The past month or so has been an incredible period of scandals for the financial sector. Reviewing the details, though painful, is highly instructive. Clearly, politicians and regulators alike will now be watching the big banks, including their wealth-management units and especially cross-selling arrangements, as never before.
The catalyst for this development was the news that Wells Fargo agreed to pay $185 million to the U.S. Consumer Financial Protection Bureau in early September over allegations that it secretly opened about 2 million unauthorized accounts. (Some 5,300 employees were fired for creating them from 2011 to 2014.)
Next, the U.S. Senate grilled then-Chairman and CEO John Stumpf. Sen. Elizabeth Warren said he should resign, which he did several weeks later. (At a second hearing called by the House Financial Services Committee, Stumpf denied that the bank had organized the effort to open fake accounts.)
“The decision is good news in the short term, because it removes a dark cloud of uncertainty that was hanging over the bank,” said Ian Katz, an analyst at Capital Alpha Partners, in a note in mid-October.
But lawmakers say they will push for more investigations of the bank, which includes Wells Fargo Advisors. The bank is now being led by CEO Tim Sloan, after Stumpf stepped down on Oct. 12, and it tapped Stephen Sanger, a former executive at General Mills, to serve as non-executive chairman and vice chair of its board.
Wells Fargo said it has refunded $2.6 million to affected clients and ended the sales incentives tied to the fake accounts. Meanwhile, California and Chicago decided to cut business ties with the bank for one year.
“The damage you have done to the market, to your industry, far exceeds the damage to your own business,” Rep. Mick Mulvaney said during a Sept. 29 hearing. And government entities aren’t the only ones unhappy with the San Francisco-based business.
Angry Advisor Client
Former Wells Fargo investor-client Lacy Harber took out a full-page ad in several newspapers across the country in early October to highlight his displeasure with Wells Fargo Advisors. The ads appeared in The New York Times, Dallas Morning News, San Francisco Chronicle and The Charlotte Observer.
The ads called for Congress to look into Wells Fargo’s brokerage business, which Harber claims cost him about $6 million. The ad’s headline reads: “Greed. Dishonesty. Betrayal.”
The Denison, Texas, resident said he was buying close to $35 million of stocks on margin when the Dow Jones index started declining on Aug. 24, 2015. “But for some reason, somebody panicked because the market opened down 1,000 points. To make a long story short, they forced me to sell my stock. It was either that or they wanted the complete $34.8 million before 3 p.m.,” Harber told The Dallas Morning News.
“I sent them $19 million by noon, and the local broker said, ‘I think that’ll do it.’ He called back and said, ‘No, they want the whole $34.8 million today,’” the businessman, 80, added.
Since Harber did not produce the rest of the amount, Wells Fargo liquidated his account, which cost him more than $5.8 million, he maintains. The company also charged him some $483,000 in brokerage fees.
His complaint, filed before the Financial Industry Regulatory Authority, is pending.
“At Wells Fargo Advisors, we are focused on our clients and on the longstanding relationships we have with them. Mr. Harber has chosen to use the current media focus on Wells Fargo as a means to draw attention to his own lawsuit. Mr. Harber is a highly sophisticated, experienced investor who routinely made his own investing decisions,” the business said in a statement.
“We executed his transactions on a day of extraordinary market volatility that included a 1,000-point drop in the Dow Jones Industrial Average. Mr. Harber’s trades were done on margin. Unfortunately, his trading was affected by adverse market conditions. We’re in litigation with Mr. Harber and are strongly defending against his claims,” it explained.
Morgan Stanley’s Mess
The attention on Wells Fargo has spilled onto its rivals, too, according to one equity analyst. “We should still expect heightened regulatory scrutiny of incentive structures and persistent legislative calls for breaking up the nation’s biggest banks,” wrote Isaac Boltansky of Compass Point.
Activities at Morgan Stanley’s wealth-management business drew the attention of a state regulator and raised plenty of eyebrows on Oct. 3. That’s when Massachusetts Secretary of the Commonwealth William Galvin said the firm’s sales contests tied to securities-based loans (or SBLs) encouraged “dishonest and unethical conduct” and “created a material conflict of interest, which violated the firm’s fiduciary duty.”
The regulator took action aimed at requiring the firm to cease and desist such activities in Massachusetts and Rhode Island, and provide “equitable relief” to clients, and requested an administrative fine be imposed on the firm. Securities-based loans allow clients to borrow against the value of the securities in their investment accounts using their securities as loan collateral.
“This complaint lays bare the culture at Morgan Stanley that bred the high-pressure effort to cross-sell banking products to its brokerage customers without regard for the fiduciary duty owed to the investor,” Galvin said in a statement.
“This contest was relatively local, but the aggressive push to cross-sell was companywide. Morgan Stanley has stated publicly that this was extremely limited — this defense has not worked for Wells Fargo and it does not work for Morgan Stanley,” he explained.
According to the regulator, Morgan Stanley’s internal materials “downplayed the risks” of SBLs. He said those documents showed Morgan Stanley could:
Liquidate securities if the value of securities pledged as collateral declines significantly
Liquidate securities without notifying the client, if a client cannot repay a loan
Charge the client a prepayment penalty
Make it more difficult for a client to move assets to another firm if they are pledged as collateral
For its part, Morgan Stanley maintains that Galvin’s 28-page complaint “is without merit,” and that the securities-based loan accounts are “valuable to clients.”
“We object strongly to these allegations. The securities-based loan accounts were opened only after discussing the product with each client and obtaining their affirmative consent. These accounts are valuable to clients, providing access to low-cost liquidity whenever they choose to access it,” the firm said in a statement.
“Importantly, clients pay no fee to open a securities-based loan account. They are charged only if they choose to borrow money. The complaint is without merit, and Morgan Stanley intends to defend itself vigorously,” it explained.
At Morgan Stanley’s MetroWest-Rhode Island advisor complex, both the manager and the office’s private bankers held a sales contest to push SBLs in response to Morgan Stanley pressure, and to boost banking and lending business, Galvin’s office says.
Thirty financial advisors in the Springfield, Wellesley, Worcester and Waltham offices in Massachusetts and in the Providence, Rhode Island, office participated. The complaint says they were given incentives of $1,000 payouts for 10 loans, $3,000 for 20 loans and $5,000 for 30 loans.
“Moreover, the sales contest involved a high degree of pressure as the complex manager incessantly tracked the performance of the advisors as well as the private bankers participating in the contest,” thus putting them in a position to recommend that their clients “burden themselves with debt,” the regulator’s office stated.
As a result, the number of SBL accounts opened nearly tripled in 2014 from the prior year to 163, generating close to $24 million in new loan balances.
“From the moment it was implemented in January 2014, the sales contest ran in violation of Morgan Stanley’s internal prohibition against sales contests,” the complaint states.
Furthermore, after it was detected, Galvin’s office says “no immediate steps were taken to end it,” and a new sales contest was organized for 2015, which ran until April.
“Despite knowledge of the prohibited sales contest running in MetroWest, Morgan Stanley has repeatedly denied the existence of the sales contest in statements to the public,” the complaint adds.
The incentives promised to advisors were “business-development allowances,” which they could use to treat clients to cocktails, fancy meals and gifts (including tickets to Boston Celtics games), the complaint states.
Some Morgan Stanley advisors allegedly targeted clients facing expenses tied to weddings, graduations or tax liabilities. A former advisor told regulators that competition from Bank of America-Merrill Lynch and its express credit lines appeared to be one motivation behind the sales contest.
“One internal document used by MetroWest Private Bankers quoted the movie Field of Dreams, ‘If you build it, they will [come],’ thus illustrating that Morgan Stanley clients increasingly utilized their Morgan Stanley lines of credit the longer they remained open,” the complaint says.
— Read Wells Fargo Starts Nationwide TV Commercials Addressing Scandal on ThinkAdvisor.