When Will Wells Fargo's Scandals End?

By Janet Levaux

Analysis July 30, 2018 at 02:24 PM

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July 13, 2018, was a bad day for Wells Fargo. Its second-quarter earnings and revenues missed analysts' expectations, loans and deposits dropped over the past year, and its stock price fell 1.2%. Meanwhile, net income at the Wealth and Investment Management unit sank 37%.

The bank revealed that it has set aside $114 million for refunds to wealth clients tied to "incorrect fees being applied to certain assets and accounts … during the past seven years," according to CFO John Shrewsberry. During a call with equity analysts, he explained that the third-party review of its client accounts continues "to determine the extent of any additional necessary remediation, including with respect to additional accounts not yet reviewed." In other words, stay tuned.

Click here for a Timeline of Wells Fargo's Scandals

Client assets in the wealth group remain steady at $1.9 trillion. But the number of financial advisors as of June 30 is 14,226 — down 860, or about 6%, from September 2016. That's when the fake-accounts scandal at its parent company resulted in a $185 million fine from the Consumer Financial Protection Bureau; an estimate of the number of unauthorized deposit and credit-card accounts opened since 2009 stood at as many as 3.5 million (as of August 2017).

[Editor's note: After this report went to print in mid-July, The Wall Street Journal reported Wells Fargo is working on plans to refund tens of millions of dollars to clients due to sales of add-on products as varied as pet insurance and legal services, which were added to their accounts without their full understanding and entailed monthly fees.]

Will the bank's latest rebranding and other corporate efforts make a difference to its wealth business, and can Wells Fargo stop the outflow of registered representatives? And what do the fake-accounts and other scandals at Wells Fargo mean for the broader wealth industry? Investment Advisor spoke with a group of industry experts about these issues to gauge both the significance of the bank's troubles and their resolution.

Reputational Risks

Wells Fargo, now subject to a Federal Reserve consent order that restricts its growth, was raked over the coals by Congress in September 2016.

"The damage you have done to the market, to your industry, far exceeds the damage to your own business," Rep. Mick Mulvaney (R-S.C.) told then Chairman and CEO John Stumpf on Sept. 29. "Y'all were rotten."

Earlier, Sen. Elizabeth Warren (D-Mass.) said to the executive: "You should resign, … and you should be criminally investigated." Stumpf gave his resignation to the bank in mid-October 2016, and Tim Sloan took over as CEO.

At the time, Sloan told employees: "Simply showing we care and we're committed to regaining the public's trust is invaluable. It's also important to note there are no quick fixes to our challenges. You also should expect more tough headlines, as additional accountability actions occur, and other investigations and reviews are completed. Some of that is going to be very painful for us."

He also pledged that the bank would "learn from [its] mistakes," adding that Wells Fargo's legacy and future are "worth fighting for." Issues continued to pile up. (See "Timeline for Wells Fargo's Scandals").

Meanwhile, the bank launched its "Building Better Every Day" campaign in 2017 and staged the "Re-Established" rebranding effort this year. "While we have made solid progress, we recognize there is still work to be done," Sloan said in a statement about the PR effort on May 7, 2018.

"Better late than never is probably the best perspective to view Wells Fargo. They only ramped up the PR when things started to get ugly," said recruiter Jon Henschen.

At an industry event later that month, Shrewsberry acknowledged that the "whole 'mission accomplished' thing has failed for other people before … so I don't think you're going to hear those words. [from us]."

Plus, after Wells Fargo disclosed its second-quarter earnings, the CFO explained that its advisors could "make the case that it's a little harder to compete for new business or to compete head-to-head with other advisers for new business," according to a Reuters report. "Just as it was a big tailwind because of Wells Fargo's reputation before that."

This fallout has been predicted by recruiter Danny Sarch of Leitner Sarch Consultants and others for nearly two years. "Every competitor wins in this situation to a certain extent. [Wells Fargo] will lose people. If it drags on for months with more investigations by authorities, that makes it worse. Advisors will get tired of answering questions" from clients and prospects, he said in October 2016, adding that such fatigue with a "tainted brand" leads advisors to do some serious thinking about leaving and perhaps to take action.

Since then, of course, attention has turned to other problems at the bank and, in 2018, even within the wealth unit. Earlier this year, Wells Fargo said it was reviewing some overcharges and incorrect wealth management fees, as well as possibly "inappropriate" referrals and recommendations affecting 401(k) rollovers to its wealth unit. Regulators soon became involved.

Next came news that some segments of Wealth Brokerage Services and the Private Client Group could possibly be merged, according to a report in The Wall Street Journal. The bank's "Wealth and Investment Management group is reimagining our business to become more efficient," a spokesperson said in a statement, but "no final decisions have been made."

These developments seem to have negatively affected Wells Fargo's advisors and its wealth-management business, but to what degree?

"There's no question that other reps at other firms have used it against them. They do not know the opportunities that they have lost …" in terms of clients, prospects and assets, Sarch explained in mid-July. "An advisor never hears about these lost opportunities, and that's why [hits to a firm's] reputation are so damaging."

For Chip Roame, head of the consulting group Tiburon Strategic Advisors, however, Wells Fargo's wealth-management business appears to be "one of the least-accused businesses." Though improper 401(d) referrals and other issues have come to light, generally speaking "its wealth-management business alone seems no more troubled than its peers."

Down, Down, Down

Since Wells Fargo's fake-accounts scandal first made headlines nationwide in the fall of 2016, its advisor headcount has steadily declined — going from 15,086 as of Sept. 30, 2016, to 14,226 as June 30, 2018. News of departing reps have been steady.

Some of the more interesting announcements involve Wells Fargo advisors leaving to join Benjamin F. Edwards, a St. Louis-based firm started by the great great grandson of broker-dealer A.G. Edwards' founder Albert Gallatin Edwards in 2008.

A.G. Edwards was bought by Wachovia in 2007 and then merged with Wells Fargo on Dec. 31, 2008; in July 2009, Wachovia Securities was renamed Wells Fargo Advisors and Wells Fargo Investments. (See "Wells Fargo Advisors' Recent M&A Roots.") Of the eight advisors Ben Edwards recently recruited with about $616 million in combined client assets, for instance, five joined from Wells Fargo.

Most of the departing advisors have not gone to other wirehouse firms. Instead, they have left to join Raymond James, Stifel Financial, Baird, Commonwealth Financial, Kestra Financial and other broker-dealers. In April, for example, a team of three FAs with over $900 million in assets moved to RBC Wealth Management in Hartford.

"Wells Fargo has always had the problem of being bureaucratic, like the other wirehouses. And with a tainted reputation, it's become a place where people are asking, 'Why would I want to stay?' And that has continued," Sarch said.

"In fact, I do not see that going away," he added, pointing to the likelihood of more policies and procedures in the wake of the regulatory review of fees and other issues in the wealth-management unit. "They likely are tightening all that up, because they are rightfully paranoid about any looseness they may have had before."

For some advisors, these new rules "could be another shoe to drop," as might anticipated details regarding the planned restructuring of the wealth unit, according to the recruiter. Questions about how the traditional, bank-based and independent advisors could be integrated, for instance, might be one more factor that could prompt some advisors with Wells Fargo to leave. "So, I don't think they are through the worst by any stretch," said Sarch.

Wells Fargo's Take

For its part, the bank insists its advisor-headcount issues are tied to the industrywide problem of aging. Over the past 12 months, its FA force dropped by "301 or 2.1%, with 259 producing FAs retiring during that time, which is nearly 80% of the net reduction in FA headcount," according to a statement.

In the second quarter of 2018, it notes, its headcount fell 173 or 1.2% from the prior quarter, with 56 producing FAs retiring. "On a percentage basis, we are basically flat from last quarter. While Q2 saw some challenges, we feel confident in our approach going forward," Wells Fargo explained.

According to Sloan, "I wouldn't necessarily describe it as a concern on our part … [W]hat you're seeing is an aging and retirement of the FA population. I think it's somewhere between one-third or 40% of the population — or the attrition is just folks retiring, which we've been planning for, for a while."

The executive discussed advisor retention issue at length in a call with equity analysts on July 13. He explained that Wachovia's purchase of A.G. Edwards involved a 10-year agreement structure, which "matured in the second quarter [of 2018]. And so, we saw a little bit of an increase [in departures] there."

Overall, Sloan said, "when you look at the first quarter to the second quarter, I think we're down less than 200 FAs, and the overall quality of the FAs has actually increased a bit."

He also mentioned that as aging reps depart, Wells Fargo is "continuing to develop the new FAs in the salary and bonus kind of business model structure and then making sure that we're continuing to invest on the digital side … so that the new demographic of investors has got additional options in addition to a real high-quality traditional FA model."

Heather Hunt-Ruddy, who heads Client Experience and Growth for Wells Fargo Advisors, said in a statement: "When we think about how we retain our advisors, it's about culture and how we enable our FAs to succeed … Our culture is the result of our history of merging smaller firms, and we've worked hard to keep that connected feeling even as we've grown."

In general, the bank appears upbeat on WFA's headcount, despite the quarterly pattern of declines. "Our retention programs are working. We're hiring top-notch advisors. We're proud of the great work being done," it stated.

'Picking at the Scab'

Others disagree with this sanguine view of the wealth unit and the bank's overall situation given the lengthy nature of its regulatory scrutiny and time in the headlines.

"For Wells Fargo, the challenge seems to be that outsiders are continually picking at the scab. Every couple of months you hear some new things, …." said Andy Tasnady, head of the compensation consulting firm Tasnady & Associates.

While Tasnady and other experts point out that some of Wells Fargo's issues also may exist at rival wealth units and banks, "It seems like they are getting so much attention from government agencies," he said.

As Janet Yellen explained, before stepping down as chairperson of the Federal Reserve in February: "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."

In Tasnady's view, businesses that want to improve their brands and get back to focusing on business "have to stop being in the press." They also need to "clean house, get all the dirt out and own up to it; a [tainted] brand can survive, but it takes much longer to recover when there's a drip, drip, drip of bad news," he explained.

"My guess is that they have tried internally to review all they can. Hopefully, if they do discover more, they can get ahead of any potential fallout, which is commonly understood as Crisis Management 101," said Tasnady.

Wells Fargo said in 2016 that it had fired some 5,300 employees connected with the bad accounts. At the executive level, Stumpf and Carrie Tolstedt — the company's head of Community Banking — left that same year; about $180 million of their compensation and that of several other senior executives was clawed back.

The bank's board released a 110-page investigation of Wells Fargo's sales practices in April 2017. This report summarized of what went wrong and some steps taken to correct problems.

In 2018, regulators demanded that Wells Fargo replace four board members. They also reportedly worked with the bank to ensure the retirements of the head of financial crimes risk management Jim Richards, head of operational risk and compliance Kevin Oden, enterprise risk head Keb Byers and community banking risk group head Vic Albrecht.

Regarding what steps Wells Fargo Advisors should take, it could "get creative with some type of an incentive program, which recognizes that advisors have been dealing with some short-term brand issues," Tasnady points out. "Most likely, the retention situation won't get more dire, and they can avoid the industry drama of '08-'09 when some firms moved to add long-term retention incentives."

Also, recruiting bonuses "would help," according to Roame.

Because switching firms often takes about six months for due diligence, some recruiters remain skeptical about Wells Fargo's ability to turn around its declining headcount, at least in the short term. "We have yet to see the end of significant attrition at Wells Fargo," Sarch said.

While the firm could decide (like Morgan Stanley and UBS) to leave the Protocol for Broker-Dealer Recruiting protocol to slow down the cycle, "Until it's truly seen a culture change, it remains tough place to work," he explained. "For business and for the country, it would be good if the scandals slowed down."

Lessons to Learn

As for what the Wells Fargo saga represents for the broader wealth industry, the recruiter points to risks associated with cross-selling products based in other parts of the bank or parent company: "The big takeway is that the big firms do not recognize advisors' fears when they refer clients to other places in the bank, where client experience and service are out of the advisors' hands."

This risk has little upside but lots of downside, Sarch adds, given potential problems with a commercial loan, mortgage or credit card. "Cross-selling should not be considered evil, … but the fear is that when clients are subject to a frustrating experience, this will damage the relationship between clients and advisors," he explained.

As issues linger, as they have at Wells Fargo, they "chip away at trust," Sarch says. As a scandal-hit company makes a series of changes — to leadership, corporate culture, organizational charts, etc., — advisors and staff look for consistency.

"It matters. Firms need to reinvent themselves when things go wrong, but every time they do so it's like [they're] starting over," the recruiter explained. In general, this scenario has been experienced by wirehouse reps, which has given other broker-dealers a chance to shine and capture more advisors.

"Doing what is in the clients best interest rather than solely focused on corporate interests would be a great takeaway for other firms to learn from Wells Fargo," said Henschen. "Even in the independent channel, firms are increasingly profit focused, which doesn't always line up with the interests of the advisor or their clients."

Deviating from doing what is in the clients best interest risks future profits, he adds, and "more importantly, reputation and client loyalty, as we've witnessed with the exodus of Wells Fargo Advisors to competitors."

Brands can bounce back, points out Tim Welsh, head of the financial-services consultancy Nexus Strategy. After a series of problems, Merrill Lynch was sold to Bank of America in 2008 at a deep discount from its 2007 level. "You would think that if any advisors or clients were going to leave, this would have been it. But no … the brand survived, though it got dented [for] a bit."

Welsh sees similarities with Wells Fargo and its fake-accounts scandal. "There is pickup … and business is back" in wealth management, he said, based on conversations he has had with some advisors.

Its reputation "definitely took a hit, there was a slowdown, lots of clients were asking questions," the consultant says. "But Wells Fargo has been powerfully communicating, rebranding itself and re-establishing itself."

The impetus for advisors to breakaway, though, has not resulted in a dramatically lower headcount at Wells Fargo, Merrill or other brands that have hit bumps. "The majority of [advisors] do not leave. They do not go, though there may be a spike [in departures]."

For Wells Fargo, the bull market "really helped," Welsh points out. "There were headline problems, but clients did not lose money. There could have been a much worse outcome."

Across industries, clients and employees "tend to forget," he says, adding that he sees Wells Fargo not as a sinking ship but as a firm that has survived its time in the eye of the storm.

How long will it take for brand overall to bounce back? "Time heals all wounds," Roame said. "Think of firms that went through their own troubled periods; many are thought of highly today."

"As we witnessed with the firms involved with [the 2008 Troubled Asset Relief Program, or] TARP, people have short memories," Henschen explained. "Five years from now, it is likely we could see Wells Fargo on a footing of recovery."

More Lessons

Many firms run into rough patches and find themselves in the press due to their own activities or those of parent companies, according to Tasnady. At first, it looks horrible and then six to nine months later everyone seems to forget about the rough patch, he says. Past examples include issues at Citigroup Smith Barney, PaineWebber (now part of UBS) and Merrill Lynch.

For advisors, there's the tipping point issue, the compensation consultant points out: "Once and a while, you get a situation where things get worse and worse, with recruiters focusing on the weakest link trying to get advisors to jump from whatever firm has issues. That's probably what has been happening with Wells Fargo — the more you lose, the more [advisors] think maybe they should go too."

But, as other industry experts have pointed out, strong brands tend to take a hit "and as long as that is temporary, they come out OK," said Tasnady. Furthermore, the Wells Fargo situation and its implications are more instructive for firms owned by banks than for the wealth industry overall.

Specifically, there are benefits to being part of a much larger institution with a large mix of products and services, "with the downside being that you can be exposed to and dragged into the problems of the bank," he explains. Having a brand that differs from that of the parent company — Bank of America vs. Merrill Lynch — is beneficial, the consultant adds.

Smaller firms and non-bank-owned firms can attract regulators' attention due to problems like excessive trading, inappropriate product sales, rogue advisors, and lower levels of supervision and controls, Tasnady states. Also, compared with larger rivals, these firms have less to spend on the compliance resources needed to ensure that corporate reputations are protected.

For advisors overall, this means it is best to "stick with a company that has [proper] policies and risk controls, can stay out of news" and is very well run, he says.

This sounds like the perfect formula. Yet the financial-advice sector likely will continue to hit bumps — at least occasionally — as it pursues business growth in a complex and highly regulated field, and that promises to keep the press diligent.

***

The Scandal Causes According to CEO Tim Sloan

We had product sales goals that sometimes resulted in behaviors and practices that did not serve our customers' or our team members' interests. And we were slow to see the harm they caused.
Second, despite our ongoing efforts to combat these unacceptable bad practices and bad behaviors, they persisted, because we either minimized the problem, or we failed to see the problem for what it really was — something bigger than we originally imagined.
Third, we failed to acknowledge the role leadership played, and, as a result, many felt we blamed our team members. That one still hurts, and I am committed to rectifying it. Fourth, there were warnings signs in hindsight that we should have heeded sooner.
And finally, our leaders should have invited inspection more often and welcomed credible challenges to how we operate.

Source: Speech of Oct. 25, 2016

For further details on Wells Fargo's fake-accounts saga, see the board's 110-page report.

Janet Levaux, MA/MBA, is editor-in-chief of Investment Advisor; reach her at [email protected].