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Why Wells Fargo CEO John Stumpf is on the hot seat

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Wells Fargo CEO apologizes for bogus accounts, and other MoneyWatch headlines 01:04

Wells Fargo (WFC) CEO John Stumpf is expected to face tough questions today from the Senate Banking Committee. Among the those grilling him will be Wall Street nemesis Sen. Elizabeth Warren (D-Mass.), who has described the bank’s unauthorized opening of millions of accounts as “a staggering fraud.”

Leaders of other financial institutions will be watching closely -- and reviewing their own policies governing sales efforts. Experts say sales incentives for financial products require serious monitoring against abuse, compensation structures with reasonable goals that reward honest performance and responsibility that stretches up and down the organization chart.

“Unchecked incentives can lead to serious consumer harm, and that is what happened here,” said Richard Cordray, director of the Consumer Financial Protection Bureau (CFPB), earlier this month in announcing a $185 million fine against the San Francisco-based bank.

Wells Fargo fined over fake accounts 02:17

Wells Fargo for years cultivated an industry-leading reputation for sales prowess, but revelations that its employees opened 2 million deposit accounts and credit cards without customer authorizations suggest a sales culture run amok. The Department of Justice has reportedly opened its own investigation, and the company’s shares have dropped about 8 percent since the CFPB settlement on Sept. 8, shaving about $18 billion in market value. 

The bank said it has fired more than 5,000 employees in connection with the fraud, which stretches back at least five years, and it has announced plans to eliminate the use of sales goals in its retail-banking division in 2017. 

Congress, suspecting mainly low-level employees are taking the fall, is seeking documents from the bank on a myriad of topics. 

Scrutiny from politicians, regulators and the media is unlikely to abate in the near term for Wells Fargo. That could put pressure on the bank and its share price, UBS analysts noted in a report, which drew parallels between the troubles at Wells, a favorite among blue-chip investors including Warren Buffett, and JPMorgan Chase’s (JPM) “London whale” scandal in 2012, in which a London-based derivatives trader lost $5.8 billion. 

“The bank’s sales culture has been viewed as a differentiating factor by both management and investors, and this announcement could dent [Wells Fargo’s] reputation as being a more Main Street focused bank,” UBS wrote.

Wells Fargo resumes sub-prime mortgages 01:59

Banking analysts at KBW say the controversy and ongoing investigations could deal serious damage to Wells Fargo’s reputation, but they’re unlikely to push its stock much lower than where it trades now, around $46 per share.

Large-scale incentive compensation programs were wildly popular at banks, particularly big ones, in the 1990s and early 2000s, but they fell out of favor more recently, other than for branch-level employees, said Sudhir Suchak, an assistant professor of finance at the University of Buffalo School of Management.

But that doesn’t mean the practice has disappeared. In announcing the Wells Fargo settlement, Cordray said banks commonly use employee sales targets and other incentives, leading to abuses.

Such programs require serious monitoring at all levels, Suchak said, making the extent of the abuse at Wells Fargo -- and slow response by management -- particularly striking.

“The key is monitoring and serious, serious monitoring,” Suchak wrote in an email. “Without that, it will not be successful. And that means monitoring by all levels at the bank, especially upper management.”’

Banks have several ways to structure sales incentives that avoid tacitly encouraging bad behavior, said Dan Hill, president of Hill Impact, a communications and government relations consultancy in Washington, D.C. The incentives themselves aren’t “the core of the issue,” he said.    

“The issue stems when a company creates a culture that values achievement over character, integrity and ethics,” Hill said. “In the case of Wells Fargo, it doesn’t appear they were upholding laws or their promise to protect customers. Financial institutions really need to implement systems that recognize and reward integrity and character, and not just performance.”

One simple solution would be to reward salespeople based on active accounts, rather than sign-ups, suggested John Rampton, CEO and founder of digital-wallet company, which uses a similar model to pay its associates.

Most of the fake accounts Wells Fargo employees set up for unsuspecting customers went unused until they received notices about unpaid fees or spotted unexpected blips on their credit reports.

“If an account is set up that’s idle, it still counts as a number but overall doesn’t count toward the bonus of an individual as the account is pointless,” Rampton said.

He said ultimately the top management at Wells Fargo including the CEO should be held responsible.

“They couldn’t get away with that many fake accounts without someone raising an eyebrow or knowing about it,” he said. “It’s been going on for a while.”

The Los Angeles Times in 2013 spoke with employees in nine states who “shared similar accounts of overwhelming, unrealistic pressure and even harassment” from supervisors pushing them to open new accounts, noted Paulina Gonzalez, executive director of the California Reinvestment Coalition, a nonprofit advocate for fair access to credit.

“That’s a systematic, companywide problem that originates from the leadership of the bank creating unrealistic revenue goals and then forcing front-line workers to try and meet them,” Gonzalez said in a statement. “For true accountability, the senior leadership at the bank who were responsible for this scandal, who knew about this problem and who profited from these ill-gotten gains, should be shown the door.”

The issues at Wells Fargo may be particularly egregious, but they aren’t isolated within the financial services industry, said Rasheed Hammouda, co-CEO of Bridge Financial Technologies and a former PNC investment adviser.

Banks will be reluctant to give up the revenue opportunities of cross-selling and upselling, so they aren’t likely to aggressively pull back.

“When these things happen, bank executives must take responsibility,” Hammouda said. “These perverse incentives are ultimately driven by high goal setting at the executive level, completely abstracted from the rank-and-file experience.”

Wells Fargo’s CEO now is emphasizing a “service” -- rather than sales -- culture. In a statement last week, he said the elimination of sales goals helps reinforce that message among employees.

“For the past several years, we have significantly strengthened our training programs, controls and oversight,” said Stumpf, “and have evolved our model to ensure we are rewarding deeper relationships and providing excellent customer service.” 

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