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Pervasive Sham Deals at Wells Fargo, and No One Noticed?

"I don't want anyone ever offering a product to someone when they don't know what the benefit is, or the customer doesn't understand it, or doesn't want it, or doesn't need it."

That was John Stumpf, the chief executive of Wells Fargo, one of the nation's largest banks, in an interview about a year ago with The San Francisco Chronicle.

We found out Friday that at least 5,300 of his employees — let me repeat that number because it is so mind-bogglingly large: 5,300 — were engaged in rampant sham deals, secretly signing up myriad customers for two million accounts that they did not authorize, did not know they had, did not need, and clearly did not understand.

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Wells Fargo then charged customers at least $1.5 million in fees for those unwanted sham accounts, which were created simply to goose the income of bank employees whose incentive programs rewarded them for opening as many new accounts as possible. Some of the accounts were closed right away, as soon as the employee got credit for them.

The executive who oversaw this group of rogue employees, Carrie Tolstedt, conveniently announced plans to retire over the summer and, according to Fortune, is being paid $124.6 million on the way out. (One analyst has called for a clawback of that exit package.)

John Stumpf, chairman and CEO of Wells Fargo.
Lacy O'Toole | CNBC
John Stumpf, chairman and CEO of Wells Fargo.

Clearly there is a disconnect between whatever Mr. Stumpf was telling the public and what was actually going on at Wells Fargo — and that's putting it politely.

Here's Mr. Stumpf from that same interview in The Chronicle: "We think everyone here is a risk manager," he said. "Whether it's your official title or not, everything we do is a part of that."

Wells Fargo has long tried to separate itself from Wall Street. Given its West Coast headquarters, in San Francisco, the bank has sought to portray itself as a bank for Main Street. Its entire ethos, Wells Fargo has long suggested, is one of trust and ethics.

But this episode raises all the same questions that have been asked about virtually every firm on Wall Street. Whatever distance Mr. Stumpf tried to maintain for Wells between it and the big New York banks with bad-boy reputations just evaporated.

When politicians talk about Wall Street as a "criminal enterprise," this is exactly what they are talking about.

"This problem is a serious one and indicates that the company is feeling an intense pressure to perform that it cannot meet," Richard Bove, a longtime research analyst, told me. "I would expect to see some meaningful internal adjustments. There clearly will be some management changes — whether they reach as high as John Stumpf is very hard to say."

Mr. Stumpf has always said, fairly, that it is impossible to do a perfect job policing hundreds of thousands of employees. Warren Buffett, Wells Fargo's largest shareholder, has sounded a similar note, describing his own company, Berkshire Hathaway.

"Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it," Mr. Buffett once said. "That's inevitable: We now employ more than 250,000 people, and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety."

Perhaps if a handful of employees at Wells Fargo were responsible for signing up some phony accounts, we could generously say, "Oh, there were some bad apples."

But the scale and brazenness of this phoniness does not permit that. This sham, in its reach, is breathtaking.

"The magnitude of this situation warrants thorough and comprehensive review," Senate Banking Committee members, led by Senator Robert Menendez of New Jersey, wrote in a letter to the committee's chairman, Senator Richard C. Shelby of Alabama.

The letter continued, "Specifically, the committee should thoroughly examine this issue, including: How it is possible that more than 5,000 employees could bilk customers over the course of five years; the timing, extent and disposition of customer complaints; whether Wells Fargo's sales and compensation structure incentivized employees to engage in deceptive and abusive practices; and what additional safeguards may be needed to prevent this type of behavior."

All of this raises the question, based on Mr. Stumpf's assertion that everyone at Wells Fargo is a risk manager: What, exactly, does an actual risk manager at Wells Fargo do?

That's an important issue because Wells Fargo has always had a reputation as one of the best-managed banks, especially when it comes to risk. On Monday, the bank said it had temporarily suspended its cross-selling initiative, to be on the safe side.

Indeed, the great irony of this sham is how tiny it is in terms of dollars. That's why the $185 million fine by the government wasn't bigger.

As scams go, this one was, well, for lack of a better word, lame. It did not produce much profit, nor was it particularly hidden. For example, employees would use fake email addresses with the wellsfargo.com domain.

If investors are yawning, it's because in pure dollar terms this is a minuscule deceit. But they shouldn't be, because this could portend a larger problem, particularly as Wells seeks to become more aggressive in the risky business of investment banking.

Given all the regulations in place and the billions of dollars poured into compliance efforts, how could something so staggeringly widespread and so blatantly corrupt have happened in the first place?

Another question is what this scandal says about Wells Fargo's seemingly down-home culture. Mr. Bove, noting that part of the sham included opening "566,000 phantom credit card accounts," asked in a note to clients, "What does this indicate about the bank's underwriting policies? Can anyone have a Wells credit card without any checks being made concerning that person's ability to make payments for debt created using this card?"

And what does this say about the information the company has reported to investors and regulators? Mr. Bove added: "The bank also apparently opened 1.5 million false transaction accounts? Does this mean that accounts can be opened with no balances? What does it say about the willingness of the bank to operate with accounts on which it makes no money? What policies and procedures at this bank allowed this to occur?"

So far, these are all just questions without answers. Wells Fargo took out full-page ads last week in many newspapers (including this one) to "take responsibility." But taking responsibility includes answering those questions — and we are all still waiting.