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Wells Fargo Scandal's Effects on Incentive Compensation

In the midst of the Wells Fargo scandal, including the CFPB consent order announced on September 8, 2016 (the “Consent Order”) and subsequent revelations, public discussion regarding incentive compensation has risen more prominently in the public eye than any other time since the Great Recession. As seen in the recent news, thousands of Wells Fargo employees have been fired for creation of fraudulent accounts. These acts appear to have been driven by a combination of three factors: (1) incentive compensation based on aggressive cross selling goals; (2) disciplinary measures for lower level employees that strictly enforced sales goals; and (3) a corporate culture that got in the way of any brakes or checks for the perverse incentives that followed from the first two.

For much of the time since the Great Recession, including in the 2016 Interagency Proposed Rule on Incentive Compensation (the “Proposed Rule”) and in much of our firm’s past commentary, attention has been placed on incentive compensation for executives—people who individually have the ability to drive risk decisions. We now see that the structure of incentive compensation at the lower levels can just as greatly affect the risk for the entire institution.

Fortunately, both the Wells Fargo Consent Order and the Proposed Rule provide financial institutions with resources to design and assess policies and internal controls for incentive compensation arrangements to help prevent the perverse incentives that took hold of the culture at Wells Fargo.

In the Wells Fargo Consent Order, Wells Fargo was ordered to select an experienced and specialized Independent Consultant to assess certain company actions, such as whether Wells Fargo employees undergo adequate and proper training designed to prevent improper practices, and whether the company devotes enough personnel and resources to monitor their employee’s actions. Moreover, Wells Fargo’s policies and procedures will undergo evaluation to determine, not only if the company tracks employees involved in improper practices, but also whether Wells Fargo will remedy consumers who are affected by such violations. Similarly, the Independent Consultant is to determine whether or not Wells Fargo’s policies and procedures are designed to ensure consumer consent is required prior to issuing credit cards, deposit accounts, or unsecured lines. Wells Fargo has begun its compliance with the measures noted in its “Commitment,” internal controls designed to alert consumers about opened accounts.

Similarly, the NCUA proposed rules would implement regulations regarding incentive-based compensation arrangements, and particularly any that encourage inappropriate risks at covered financial institutions. These would require Board level controls even for lower level employee incentive compensation arrangements. This includes annual documentation on design of plans and Board policies and oversight of such arrangements. The goal of the federal financial regulators has been to curb imprudent or undue risk-taking—unfortunately, with scandals like that at Wells Fargo, we and many financial institutions grow concerned that regulation and enforcement regarding incentive compensation and sales culture will go further than necessary and inhibit legitimate business decisions that drive profitability.

Based on the Wells Fargo scandal and the Proposed Rule regarding Incentive Compensation Arrangements, it is important that financial institutions of all sizes, but particularly those with over $1 billion on assets, begin to socialize internally concepts regarding incentive compensation plans and put into place the policies, systems, and internal controls that will be a subject of attention for all of the federal financial institution regulators.