MSFA 728-02 N.Weggeland Wells Fargo PDF

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MSFA 728-02 Ethics and Finance N. Weggeland Assignment #2 Wells Fargo’s Unauthorized Accounts This assignment discusses the violations of the CFA Institute Code of Ethics through Wells Fargo’s account scandal that unfolded in 2015 when allegations arose that Wells Fargo employees were engaging in illegitimate sales practices which the CFPB deemed UDAAPs (unfair, deceptive, or abusive acts and practices) by opening deposit accounts, applying for credit accounts, and issuing debit cards without customer authorization, resulting in fining the bank $185 million (the largest CFPB fine to date). There are several aspects that contributed to expanding the already unnerving dimensions of this scandal: 1. The fact that Wells Fargo was a top competitor in the banking industry and well trusted American institution. 2. The source of the scandal, which was the fact that the exploitation of existing employee compensation incentives was only possible due to poor monitoring by supervisors and executives. 3. The fact that this scandal unfolded only 6 years after the financial crisis of 2008. Wells Fargo implemented the sales strategies contributing to the scandal in 2002 and continued to build profits because of them despite tightened regulations (especially in regard to [Top-Management] compensation incentives; think Enron, among many others) after the crisis. The CFA Institute Code of Ethics and Standards of Professional Conduct describes the need for its members and candidates to act with integrity, competence, diligence and in an ethical manner when interacting with stakeholders. To meet these standards members are encouraged to exercise independent professional judgment whilst practicing and encouraging others to practice their

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MSFA 728-02 Ethics and Finance N. Weggeland profession in an ethical manner that will reflect positively on themselves and, in return, the profession itself. The CFA Code of Conduct continues to identify seven main ethical standards: 1. Professionalism, 2. Integrity of Capital Markets, 3. Duties to Clients, 4, Duties to Employers, 5. Investment Analysis, Recommendations and Actions, 6. Conflicts of Interest and 7. Responsibility as a CFA Institute Member. Following we will examine which of the standards were mostly affected by Wells Fargo’s Scandal regarding opening unauthorized accounts. Duties to Clients. Wells Fargo’s mission states the priority to help customers succeed financially, priding itself on customer loyalty and long business relationships with its clients. As of 2015, the bank had $1.9 trillion in assets under supervision and business relationship with one third of American households. Clearly, the first CFA standard violated is Wells Fargo’s Duty towards its clients, blatantly ignoring set company mission. The first underlying standard affected is III.A. Loyalty, Prudence and Care. Members have an obligation of loyalty to their clients and must act with reasonable care while exercising prudent judgment. Wells Fargo incentivized its employee to cross-selling and san-bagging client accounts, by basing a portion of employee compensation on the number of accounts they sold within a given period. Crossselling describes the practice of expanding customer’s relationship through sales of multiple accounts and services, with Wells Fargo promoting that “eight [financial products and/or accounts] is great”. More Accounts meant more client fees to profit of off in the first place, violating both the Loyalty and Care aspect of CFA standards. In Addition, it disrespected underlying standards III.B and C: Fair Dealing and Suitability. Many employees falsely informed customers that certain banking 2

MSFA 728-02 Ethics and Finance N. Weggeland services had to be purchased in bundles with other banking services in order to sell more accounts, which greatly affected the aspect of fair dealing. The violation of fair dealing becomes especially apparent through the practice of sandbagging. An intentional delay in opening legitimate accounts to fall under new sales reporting periods for the Wells Fargo employee. This increases the potential impact on a client’s financial stability, especially if clients were trying to open business accounts with Wells Fargo. The aspect of suitability was already greatly compromised by prioritizing the objective of opening a great number of new accounts over customer satisfaction and service. Not all clients actually have the need and actually more cost than value through maintaining eight different financial instruments. Instead, the CFA institute recommends for members to make a reasonable inquiry into a client’s financial situation before making any financial recommendations. Most important, the institute states that employees must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests. Well Fargo, often described as a profit-making machine with an “aggressive sales culture” made it impossible to work ethically by this definition. It seems everything in regard to sales incentives was set up to exploit ethical standards. Wells Fargo required simulated funding to each account in order for employees to gain compensation on each newly opened account, therefore actively engaging behavior of employees to rerouting client’s funds without their permission to fund the fraudulently opened accounts they didn’t know anything about. To make matters worse, the bank imposed sanctions upon employees for not following their sales strategy as there were several employees fired for refusing the malpractice. Which leads us to the next CFA standard that was impacted: Conflict of Interest. The IV.A. section of disclosure of conflicts within the code of conduct 3

MSFA 728-02 Ethics and Finance N. Weggeland states that members must make full and fair disclosure of all matters that could reasonably be expected to impair their independence and objectivity or interfere with respective duties to their clients. Clearly, Wells Fargo employees were completely impaired in respecting this work standard by the sales culture imposed by their employer. Another rather interesting standard that was violated by the scandal was VI. C. Referral Fees. Interesting, because abiding by it could have completely prevented a scandal to unfold. Members must disclose to their clients as appropriate, any compensation received from others [here: their employer] for the recommendation of products or services. If employees were disclosing the fact they receive additional compensation by selling more accounts to their clients, it would have a stressed a certain thoughtfulness reaching certain sales objectives. Additionally, many clients might have decided to not open accounts with Wells Fargo, possibly forcing the financial institution to rethink their sales strategy. Lastly both Wells Fargo executives and employees violated the CFA Institutes conduct of Professionalism in regard to B. Independence and Objectivity, C. Misrepresentation and D. Misconduct. Members must use reasonable care and judgment to achieve and maintain independence and objectivity in their professional activities and just refrain from any measures impairing them. As discussed previously the core compensation incentive impaired Wells Fargo employees to follow this standard. However, the sheer disregard of Professionalism and Objectivity to gain Bonus and Profits is staggering. The Bank fired 5,300 involved employees that opened 1.5 million deposit accounts and 565,000 unauthorized credit cards, while issuing debit cards without the customer’s knowledge or consent, additionally enrolling them in online

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MSFA 728-02 Ethics and Finance N. Weggeland banking. Consultants findings later brought the number of opened accounts to 3.5 million, a 70% increase over the bank’s initial estimate. Which could be an indicator for active Misrepresentation, in order to save face during the scandal. One certain one is the fact that executives may have intentionally misled lawmakers in its previous court testimonies, prior to the scandal completely unfolding in 2015, resulting in 33 consumer groups urging congressional leaders to question Wells Fargo executives once again about the bank’s misconduct. That said, Wells Fargo never publicly admitted or denied the findings of the CFPB, yet agreed to remedial actions. Another proof of violating professionalism and misrepresentation is the fact that Wells Fargo has made great efforts to diffuse legal cases (also called arbitration), possibly with the objective to increase duration and certain parties to cease investigations. Last, but certainly not least is the fact that Wells Fargo engaged in Sales Misconduct. The CFA institute states members must not engage in any professional conduct involving dishonesty, fraud, or deceit or commit any act that reflects adversely on their professional reputation, integrity, or competence. This standard was clearly violated both by Wells Fargo employees and executives with Shearman & Sterling identifying sales misconduct dating back to at least 2002. What could Wells Fargo done better? While basing the compensation scheme on numbers of accounts sold is not necessarily illegal or unethical it was the poor implementation and control by executives that aided in employees exploiting it. Probably because they were held accountable to same compensation scheme. In combination with its employees barely working at minimum wage, plus pressure to perform, this sales strategy was ideally set up for abuse. Wells Fargo could have set

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MSFA 728-02 Ethics and Finance N. Weggeland alternative performance measures in addition to the existing one, and based compensation upon a matrix of these performance indicators. Fortunately, Wells Fargo has undergone measures to restructure the business: They’ve hired two consultants aiding them in meeting the requirements of the CFPB order while investigating the existing sales strategy and making recommendation thereof. In addition, the bank has increased their employee’s minimum wage while paying back most of their client’s losses. That said, the total of damages seems hard to accurately measure and so is the fact whether or not Wells Fargo has repaid all damages. More certainly, is the impact of the scandal for the banking industry. With banks still recovering from the 2008 crisis, Wells Fargo sadly proved that misconduct

still

wreaks

havoc

among

America’s

most

prominent

financial

institutions, with tightened regulations having little impact on the implementation of ethical leadership and strategy.

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