From 2011 to 2015, thousands of Wells Fargo (NYSE:WFC) employees decided to take matters into their own hands -- ethics and legality be damned.
Hounded by managers and beholden to the most outwardly aggressive sales culture in the bank industry, they were instructed and incentivized to use customer interactions in their "stores" (not branches) to cross-sell additional financial products.
Need to cash a check? Why not open a credit card as well, a Wells Fargo teller would ask if you walked into one of its locations. Or how about a savings account to supplement your checking account?
Anyone who's worked retail (as I have) knows how this goes. Once in a while, an unwitting customer will say "yes," but more often than not, they just want to cash their check and get on with their day.
For Wells Fargo's employees, though, it wasn't that simple. According to the Los Angeles City Attorney:
Wells Fargo has strict quotas regulating the number of daily "solutions" that its bankers must reach; these "solutions" include the opening of all new banking and credit card accounts. Managers constantly hound, berate, demean and threaten employees to meet these unreachable quotas. Managers often tell employees to do whatever it takes to reach their quotas. Employees who do not reach their quotas are often required to work hours beyond their typical work schedule without being compensated for that extra work time, and/or are threatened with termination.
The quotas imposed by Wells Fargo on its employees are often not attainable because there simply are not enough customers who enter a branch on a daily basis for employees to meet their quotas through traditional means.
So, what did Wells Fargo's employees do? They signed customers up for additional financial products whether the customers wanted them (or knew about them) or not. This allowed the tellers to keep their jobs (temporarily, as things came to pass) and get on with their own days.
Wells Fargo admits that as many as 2 million checking and credit card accounts may have been fraudulently opened for customers without their consent. And the bank's employees didn't just stop at that. They also surreptitiously transferred customer money into these accounts, sometimes causing overdrafts in the customer's existing, authorized accounts.
Wells Fargo chalks all of this up to rogue employees. "We never want products, including credit lines, to be opened without a customer's consent and understanding," said Wells Fargo spokeswoman Ms. Eshet to The Wall Street Journal. "In rare situations when a customer tells us they did not request a product they have, our practice is to close it and refund any associated fees."
Chairman and CEO John Stumpf doubled down on this in a memo to employees after the bank agreed to pay $185 million in fines to federal regulators as wells as to the City and County of Los Angeles. "As you know, every Wells Fargo team member is expected to adhere to the highest possible standards of ethics and business conduct, which are spelled out in our Code of Ethics," he wrote. "If you ever see activity that is inconsistent with our Code of Ethics, please report it immediately to your manager, HR Advisor, or our anonymous EthicsLine."
Moreover, says Wells Fargo, these violations represent an exception to its standard operating procedure, not the general rule. The accounts that were refunded for illegal overdraft and insufficient funds fees represented a fraction of 1% of the accounts that a third-party consultant reviewed for the bank, and refunds averaged only $25, Wells Fargo asserts in its defense. And while the bank fired 5,300 people, that too is only a drop in the bucket, it notes, when you consider that it employs more than a quarter million "team members."
Bigger than it seems?
The problem, of course, is that the scale of the problem belies Wells Fargo's rationale. We are, after all, talking about 2 million unauthorized accounts. And while 5,300 employees may account for less than 2% of its total headcount, it equates to more than 5% of the roughly 100,000 team members who work in its stores. That's a significant amount, and too large to be the work of rogue employees scheming in isolation. "You'd have a tough time organizing 5,300 people into a conspiracy, which makes me think that this was less a conspiracy and more a spontaneous revolt," writes Matt Levine for BloombergView.
The problem, so it seems, goes deeper. One could even argue that it goes to the heart of Wells Fargo's competitive advantage -- its, until now, largely unchallenged ability to ply customers with more products than any of its competitors. Insofar as I'm aware, it's the only major bank that routinely publishes its cross-sell ratio, the number of products its average retail customer uses.
In the most recent quarter, the average Wells Fargo retail customer used 6.27 of the bank's products -- be it a checking or savings account, credit card, car loan, mortgage, or whatever. This gives Wells Fargo a powerful advantage, as each of these products, in one way shape or form, produces revenue. It's one reason the California-based bank generates more revenue from each dollar of assets than all but two major lenders: U.S. Bancorp and Capital One Financial (Capital One is an anomaly in this regard in light of its heavy concentration in credit card loans, which yield more interest income than your standard commercial or consumer loan).
Given this, there's no getting around the fact that Wells Fargo's settlement with regulators is bad news -- as is, of course, the underlying behavior that led to the deal. It strikes at the heart of the bank's sales-oriented business model. It hurts Wells Fargo's reputation. And it cost a lot of money.
At the same time, though, if you're a Wells Fargo shareholders, as I am, there's ironically little reason to be worried about the impact all of this will have on your investment. In an interview yesterday, I was asked to guess how many of its customers were likely to leave as a result of the allegations. "Very little," I answered.
Par for the course
The fact of the matter is that this type of behavior is standard operating procedure for all of America's biggest banks. Their CEOs talk a big game when it comes to treating customers honestly and fairly, but the banks' actions over the last few decades contradict this.
For years, they quietly reordered their customers' daily debt card transactions to maximize overdraft fees. Let's say, for instance, that you made five transactions one day. The first four were for small purchases like coffee or to pay for parking downtown, while the last one was your mortgage payment. By processing the mortgage payment first, as opposed to last, which is when it landed in the actual chronology, banks increased the likelihood that you would overdraft on all five of these transactions as opposed to just, say, the last one.
"I used to sit in bank boardrooms and hear their executives refer to customers as deadbeats," the now-retired general counsel of a major bank told me last year when I asked him how bankers rationalize doing this.
And overdraft fees are just one example. The entire bank industry was also recently sanctioned for selling credit card add-on products, such as payment protection that would purportedly kick in if you were injured or lost your job. The problem was that the services didn't provide any actual benefits. If you were injured, it was almost certain your claim for payment protection would be denied. It's the oldest trick in the book. It reminded me of the people who peddled fake cures for the plagues that struck Europe in the 1600s. For all intents and purposes, the payment protection services were the modern financial equivalent of snake oil.
One could go on and on with examples like these. My point is that Wells Fargo is in good company when it comes to the alleged mistreatment of customers. So, while it's tempting to think Wells Fargo's customers will flee in droves, there's no safe harbor for them to set off toward, as every other major bank acts similarly. It was JPMorgan Chase and Citigroup, after all, that were pretty clearly complicit in something as egregious as the Bernie Madoff scandal. Both of these banks also acted as enablers for Enron. And, again, these are just a small handful out of many, many other similar examples of questionable conduct at the nation's largest lenders.
Why don't customers just abandon the big banks? This is, unfortunately, harder than it sounds, as high switching costs impede customers' ability to respond to mistreatment by leaving one bank for another. If you've ever wondered why banks will often wave account fees if you set up direct deposit and automatic bill pay, this is why. It's a nightmare to unwind all of these things, and particularly if you're living paycheck to paycheck, which accounts for a meaningful share of customers at large banks. This reduces the incentive for banks such as Wells Fargo and JPMorgan Chase to worry themselves sick over whether certain of their products defraud customers.
The net result is that Wells Fargo isn't likely to lose many of its customers over this, despite the horrible optics. In addition, while the $185 million fine levied against the bank was large, it represents a fraction of Wells Fargo's quarterly earnings, which typically come in around $5.5 billion, and has already been provisioned for, meaning the fine has already made its way through the bank's income statement. Shareholders will therefore be hard-pressed to see any impact from the deal on Wells Fargo's bottom line going forward.
If there is to be any impact, in turn, it's likely to be intangible. Assuming Wells Fargo substantively addresses the shortcomings in its business model, which incentivized employees to open accounts for customers without authorization, then it could affect the aggressive sales culture that has been one of the keys to Wells Fargo's success.
Still a great stock?
All of this being said, I'm still bullish on Wells Fargo. Yes, it has shortcomings, but it has fewer than many of its competitors. More importantly, it remains one of the most prudent banks in the industry when it comes to credit risk, which serves as the most potent threat to a bank's solvency. And, though all banks are struggling right now to generate respectable earnings in the most inhospitable environment for banks in three decades, Wells Fargo comfortably earns its cost of capital -- and thereby creates value for shareholders.
In short, despite the egregious nature of Wells Fargo's behavior in this instance, I continue to think its stock offers investors a lot of opportunity going forward.