DIRECTOR ALERT - Unprecedented US deal breaks new ground on individual Director Accountability and Board Effectiveness.

6th February 2018 - Company Directors and Boards, not only in the Financial Services sector but beyond, should take special note of a landmark deal between the US Fed and Wells Fargo Bank. Yesterday the New York Times led its reporting with the headline “Key to the Deal: Holding Directors Accountable”.

On Friday last, an unprecedented deal was signed addressing how Wells Fargo will be punished (under a Consent Order) in the wake of its “fake accounts” scandal. (Over many years, staff created and charged customers for fake accounts to boost incentive compensation - many argue it was part of the culture.). Wells Fargo is the third largest bank in the US. It had already been levied with a $186m fine. While the financial impact of this Consent Order will be a multiple of this, it also breaks new and interesting ground that we wish to bring to the attention of Navigo clients.     

Of most interest to Navigo is that:

1.      The Fed ordered that the bank cannot grow its assets beyond 2017 levels until its governance and Board Effectiveness is demonstrably improved to an acceptable level. And it won’t last a few weeks, at best it will be for most of 2018. For any business (even the third largest bank in the US) such a cap on growth is highly restrictive. 

2.      Individual accountability on the part of Board Directors is a strong message.  In its Press Release, the Fed links the Consent Order with a simultaneous announcement to retire four Board members of the bank, further depleting the ranks of those who were there during the scandal. (This angered Wells Fargo as it is not formally part of the deal, but the clear implication is that it was a tacit aspect). All of the current individual Directors were asked to sign up to this ‘cease and desist’ order. While regulators typically have powers in these areas, to date they have been reluctant to use them.  

3.      The Order reinforces the responsibilities of Boards to provide effective oversight of “senior management” and having a sufficiently strong risk management process. It continues a trend whereby it is an infeasible argument for Boards and Non Executive Directors to distance themselves from problems such as cultural issues, the impact of dysfunctional incentive compensation arrangements beyond the CEO and poor operational risk management and compliance. It also effectively reminds Directors of the need to look and see beyond the CEO – something that there is too often a reticence to do.    

4.      This deal will catch the eye of regulators and regulated around the world and may become a template that will be used for errant banks and (potentially) individual Directors who sit on their Boards. As the Fed put it “Wells Fargo will not expand until it is able to do so safely and with the protections needed to manage all of its risks and protect its customers.” The structure has potential applicability in other sectors, including caps/restrictions on customer numbers or fundraising (for example) in other contexts.

5.      As a result, reviewing and refreshing your approach to Board Effectiveness evaluations and governance reviews should now be front of mind for most Boards and Directors.  Navigo will declare a conflict of interest here because we provide such services, but that doesn’t impact our genuine belief that this should be an appropriate response for any responsible Board. In a rising economy could your business risk standing still for a calendar year while it sorts out governance?

Extracts from the Fed’s press release are instructive –

Responding to recent and widespread consumer abuses and other compliance breakdowns by Wells Fargo, the Federal Reserve Board on Friday announced that it would restrict the growth of the firm until it sufficiently improves its governance and controls. Concurrently with the Board's action, Wells Fargo will replace three current board members by April and a fourth board member by the end of the year.

In addition to the growth restriction, the Board's consent cease and desist order with Wells Fargo requires the firm to improve its governance and risk management processes, including strengthening the effectiveness of oversight by its board of directors. Until the firm makes sufficient improvements, it will be restricted from growing any larger than its total asset size as of the end of 2017. The Board required each current director to sign the cease and desist order.

"We cannot tolerate pervasive and persistent misconduct at any bank and the consumers harmed by Wells Fargo expect that robust and comprehensive reforms will be put in place to make certain that the abuses do not occur again," Chair Janet L. Yellen said. "The enforcement action we are taking today will ensure that Wells Fargo will not expand until it is able to do so safely and with the protections needed to manage all of its risks and protect its customers."

In recent years, Wells Fargo pursued a business strategy that prioritized its overall growth without ensuring appropriate management of all key risks. The firm did not have an effective firm-wide risk management framework in place that covered all key risks. This prevented the proper escalation of serious compliance breakdowns to the board of directors.

Additional resources

Fed Press Release - https://www.federalreserve.gov/newsevents/pressreleases/enforcement20180202a.htm;

Navigo Consulting specialises in business planning, strategy, governance and change. Our consultants are experienced professionals and have seen business from a number of perspectives including both as executive and non-executive Directors of very significant international businesses as well as many years as professional consultants.  If we can help your organisation to succeed with a business objective that is important to you, contact our Managing Director, Brendan Lenihan on +353 1 477 3404 or contact us through www.navigo.ie