Earlier this month, the SEC announced settled charges against former Wells Fargo CEO and Chairman, John G. Stumpf, as well as charges against former head of Wells Fargo’s Community Bank, Carrie L. Tolstedt, alleging that they misled investors about the success of the Community Bank, Wells Fargo’s core business. (Wells had already agreed to pay $3 billion to settle charges from the SEC and the Department of Justice.)  The SEC charged that they made misleading public statements about the company’s strategy and a key performance indicator, the “cross-sell metric,” and signed misleading certifications and sub-certifications as to the accuracy of these and other public disclosures.  In the Order, Stumpf has agreed to settle the action against him for $2.5 million, but Tolstedt has not agreed to settle, and the SEC has filed a complaint against her in Federal District Court, seeking an officer and director bar, a monetary penalty and disgorgement.  The Order and complaint highlight, once again, problems that can arise out of public disclosure of misleading key performance indicators.  Moreover,  the SEC’s allegations provide a cautionary tale about the responsibility of those signing certifications (and sub-certifications) regarding the accuracy of periodic reports to heed clear alarm bells and question sub-certifications where appropriate to do so.

According to the Order and the complaint, for several years, Wells, Stumpf and Tolstedt publicly touted Wells’ cross-selling strategy as key to Wells’ successful growth, a strategy that sought to increase the number of accounts and products used by each customer. The company “described the strategy as ‘increas[ing] the number of products our customers use by offering them all of the financial products that satisfy their financial needs.’” [Emphasis added.] The success of the strategy was purportedly demonstrated by the Community Bank’s “cross-sell metric,” a metric that “was supposed to represent the average number of products sold to households that had ‘the potential for revenue generation and long-term viability.’” This key performance indicator was included in numerous periodic reports, earnings releases and earnings calls, often presented in comparison to the prior period.

However, instead of “needs-based” selling as described, the SEC alleges, the Community Bank “employed a volume-based sales model that incentivized employees to sell to existing customers, often with little regard to actual customer need or expected use. By 2015, the Community Bank’s model had led to thousands of its employees engaging in unlawful or unethical sales misconduct, including selling a significant number of accounts and products that customers did not need, want, or use.” In addition, for “several years, until mid-2016, Wells Fargo opened millions of accounts or sold products that were unauthorized or fraudulent.” This misconduct, which was reflected for some time in growth of the cross-sell metric, was alleged to have been spurred by the “Community Bank’s onerous sales goals and accompanying management pressure.”

More specifically, according to the Order, the Forms 10-Q for the second and third quarters of 2015 stated the company’s “cross-sell strategy” was “needs based” and described the cross-sell metric as “calculated based on the products ‘used’ by households.”  However, the disclosures of the metric (e.g., 6.13 products per household) failed to indicate that it was overstated by a substantial number of unused, unneeded and unauthorized accounts and products: the periodic reports “inaccurately claimed that the figure measured the success of a strategy based on customers’ ‘needs.’ In truth, the metric was inflated by accounts and products that were the result of sales misconduct and were not needed or wanted by customers.”

The SEC alleges that Tolstedt was aware that, to make the metric “meaningful” for investors, these “low-quality products” should have been, but were not, regularly purged from the metric. Despite ongoing discussion of a proposed modification that would have excluded inactive accounts and made the metric more accurate, the company continued to use the allegedly inaccurate metric in its Form 10-K, which the SEC concluded was false and misleading: “In reality, by the Community Bank’s own measure, the reported cross-sell metric included products that were not used by customers—as much as 18 percent compared with products and accounts actively used. Instead, the reported cross-sell metric was inflated by accounts and products that were the result of sales misconduct and were not needed, wanted, or used by customers.” Nevertheless, the SEC charges, Tolstedt delivered “slanted” investor presentations that led investors and analysts “to believe that Wells Fargo was executing its cross-selling strategy as intended, and that its results were strong.”

As CEO, Stumpf was required to sign certifications as to the accuracy of the company’s periodic reports filed with the SEC.  However, according to the Order, “Stumpf learned of facts that put, or should have put, him on notice about material inaccuracies” with regard to disclosure about the cross-selling strategy and the related metric, and his reliance on assurances of accuracy by several senior officers, including Tolstedt, “was unreasonable.” For example, in 2013, there were news reports about widespread employee misconduct—including practices such as “bankers ordering credit cards without customers’ permission [and] forging client signatures.” Between 2011 and 2016, this misconduct led to the termination of over 5,300 employees and the referral of over 23,000 employees for sales practices investigations. The media reports led to a decline in sales, as well as pressure from the board, the Chief Risk Officer, and from the bank’s primary regulator “to curb bad behavior resulting from aggressive sales goals.” 

By 2015, multiple alarm bells were sounded: repeated and diligent inquiries and expressions of dissatisfaction from the board’s risk committee triggered by media reports of misconduct, commencement of litigation by municipal authorities alleging that the company had engaged in unlawful sales practices (including opening accounts without customer consent), a report by consultants engaged by the company’s Chief Risk Officer identifying structural weaknesses tied to the sales misconduct, board communications of lack of confidence in Tolstedt—particularly after she played down the misconduct to the board’s risk committee—and recommendations that she be replaced, and expressions of concern by the bank’s primary regulator regarding sales practices. 

Nevertheless, Stumpf and other members of management were given assurances by Tolstedt and other Community Bank leadership “that minimized the scope of the sales practices problem and led key gatekeepers to believe the root cause of the issue was individual misconduct rather than the sales model itself, and that the controls within the Community Bank were effective and reasonably designed to detect or prevent misconduct.” Tolstedt repeatedly signed sub-certifications confirming the accuracy of the company’s periodic reports, notwithstanding assertions in the reports regarding the cross-selling strategy and the cross-sell metric that the SEC alleged were materially false and misleading. In signing his certifications, Stumpf relied on these sub-certifications, failing “to ascertain that the assurances he received were credible and accurate.” Stumpf had learned of facts, the SEC concluded, “demonstrating the severity of the sales misconduct” that rendered public statements about the strategy and the metric “false and misleading.”

During the period, Stumpf and Tolstedt sold shares of Wells and Stumpf exercised certain of his option grants, resulting in a net increase of his holdings. In July, Tolstedt retired and, after announcement of three settlements related to allegations of sales misconduct by bankers, Stumpf also retired.

In the Order, the SEC charged that Stumpf “violated Section 17(a)(2) of the Securities Act, which proscribes obtaining money or property through misstatements or omissions about material facts, and Section 17(a)(3) of the Securities Act, which proscribes any transaction or course of business that operates or would operate as a fraud or deceit upon a purchaser of securities. A violation of these provisions does not require scienter and may rest on a finding of negligence.”

In the complaint, the SEC alleges that Tolstedt “knew, or was reckless in not knowing, that her conduct in publicly describing the Community Bank’s cross-sell strategy and its metric, and in sub-certifying the accuracy of the annual and quarterly reports during 2014, 2015, and 2016, operated as a fraud or deceit and created a false and misleading impression to Wells Fargo’s investors.” The SEC has charged her with violations of Rule 10b-5, violations of Securities Act Sections 17(a)(1), (2) and (3), aiding and abetting Wells in violations of Exchange Act reporting requirements and books and records requirements.

Posted by Cydney Posner