Janet Yellen ended her tenure as Chair of the Federal Reserve with a bang last Friday when the Federal Reserve Board (the Board) voted 3-0 to issue a consent cease and desist order that imposes unprecedented sanctions on Wells Fargo for its phony-accounts scandal and other “widespread consumer abuses.”
The primary sanction is a restriction on Wells Fargo’s growth that prevents the bank from growing beyond its current $1.95 trillion asset size until the firm improves “its governance and risk management processes, including strengthening the effectiveness of oversight by its board of directors.” The Board also sent “letters to each current Wells Fargo board member confirming that the firm’s board of directors, during the period of compliance breakdowns, did not meet supervisory expectations. Letters were also sent to former Chairman and Chief Executive Officer John Stumpf and past lead independent director Stephen Sanger stating that their performance in those roles, in particular, did not meet the Federal Reserve’s expectations.” While not included in the cease and desist order, the Board also announced on Friday that Wells Fargo agreed to replace three current board members by April and a fourth board member by the end of the year.
While the consent order does not provide direct relief to the millions of consumers Wells Fargo has defrauded in recent years, the Board’s actions should be music to the ears of a public that has grown accustomed to watching large financial institutions commit all kinds of misdeeds only to get off scot-free. For once there is no “Neither Admit nor Deny Settlement,” there is no deferred prosecution agreement, there is no slap on the wrist fine, and there is no avoidance of personal accountability. No, not this time. This time, the regulator has pointed its long finger directly at Wells Fargo’s board of directors and placed the blame for pervasive risk management failures squarely on their shoulders.
The Federal Reserve’s actions should send a shiver down the spine of any bank director, particularly those at the largest banks. The fact that the Fed sent individual letters to Wells Fargo’s former lead independent director Stephen Sanger and former Board Chairman and CEO John Stumpf opens both of them up to personal liability and potentially massive civil damages. If they didn’t after the fake account scandal first erupted, every bank director should now be asking themselves: “how do I know that what happened at Wells Fargo can’t happen here?”
To help directors answer this question, Joseph A. Smith Jr. and I developed a case study that was primarily based off of the 113 page report that was commissioned by the Wells Fargo board to investigate retail banking sales practices. The case study breaks up events that occurred over many years at Wells Fargo into discrete time increments and at the end of each increment lists several questions for the reader to consider. This format is designed to get the reader to place themselves in the shoes of a Wells Fargo director and to have them think critically about what actions, if any, the board could have taken at multiple points leading up to the September 2016 settlement with the CFPB, OCC, and Los Angeles city attorney, in which it was revealed for the first time that the firm had opened over two million fake deposit and credit card accounts without informing its customers.
Our case study reveals that Wells Fargo’s board dropped the ball in its basic duty of oversight. The board had sufficient information that something was awry in the community bank division long before the settlement was announced and did not act forcefully enough to ensure that known problems were being appropriately addressed. Instead, the board relied on, and believed in, assurances provided to them by bank management that the problems were isolated in nature and being remediated. In their letter to Wells Fargo’s board, the Fed called out this imprudent reliance on bank management for accurate information:
“starting in February 2014 and continuing thereafter, the board and certain committees of the board received from management assurances that Corporate Risk, Human Resources, and the Community Bank were undertaking enhanced monitoring of sales practice misconduct and were addressing sales practice abuses. Management’s reports, however, generally lacked detail and were not accompanied by concrete action plans and metrics to track plan performance. The board should have received more detailed and concrete plans from senior management on such a critical issue.”
Call it a Learning Opportunity
Serving on the board of a blue chip company can be thought of as cashing in on one’s reputation. Board members tend to be titans of industry or former senior government officials. By serving on the board, these luminaries lend their name recognition and prestige factor to the company in exchange for handsome compensation (fees plus stock awards) that requires relatively little time and effort. Last year, the average Wells Fargo director took home total compensation well in excess of $300,000.
Typically, these arrangements work well for the company and directors; although perhaps not so much for shareholders, employees, or customers. Directors serve their time without event while collecting a hefty pay package, and the company benefits from having highly regarded directors who are generally happy to go along with management initiatives. But this structure can also be easily abused by managements willing to mislead or misinform uncritical directors.
The stakes are even higher when you serve on the board of a systemically important financial institution like Wells Fargo. A board’s failure to fulfill the duty of oversight could not only harm the firm and its shareholders, it could also imperil the entire economy. For this reason, and others, bank directors are subject to a host of supervisory expectations that extend well beyond your standard fiduciary duties.
Thankfully, the misconduct at Wells Fargo does not threaten financial stability. Still, the Federal Reserve’s order on Friday represents a near worst case scenario for any bank director. The reputations of Wells Fargo’s directors, which had been built up over decades, now stand in tatters. The situation will be even worse for the four directors Wells will dismiss by year’s end (they will likely resign at the firm’s urging.) For these directors, what first looked like a high-profile and well-paid part-time job has turned into a nightmare. All current and future directors would be wise to learn from their mistakes.
 Last August, the Federal Reserve released a proposal regarding its supervisory expectations for the boards of directors of bank holding companies, savings and loan holding companies, state member banks, U.S. branches and agencies of foreign banks, and non-bank systemically important financial institutions supervised by the Federal Reserve. More info on the proposal can be found here.
 Although it is speculation, I expect the longest serving directors will wind up leaving. Enrique Hernandez, Jr., John S. Chen, and Lloyd H. Dean have been on the board since at least 2006, while Donald M. James and John D. Baker II have both been on the board since 2009.