How Wells Fargo Betrayed Its Customers

SMITH BRAIN TRUST — Finance professor Clifford Rossi at the University of Maryland’s Robert H. Smith School of Business says fraud allegations against Wells Fargo represent a failure across the board to identify and address a culture that emboldened "employees to elevate wrongdoing and risky activities without fear of retribution." Rather than facing discipline, some employees received bonuses after inflating sales numbers by secretly opening millions of fake accounts for customers without their permission.

The scandal cost the bank $185 million in fines last week, and now Sen. Elizabeth Warren, D-Mass., has called for Wells Fargo CEO John Stumpf to testify before the U.S. Senate Banking Committee about what she calls a "staggering fraud." In a column this week for American Banker, Rossi traces the problem to a breakdown in the application of guidance written by the Office of the Comptroller of Currency. Specifically, Rossi cites the failure of an edict called "Heightened Expectations" and the related concept of "Three Lines of Defense."

Heightened Expectations refers to an expansive set of regulatory guidance intended to firm up the risk management governance practices that were clearly lacking in the years leading up to the financial crisis. "It set out clear expectations for the board of directors and a three-layered firewall of protection against risk events," says Rossi, a risk professional who has battled risky behavior steeped in corporate culture at Citi and other big financial institutions. 

Line management under this construct serves as the first line of defense by owning the risk. "In this role they are on point to identify and call out risks that are going on in their business," Rossi says. "If, as the reports suggest, Wells Fargo terminated more than 5,000 employees over a five-year period for opening unauthorized accounts, the first line of defense collapsed."

The second line of defense in this structure is corporate risk management, intended to oversee and identify material risks that differ from line management. "Given the result, the second line of defense also failed the company," Rossi says.

Internal audit is the third line of defense. "It's meant in part to monitor and report on emerging risks through its periodic audit program," Rossi says. "The results suggest that all three lines of defense let Wells Fargo down."

The Wells Fargo allegations are especially shocking to Rossi because he says the bank has been a "paragon of risk management." He says reading the Consumer Financial Protection Bureau account of the scandal “was like finding out your favorite professional athlete just failed a drug test.”

Rossi says Wells Fargo's collective $185 million penalty isn’t even a flesh wound, considering the bank’s $5.6 billion second quarter net profit. The significant damage is to its brand, as the activity "severs the very foundation of the bond between customer and bank that even in the digital age is priceless."

The vigilance of the Office of the Comptroller of Currency might also be challenged, Rossi says, because the regulator has engaged itself as an on-site risk supervisor at Wells Fargo and other big banks. The scandal illustrates regulatory oversight, alone, as insufficient and "underscores the need for bank boards to insist on strategic plans that contain realistic objectives and incentive compensation plans that balance risk and return," Rossi says.