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Wells Fargo's Rehab Requires a Change at the Top

The board could improve perceptions and set a different tone by replacing a CEO who is partially culpable for its various scandals.
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Photographer: Craig Warga/Bloomberg

Wells Fargo & Co.'s sins of the past are going to haunt it for a little longer. 

Late Friday, on Janet Yellen's last day as Federal Reserve Chair, the regulator slapped the San Francisco-based lender with sanctions for poor governance, compliance and risk management relating to abusive sales practices that culminated in the creation of millions of fake accounts and inappropriate charging of auto-insurance and mortgage fees. 

The Fed also took the unprecedented step of prohibiting Wells Fargo from growing any larger than its total asset size at the end of 2017, or $2 trillion, without clearance from the central bank. Ironically, this sanction actually provides an element of cover for the lender, which has found growth to be a challenge lately.

Handcuffed

As part of sanctions from the Federal Reserve, Wells Fargo won't be able to grow assets beyond its 2017 total of $2 trillion. As you can see, it's been having a hard time growing, even without any imposed limits.

Source: Bloomberg.

The Fed's unexpected censure of Wells Fargo should also be a boon to its rivals. Though the bank is technically open for business, it's planning on trimming its deposits from financial institutions and some commercial clients in response to the central bank's action. Chief Executive Officer Tim Sloan estimates that the bank's after-tax profit this year may be dented by between $300 million and $400 million, but if clients take their business elsewhere, this range may wind up being too conservative. 

While that's far from good news for investors, the Fed's involvement has at least led to stronger corporate governance: The bank will replace three directors by April and a fourth by year-end. Neither the bank nor the Fed has identified the departing members but I'd bet on Enrique Hernandez, Federico Pena, Lloyd Dean and James Quigley, all of whom received under 70 percent of shareholder votes at the bank's most recent annual general meeting. 1  

It's worth pointing out that Wells Fargo could have chosen to more meaningfully refresh its board without regulators having to force the issue. A dramatic shake-up is something I've called for since November 2016. Senator Elizabeth Warren added her voice last summer after the board survived a shareholder vote in which the likes of Hernandez, who was until September the chair of its risk committee, scraped through for re-election. Among longtime directors, three simply retired at year-end which has ultimately proved insufficient. 2  And Wells Fargo can't say they weren't warned: "We do have the power if it proves appropriate to remove directors," Yellen said in July. 

Stop Sign

The Federal Reserve's sanctions on Wells Fargo will likely cause a pause in the stock's meteoric climb

Source: Bloomberg

Regardless, the sooner the bank can satisfy the Fed and free itself of any limits on growth, the more likely it is to regain or retain the faith of potential or existing investors. The biggest of the latter camp is Warren Buffett's Berkshire Hathaway Inc., who said back in October that the lender had yet to completely "remove the stain" in reference to folks who oversaw the bank during the scandal. 

Unfortunately, even with the additional board changes, Wells Fargo can't claim to have a clean slate. You see, Sloan was chief financial officer back in 2013 when the lender's issues with its sales practices arose and has acknowledged that management's troubleshooting efforts were deficient. As a result, he's been berated by Senator Warren, who described him as "incompetent" and "complicit", and said she doesn't believe the lender will change with him in charge.

Given the Fed's ongoing oversight, I'd argue that the bank's practices and culture will get better because it has no other choice if it wants to escape the regulator's wrath. But once the latest hurdle has been cleared, Wells Fargo's board should consider improving perceptions and setting a different tone at the top -- an opportunity they missed by replacing John Stumpf with Sloan, a veteran from within its ranks unable to distance himself from its various scandals. Bank executives across the country without clear paths for career progression (including a possible run at the CEO role at their current employer) and who are up for the challenge should begin dusting off their resumes. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Two other board members with similarly low shareholder support, Cynthia Milligan and former chairman Stephen Sanger, have since retired. 

  2. One, former chairman Stephen Sanger, is approaching retirement age (72) and the others had joined the board in 1992 and 1998 so their departures were long overdue. 

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net

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