Wells Fargo, Part III: Mundane Securities Stuff

Today we get more pedestrian with Wells Fargo and its unauthorized accounts scandal. Sure, the misconduct was egregious and leadership was a disgrace — but how, precisely, did Wells Fargo violate securities law and get a $500 million wallop from the SEC? 

By sketchy use of non-financial metrics. 

You almost have to laugh. Wells Fargo disrupted the lives of millions with its high-pressure sales culture and unauthorized account antics. Its inability to oversee corporate culture, or even to correct corporate culture after executives knew the place was on fire, will fuel business case studies for years. 

Then, adding insult to injury, is this low-rent nonsense with non-financial metrics — behavior you’d more expect to see from some quack operation in New Jersey or the Trump Organization. Which are pretty much the same thing, I suppose. 

Anyway, the settlement order from the SEC tells the tale. It begins, as we noted in our first post about Wells Fargo earlier this week, with the bank’s notorious cross-sell metric. 

That metric was defined as the number of accounts and products per retail bank household. The higher it went, the more products each customer was buying; and in theory, the more successful Wells Fargo was.

In practice, of course, that meant Wells Fargo executives had strong incentive to keep pushing that metric upward. So they set impossibly high sales goals on employees and then ladled on the pressure, which drove employees to engage in abusive sales practices. 

That was the SEC’s first beef with Wells Fargo: that the bank failed to tell investors that its sales model had “caused widespread unlawful and unethical sales practices,” and that those abusive practices were at odds with Wells Fargo’s lofty values and mission statement about only selling products a customer actually needed. 

As the SEC elaborated in its settlement order: 

By failing to disclose the extent to which the cross-sell metric was inflated by low-quality accounts, Wells Fargo sought not only to induce investors’ continued reliance on the metric but also to avoid confronting the risk of reputational damage that might arise — and eventually did arise — from public disclosure of the severity and extent of sales quality problems.

Consider those words. By neglecting to tell investors that its key performance metric was fundamentally flawed, Wells Fargo wasn’t just misleading investors on any given day. It was making the inevitable day of reckoning that much worse, when that day finally did arrive in 2016. 

So yet again, we see how Wells Fargo’s reliance on the cross-sell metric was an enormous risk. By design, it was vulnerable to pressure to game the numbers. When executive leadership didn’t hold that pressure in check (Part II of our series), abusive sales practices took root and became widespread. 

Which brings us to the logical next step of gaming the cross-sell metric: changing how it was calculated. 

Enter the Metric Shenanigans

By 2013, growth in the cross-sell metric was slowing, even with all that pressure from management for employees to hit their numbers. So Wells Fargo decided to change how the cross-sell metric was calculated. 

Starting that year, the bank also included global remittance accounts to the types of products counted in the cross-sell metric. That was a break from prior practice, and Wells Fargo never told investors about the change in calculation method. Which is a big no-no in reporting non-financial metrics. 

By the end of 2013, the cross-sell metric had grown by 0.11 since the prior year — but 0.04 of that growth came from adding global remittance accounts, and the rest came from accounts and products that had been inactive for at least a year. So all the growth in the cross-sell metric was baloney that year. 

Nevertheless, Wells Fargo’s 2013 annual report, filed February 2014, shouted that the community bank division had achieved record cross-sell heights from the prior year. 

The SEC asked Wells Fargo about the metric in comment letters in 2014 and 2015. That prompted a wave of flimflam from bank executives, where they described the metric as products “used” by customers, even when they knew they were counting products that had been inactive for a year or more. At one point executives even concocted a new “active cross-sell” metric, but knew they couldn’t disclose that to investors without people asking whether the old cross-sell metric was wrong. 

Again, the details of how Wells Fargo violated securities law aren’t important. Suffice to say, non-financial metrics are allowed under SEC rules, and in many cases they are a great thing to disclose; they can provide enormous insight to investors. 

But, a company can’t change the way it calculates a non-financial metric without reporting that change to investors. That’s common sense, which makes this behavior all the more appalling and eye-rolling at the same time. 

Then again, this misconduct was the logical endpoint of forces Wells Fargo put in motion 20 years earlier. When the cross-sell metric first started coming up short in the 2000s, executives stepped up the pressure. When it continued to come up short in the 2010s, they fudged the calculations. Where were the company’s ethical constraints? Discarded long before. 

All of it because Wells Fargo had picked a growth strategy destined to conflict with ethical business practices. And sooner or later, even the inevitable comes to pass.