The Fed hammers Wells Fargo, sends a message to the banking sector

Last Friday, the Board of Governors of the Federal Reserve System sent a powerful message to the U.S. banking industry when it issued an especially punitive and directive enforcement order against Wells Fargo & Company (WFC), the bank holding company that owns Wells Fargo Bank. 

WFC is the third-largest banking company in the United States, with total assets of $1.95 trillion at Dec. 31, 2017.

{mosads}In addition to the link to the enforcement order in the Federal Reserve news release announcing this action, there are links to letters the Federal Reserve sent to WFC’s board of directors, to WFC’s former chairman and CEO, John Stumpf, and to Stephen Sanger, WFC’s former lead director. 

The latter two letters chastised them for their poor performance when they held those positions.

The enforcement order imposed numerous obligations and limitations on WFC, most significantly a cap on its total assets. 

Specifically, going forward, the average of its total consolidated assets for consecutive quarter-ends cannot exceed WFC’s total consolidated assets at Dec. 31, 2017, until WFC has satisfied the Federal Reserve that it has fully met several conditions and requirements specified in the enforcement order. That will be a highly subjective judgment.

This asset limit is punitive as WFC will not be able to grow even as the economy grows. That growth cap, though, will force WFC’s management to rigorously scrutinize its lines of businesses and the assets it holds so as to operate more profitably under that cap. 

That ongoing assessment may lead WFC to withdraw from some businesses as well as to trim its geographic reach. It also probably will sell or securitize assets that it might otherwise have kept on its balance sheet so as to stay under the size cap.

In line with the enforcement order’s focus on WFC’s board of directors, the order directs the board to take numerous steps to improve its effectiveness “in carrying out its oversight and governance of WFC, acceptable to the [Federal] Reserve.” 

It is interesting to note that the Federal Reserve’s focus is on WFC’s board of directors and not directly on senior management. 

Among other actions, the board must ensure that WFC’s “strategy and risk tolerance are clear and aligned and within [WFC’s] risk management capacity” and that the board’s “composition, governance structure, and practices support its strategy and are aligned with its risk tolerance.”

The WFC board must have “a plan to ensure that no roles or responsibilities of the Board are unfulfilled for an undue period of time following the departure of any member of the Board.”

The enforcement order also imposes some obligations on WFC itself, and by implication, on WFC’s senior management, notably to develop a written plan “to further improve its firmwide compliance and operational risk management program, acceptable to the [Federal] Reserve.”  The order then goes into some detail as to what the plan will encompass. 

The order also specifies that there will be third-party reviews of the risk-management improvements mandated by the order. WFC, of course, will pay for those reviews.

Stepping back from the specifics of this enforcement order, the Federal Reserve has sent a powerful message to all the financial holding companies it regulates, and especially to the larger, more complex companies — the non-management directors of those companies must get further into the weeds as to how their companies are being run.

More specifically, the boards of these companies must continuously assess how well management is managing the various risks the company has assumed, including the controls that have been put in place to monitor risks and identify deviances from risk management and compliance policies. WFC’s board and management clearly failed in that regard.

In effect, a greater burden is being placed on directors to be more intense and effective in monitoring the management of the financial company on whose board they sit. The Federal Reserve has convincingly signaled that the day of board subservience to top management, where it existed, is now over.

This increased emphasis on strong board oversight is laudable, it does raise this most important question: Where will the larger financial companies find a sufficient number of outside directors who will have the time and talent to meet the expanded responsibilities implied by the enforcement order the Federal Reserve issued against WFC?

While there are a relative handful of very large financial companies — just six with more than $500 billion of total assets on Sept. 30, 2017 — there were another seven with total assets between $250 billion and $500 billion and another 24 with total assets between $100 billion and $250 billion.

These 37 financial companies, of course, are competing with other large companies, such as insurance companies, for director talent.

Perhaps serving on a bank board was once seen as a cushy, well-paying position for the well-connected, but that has long ceased to be the case at highly regulated financial firms. 

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system, cryptocurrencies, and the growing federalization of credit risk.