awareness about responsible digital financial services, spotlighting work from the Smart Campaign and others, and engaging with industry actors on how fintech can move forward in a way that’s best for clients. For more information on #FintechProtects, and to get involved, click here.

Do you have a credit card you don’t know about? Last week, we learned that over 5,000 employees across Wells Fargo, the United States’ biggest home lender and one of the nation’s largest banks, had opened at least two million unauthorized deposit and credit card accounts in clients’ names. In an effort to meet high sales targets and earn bonuses, bank employees transferred funds from customers’ existing authorized accounts to unapproved accounts in customers’ names. Clients had not consented and were mostly unaware of this, despite incurring late fees and other charges on these new unapproved accounts. The widespread practice had somehow gone undetected for 5 years.

The U.S. Consumer Financial Protection Bureau (CFPB) and the Office of the Comptroller of the Currency announced that Wells Fargo would be fined $185 million and will have to pay $5 million directly to customers who incurred costs. The bank also faces a related Los Angeles County Superior Court lawsuit. The bank has agreed to resolve the CPFB allegations but refused to admit wrong-doing. Regardless, the bank’s reputation has taken a hit. Wells Fargo will have to respond to difficult questions during next week’s September 20th Senate Banking Committee session.

How could such extensive fraud happen at a major bank with a solid reputation for customer service in a well-regulated market? We at the Smart Campaign have long cautioned about the very thing that caused this widespread breach of customer trust: inappropriate staff incentives.

The bank has historically mandated and incentivized staff to “cross-sell” existing customers for additional products and services. While many peer institutions do this today, cross-selling was a big part of Wells Fargo’s success story in becoming an industry leader. Its former CEO is widely seen as having invented the cross-selling strategy. Banks often see cross-selling as a way to increase profit.  After all, a client simply in need of a checking account is less appealing than that same client who also has a credit card and other products, especially products that generate regular fees.

Wells Fargo’s pursuit of cross sales led it to organize its staff incentives around targets that motivated bank employees to open new accounts in order to meet sales goals and earn bonuses. Employees who cannot make the number of expected deals were tempted to engage in aggressive sales, or even, as happened in this case, turn to fraudulent practices. At the Smart Campaign, we emphasize the importance of pay and commission structures in ensuring positive client treatment and limiting risky practices. After all, staff with adequate base pay are less likely to push bad loans on customers than those desperate for better commissions. We have focused mainly on the risk that poorly designed incentives will provoke loan officers to approve risky loans. The Wells Fargo example demonstrates that the same problem can occur in any aspect of bank operations. We recently drafted a tool for the providers we work with describing non-financial incentives to improve performance. It targets outcomes that relate to both portfolio growth and strong customer service. Such incentives can for instance be a powerful long term motivator for sustainable accomplishments, teamwork, and portfolio quality.

This incident spotlights the importance of effective disclosure and client engagement. While it appears that most clients were completely unaware that their names were used in unauthorized accounts, and that Wells Fargo employees effectively “leapfrogged” disclosure, there were instances after the initial account opening where clients became aware that they had a “surprise” account. Some received debit cards they did not request or paid overdraft charges and insufficient fund fees for these accounts. Would financial education, clearer explanations of fees, or knowledge of their right to efficient recourse have made a difference? Not likely. The focus here would be on how to ensure disclosure at the relevant time (i.e. upon account opening) and in ways that capture client attention.

The Wells Fargo case raises governance questions. Could the board have implemented any internal controls to detect such widespread fraud? Was the board aware of the employee culture and incentives? Has the focus on e-commerce meant a greater disconnect from end-clients? This was, after all, not an isolated incident with one ringleader but rather widespread, blatant, and pervasive, at a scale that suggests a very problematic corporate culture. Bart Naylor, a financial policy advocate for Public Citizen, said “There are two possibilities: Customer abuse was part of the business model, in which lots of high ranking people need to go to prison. Or the bank is too big to manage, and folks high up don’t even know that laws are being broken a few levels down.” Given that thousands of employees were involved, risk management monitoring, staff training whistle blower policies, and auditing measures were clearly missing or ineffective. It is especially troubling that Wells Fargo is only now considering limiting bank sale goals and doing away with cross-selling to rebuild consumer confidence – because these issues are not new in the industry. In fact, The Los Angeles Times first reported such fraud at Wells Fargo in 2013 and The Wall Street Journal began uncovering related trouble in 2011, according to New Yorker journalist Adam Davidson, and this was the same period that Wells Fargo CEO John Stumpf made $20 million and won two prestigious banking CEO of the Year awards. Comparisons to the stonewalling behavior of Volkswagen about its massive diesel engine fraud are apt here.

Ultimately, responsibility for this fiasco lies at the top, with CEOs and investors. We’d like to know to what extent Berkshire Hathaway Inc., Wells Fargo’s largest shareholder, emphasized consumer protection to the bank’s leadership. To date CEOs have not had to worry about personal criminal prosecution or job-jeopardizing fines.

The fine levied in this case and the CFPB’s decision are historic. But compare the $185 million fine CFPB levied with the compensation that will follow the executive who headed the unit into retirement: $124 million according to Forbes. The fines themselves are a small price to pay for a very large, profitable bank. The hit to the bank’s reputation will be more important. We hope consumers take action in response. At the end of the day, Wells Fargo fired 5,300 lower-level employees. Meanwhile, as Davidson points out, Stumpf was recently reappointed to the Federal Reserve Board’s Advisory Council, mandated to provide guidance to our nation’s leading bank regulator.

 

It may unfortunately come as no surprise that it is not just in the United States, a country with relatively strong laws and regulatory practices, that such bank fraud occurs. In fact, as highlighted by a recent case in India where bank officials, under pressure to improve zero balance account numbers, were dressing data by themselves making one rupee deposits to client accounts, low-income clients are particularly vulnerable in developing markets with weaker regulatory environments. In an effort to protect all customers, the Smart Campaign continues to advocate for standards of consumer care, provide tools and incentives to financial service providers, and give low income clients a voice. Our goal is to integrate client protection practices into the institutional culture and operations of financial institutions all over the world.

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