Wells Fargo’s bogus customer account scandal is back in the news again, most recently because of the bank’s release on Monday of the report of its independent directors’ investigation of the bank’s improper sales practices. The April 10, 2017 report, which the bank posted on its website, makes for some interesting reading. Of particular interest, the report discloses that as result of the independent directors’ investigative findings, the bank has imposed compensation clawbacks on former bank officials in excess of $180 million. The clawbacks, which the bank said in its April 10, 2017 press release are “among the largest in corporate history,” raise a number of interesting issues, as discussed below.
The bank’s sales practices scandal arises out of a high-pressure sales strategy that led to as many as 2.1 million deposit and credit card accounts being created using fictitious or unauthorized customer information. In September 2016, fines and penalties totaling $185 million were imposed on the bank, including a $100 million fine by the Consumer Financing Protection Bureau, $35 million penalty to the Office of the Comptroller of the Currency, and another $50 million to the City and County of Los Angeles. In addition, in late March 2017, the bank agreed to a $110 million settlement of the consolidated class action that had been filed on behalf of bank customers who were affected by the improper sales practices.
The Independent Directors’ Investigation Report
Shortly after the regulatory fines were imposed on the bank, the independent directors on the bank’s board created an Oversight Committee to investigate the improper sales practices and to make recommendations to the independent directors. The Committee in turn hired the Sherman & Sterling law firm to assist the committee with the investigation. The investigation, which was extensive, is detailed in the report.
The report identifies “the root cause” of the sales practices problems was the “distortion” of the bank’s culture, which combined with aggressive sales management, “created pressure on employees to sell unwanted or unneeded products to customers” and to open unauthorized accounts. The report place much of the blame on says that John Stumpf, the bank’s former CEO, and Carrier Tolstedt, who headed the bank’s community banking business.
According to the report, Stumpf was “too slow to investigate or to critically challenge sales practices” at the bank, and also “failed to appreciate the seriousness of the problem” as well as the reputational risk to the bank. As for Tolstedt, the report (as noted in the Wall Street Journal) singled her out 142 times for setting the tone in the bank’s retail-banking unit. Tolstedt later “minimized and understated problems” in her division.
The Compensation Clawbacks
The report also discloses that as a result of the Committee’s investigative findings, the board determined that the bank will “claw back” approximate $28 million paid to Stumpf as incentive compensation in March 2016 under a 2013 equity grant, in addition to the $41 million in unvested equity awards that Stumpf agreed to forfeit shortly before his October 2016 resignation. The total value of compensation forfeitures and clawbacks from Stumpf is approximately $69 million. According to the New York Times (here), the $28 million that the board is taking back from Stumpf will be deducted from his retirement plan payouts.
The report also discloses that based on the investigative findings, the board determined that “cause existed” for Tolstedt’s September 2016 termination, requiring the forfeiture of $47.3 million outstanding stock option awards, in addition to the $19 million of unvested equity awards the board caused to be forfeited at the time of her termination. The total value of Tolstedt’s compensation forfeitures is approximately $66.3 million.
In addition to the Stumpf’s and Tolstedt’s compensation forfeitures and clawbacks, the board also required the forfeiture or clawback of an additional $47.5 million in compensation from other former bank executives. The total amount of compensation that the board has reclaimed is $182.8 million.
The New York Times reports that, as massive as this is, it falls short of a record; the largest clawback in corporate history involved United Health Group’s then-CEO William McGuire who surrendered stock options and other benefits with a total value of over $600 million as part of an options backdating derivative lawsuit settlement (about which refer here).
There are a number of interesting things about the bank’s reclamation of these executives’ compensation.
First, the magnitude of the bank’s compensation repossession is staggering, and arguably unprecedented. Among other startling things about the recovery is the scale of the compensation that these executives were receiving. These people got paid some serious scratch. Indeed, as noted below, that may be the essence of the bank’s problems (as noted below).
Second, despite the magnitude of the bank’s scandal, the circumstances involved are not of the type that would trigger the executive compensation clawback provisions of the Sarbanes-Oxley Act or of the Dodd-Frank Act, both of which provide for compensation clawback only in the event of a restatement. As Columbia Law Professor John Coffee noted in a post late last year on the CLS Blue Sky Blog, in which he was commenting on the earlier round of clawbacks from Stumpf and Tolstedt, “Wells Fargo’s far broader clawback policy was the result of pressure from New York City’s pension funds in 2013, which had threatened to file a shareholder proxy resolution unless Wells Fargo adopted a policy broadly authorizing clawbacks beyond the context of restatements.”
Coffee also noted that the Wells Fargo scandal and other current corporate scandals have a common denominator, which is the involvement of excessive executive compensation. As he put it, “extreme incentive compensation formulas can motivate reckless corporate behavior.” Because of these risks, Coffee contends, the incentives need to be counterbalanced with a broad clawback authority, of the type Wells Fargo adopted and as was exercised here. The high-profile nature of the Wells Fargo scandal and the attention-grabbing magnitude of the clawbacks may draw attention to the kind of measures that Wells Fargo adopted. Properly designed compensation clawbacks “could move to front and center on the corporate governance stage.”
Third, though the board has taken firm action with respect to the former executives, what all of this implies for or about the board itself is another issue. In interesting April 10, 2017 Los Angeles Times article (here), Michael Hiltzik asserts that, with respect to the board, the Sherman & Sterling report is a “whitewash.” The fundamental problem with the report, Hiltzik says, is “its failure to come to grips with the duties of the board of directors.”
The report, he says, tries to suggest that misinformation from management kept the board in the dark and thwarted the board’s ability to try to manage this situation. Hiltzik says “A careful reading of the report reveals a board that took months, even years, to get its arms around the scandal despite plenty of warnings about its nature magnitude,” and despite ample red flags, including, for example, a series of article in the Los Angeles Times itself.
Hiltzik notes further that while the board showed great alacrity in recouping compensation from former executives, the report is “silent about whether the directors, not just senior executives, should be forced out or their compensation clawed back.” (Hiltzik has a number of other choice comments, including some harsh words for McKinsey Consulting which performed a risk management assessment of the bank in 2013.)
When I first heard about the huge executive compensation clawbacks at Wells Fargo, I wondered what this recoupment might mean for the various shareholders’ derivative lawsuits pending against the bank’s board and executives relating to the sales practices scandal. But upon reflection and in consideration of Hiltzik’s points about the bank’s board, I have to conclude that the clawbacks, while relevant to the derivative lawsuits, by no means make the derivative lawsuits moot. The defendants in the derivative suits undoubtedly include the members of the company’s board; the board members, as Hiltzik points out, did not repay any of the compensation they received for serving on the board, even if some of the company’s executives did.
The shareholder derivative lawsuits are just one of the various types of proceedings that remain in the wake of this scandal. The bank continues to face federal and state investigations about its sales practices. A securities class action lawsuit, filed last September, remains pending in the Northern District of California. Beyond the burdens and expense that these legal proceedings represent, the bank also faces a long climb to try to recover from the hit it has taken to its reputation.
In other words, this story has much longer to go before it is entirely played out. One of the more interesting things to watch in the near term is the bank’s upcoming annual meeting, which is scheduled for April 25. According to the Journal, Institutional Shareholders Services has suggested that Wells Fargo investors vote against 12 of the bank’s 15 directors.