Wells Fargo CEO John Stumpf Resigns

If you ever occupy a figurehead position for an organization, you will find yourself being judged unfairly for things that are outside the scope of your direct and even indirect control. Sometimes this unfairness will harm your general reputation. If you are an operating officer at Alcoa, you will often be criticized for things that are endemic to the slumping global business model which you cannot singlehandedly change. And sometimes the unfairness will help your general reputation. If you are the head of a sales department at Nike, you will be praised for lofty growth that really got set in motion by the marketing decisions of past generations that did things like hire Michael Jordan to build up the brand–your main contribution was not messing it up.

These patterns are even clearer in sports, where pitchers, quarterbacks, goalies, and coaches receive disproportionate praise during the good times and disproportionate blame during the bad times.

I was thinking about how the horns and halo effect attaches to leaders when I saw the news that John Stumpf was “resigning” from his position as CEO and Chairman of Wells Fargo. It made me examine both the merits of Wells Fargo’s previously existing reputation and the actions (or inactions) taken by John Stumpf that facilitated his once unthinkable exile.

First, we should discuss Wells Fargo’s reputation. Of the six major banks, Wells Fargo has enjoyed the best reputation this generation largely because it: (1) did not popularize robo-signing like Bank of America and Citigroup, (2) has largely avoided the patterns of charging higher interest rates or declining loans outright to racial minorities, (3) had a much lower mortgage foreclosure rate than many expected from a California-reliant bank during the 2008-2009 financial crisis, and (4) did not do something to self-inflict its reputation like JP Morgan did with its super losses involving London traders.

But really, what distinguished Wells Fargo in recent years was the fact that it was extremely well capitalized and had the endorsement of the billionaire who happens to have a very strong reputation with the general American public.

The idea that Wells Fargo has also been this saint in a cathedral full of sinners cannot be supported unless you only measure the big headlines of the past decade. In 1981, Wells Fargo had an employee embezzle $21 million. In 1986, Wells Fargo acquired Crocker National Bank, promised there would be “minimal” jobs affected regarding Wells Fargo and Crocker employees, and then laid off 6,000 employees once the aftermath settled. In 1989, Wells Fargo promised its borrowers that it would work something out with its customers if they fell on hard times, and then the company refused to modify its debt agreements when troubled times arose (the California Court of Appeals regarded this Wells Fargo move as legal because the statements were held to be “puffery language” rather than “promissory language”, but of course, legal and moral are not synonyms.) In 1996, when Wells Fargo took over First Interstate, it again promised “minimal” layoffs before axing 16% of the workforce which resulted in a class action lawsuit alleging that Wells Fargo systematically targeted female tellers over the age of 60 for employment termination.

And although Wells Fargo’s lending practices weren’t as bad as Citigroup’s or Bank of America’s prior to and during the financial crisis, this is a comparison that suffers from moral relativism and the soft bigotry of low expectations.

Wells Fargo still had to pay $1.2 billion and admitted that it deceived the U.S. government regarding the credit risk of borrowers it put on the books of taxpayers; is dealing with an ongoing investigation related to overcharging at ATMs; paid restitution on $80 million in embezzled funds as part of a 2014 straw buyer case; paid $1 billion to the FHFA as a fine in 2013 for misrepresenting bundled mortgage debt; and sold a $2.5 billion loan portfolio to investors in 2009 in which they claimed to verify the incomes of borrowers but did not (these are often called “liar’s loans). And it did pay settlements related to robo-signing and discriminatory lending–it’s just that the fines involved smaller amounts and were less coordinated.

If you look back over the past three or four decades, Wells Fargo’s behavior is nearly indistinguishable from that of the other banks. And if you look back over the past generation, the distinction isn’t that Wells Fargo is a paragon of virtue–it is that Bank of America, Citigroup, and JP Morgan were getting into more trouble.

Really, the reputational advantage that Wells Fargo has enjoyed is a product of Wells Fargo’s excellent capitalized position, the endorsement from Warren Buffett, and greater wrongdoing from peers. Being savvy when others are not, and having a rich guy that benefits from an enormous halo effect believe that he can make a lot of money from investing with you, is the narrow reputation that Wells Fargo has earned. The rest of the praise has been largely extrapolated from that, and thus, unearned.

The second question is whether John Stumpf deserved the political pressure that preceded his resignation.

The answer to that question hinges upon the scope of personal responsibility. If you ask someone to do something ambitious, should you anticipate that they will cheat? Are you materially failing in your duties if you do not monitor and audit your employees as if they are capable of wrongdoing?

The answer to the first sub-question is a tentative yes, and the answer to the second sub-question is a surefire yes.

John Stumpf did not have the responsibility to assume that any given employee will cheat. However, when you ask 20,000 employees to do something, your examination as a leader changes to: “Do I believe that one of the 20,000 employees will do something illegal or immoral to reach the sales target of eight accounts per client?” It is very difficult to put together a population subgroup of 100 people that won’t contain at least one individual that will screw you over when you’re not looking, let alone a group of employees that are 200x the size.

Once you determine that wrongdoing is possible, and at least very likely given the size of the employees acting as agents on your behalf, the natural follow-up question is: Is the anticipated magnitude of potential harm significant enough to warrant investment into strong internal controls?

The answer to that question is an obvious yes. When you have the possibility of opening up accounts on a customer’s behalf without their authorization, you are creating a risk of thousands of dollars (or perhaps hundreds of thousands of dollars) per harm occurrence because account figures affect credit scores and credit scores have an enormous role in determining borrowing rates.

This means that it is an enormous failure to get the auditing wrong.

We have discussed this before—whatever you measure people by, that system will get gamed. McDonald’s executives don’t really measure the time it takes for a customer per order; they measure the time it takes for an employee to press a button indicating that a customer has been served. As a result, you have employees that press the button before the customer actually receives the order to get the corporate executives off their back.

As a result, I don’t think John Stumpf owed an apology for asking employees to get eight products per account (maybe he does to the extent the request was an unrealistic objective.) The deserved apology is that when he was asking 20,000 employees to do something ambitious, he failed to recognize that some would cut corners and failed to implement internal controls that would protect the credit ratings and general reputation of Wells Fargo’s customers from harm. I don’t buy the argument that executives are responsible for wrongdoing when they have high-end objectives, but they are responsible for poor internal controls that enable even unsophisticated wrongdoers to cause harm to the customer base.

In short, Wells Fargo enjoyed a reputation that was greater in scope than what it deserved over this past generation, and it is also a reputation that ignores all wrongdoing prior to the 2000s. John Stumpf does not deserve blame for having an ambitious target, but he should take responsibility for the poor internal controls that ought to have monitored the achievement of the target.

As a result, I do not regard Stumpf’s termination of sales goals as the proper outcome for this kerfuffle. A better response would have been three-fold: (1) an immediate examination into accounts affected that would have immediately resulted in prompt payment to restore all customers to their status quo ante; (2) the creation of stronger internal controls and audits to understand the discretionary behavior of employees; and (3) the creation of a study to determine whether sales goals targets were effective in building shareholder wealth and saving customers money in transaction costs.

N.B. If John Stumpf knew about this upcoming scandal at the time he sold $61 million in WFC stock, and if it wasn’t part of a predetermined selling plan, then he is also responsible for insider trading and the fruits of an SEC investigation that follows from it.