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Wells Fargo's Probe Finds Major Flaws in Company Sales Model

- By James Li

Wells Fargo & Co. (WFC) recouped approximately $136 million from two executives on April 10 following the company's investigation of improper sales practices.

During the investigation, the San Francisco bank's Corporate Risk division highlighted several root causes of the retail fraud. Two major areas include failure of top management to address the underlying problems and potential corporate risks resulting from its aggressive sales model.

Investigation summary

Wells Fargo settled a $190 million remediation with the Consumer Financial Protection Bureau Sept. 8, 2016, regarding its retail customer account scandal. With assistance from Shearman & Sterling LLP, the bank's board of directors launched a deep investigation of the company's management, including "seven in-person meetings, several telephonic meetings and numerous group and individual communications" according to the investigation results. Sherman & Sterling interviewed over 100 current and former Wells Fargo employees that had significant contact with sales practice issues during the past five years. Two key personnel are former CEO John Stumpf and Central California head Carrie Tolstedt. Additionally, the multinational law company investigated the relevant Wells Fargo accounts with data analytics company FTI Consulting Inc. (FCN).

The investigation focused on Wells Fargo's decentralized "run it like you own it" business model and aggressive sales culture, two root causes of the retail account fraud. The company emphasized high sales volume and consistent year-over-year revenue growth, measuring employees by performance relative to the goals.

John Stumpf situation

Stumpf championed Wells Fargo's decentralized sales model: as the company's sales practice issues worsened in 2013, Stumpf relied on the bank to fix the issues itself with little or no supervision. An optimistic executive, the former CEO initially ignored the issue as only a few employees were causing problems. Stumpf's dilatory nature in addressing the company's business model exacerbated its reputation as a leading global bank.

According to the investigation results, Stumpf, who testified that he is "fully accountable for all unethical sales practices in [Wells Fargo's] retail banking business" and his failure to address these situations promptly, forfeited $41 million in unvested equity awards Sept. 25 and resigned as chairman and CEO Oct. 12, 2016. On April 7 the company axed about $28 million of the former CEO's incentive compensation paid in March 2016 under the 2013 equity grant.

Carrie Tolstedt situation

On Sept. 25, 2016, Tolstedt had $19 million of her unvested equity awards and approximately $47.3 million of her outstanding stock option awards stripped for her contributions to Wells Fargo's account scandal. Although Stumpf praised her leadership abilities and "conservative decision making," other executives criticized her flawed practices as head of the California region. The investigation results reported that throughout her tenure, Tolstedt reinforced Wells Fargo's "high-pressure sales culture" and established "retail scorecards," constantly pressuring management to contribute to the company's mission to achieve high sales volume and revenue growth. The lead manager had a dogged devotion to the company's sales model even though it featured several flaws. According to the investigation, witnesses chided Tolstedt as a manager who "fostered an insular culture at the top of [Wells Fargo] and had an 'inner circle' of staff."

Corporate Risk division analyzes the company's sales model

According to the report, Chief Risk Officer Michael J. Loughlin began investigating Wells Fargo's sales model in 2012 once he became concerned with management's excessive sales pressure and "the possibility that it could result in employee turnover." Loughlin and Wells Fargo head of small business Lisa Stevens raised questions about the company's unrealistic sales goals and Stevens' frustration with company leadership. Matthew Raphaelson, the head of Strategic Planning and Finance, followed up Loughlin's ERMC meeting with a letter discussing how the company's sales goals were a "balancing act." As mentioned in the investigation results, Raphaelson carried Charlie Munger (Trades, Portfolio)'s phrase that "low goals do cause lower performance and high goals increase the percentage of cheating."

According to the investigation results, Loughlin reinstated the sales practices in the 2014 ERMC meeting. Throughout 2014, Loughlin instructed Tolstedt to improve the company's sales practice model. When Tolstedt gave an unsatisfactory report on the sales practices, the Corporate Risk division had to get more involved in the oversight of the sales practices. Although Loughlin and his team made good progress from 2014 to 2016, the investigation report mentions that there was "considerable work to do" in building a sustainable sales practices oversight program.

Disclosure: No position in the stocks mentioned.

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