Wells Fargo: It Just Keeps Getting Worse

| About: Wells Fargo (WFC)

Summary

WFC continues to be in the news for its fake account scandal.

There are many ways this could go terribly wrong for WFC.

The stock has barely moved and I think that is a mistake; WFC has real problems.

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The scandal at Wells Fargo (NYSE:WFC) over fake accounts has taken some very interesting turns of late. CEO Stumpf has changed his version of events at least once and has issued some "apologies" wherein he threw former employees under the bus. However, developments in the past couple of days certainly suggest there was a culture in WFC branches that supported illegal behavior, and if that is proven true, Stumpf is gone.

Why do I think there's a good chance these behaviors were encouraged from the top? Let's take a look at what has transpired in just the past couple of days. First, former employees have filed a class action suit against WFC wherein they claim those that didn't "play ball" were demoted or fired. If any part of the claims in the lawsuit is true, WFC has not only a sizable monetary penalty coming but also yet another public relations nightmare. Time will tell and this is likely to drag on and result in a settlement instead of an actual verdict, but at this point, I'm not sure it matters all that much. Banking is about trust, and if you don't trust your bank - WFC has given you lots of reasons in the past couple of weeks not to trust it - you are probably going to move your business elsewhere.

Second, the Department of Labor has launched a formal review of the claims made by former employees of WFC regarding improprieties surrounding the culture in the branches. The DoL doesn't show up for tea and cookies so if they found enough cause to expend resources reviewing the complaints, at least some of them are likely to have some validity. This is yet another avenue that could end up costing WFC not only money but its reputation as well. In particular, if the DoL review finds some truth to the claims of former employees, WFC will have an even larger mess on its hands. Right now, it is a he said, she said sort of thing, but if the DoL sides with employees, WFC is in a lot of trouble.

In yet another piece of evidence that Wells' current retail sales compensation model is completely broken, it has moved up its date of dropping retail sales goals to this Saturday instead of January. Obviously, the culture of selling at WFC branches was totally wrong and moving the date up to essentially effective immediately is an admission of sorts that something was wrong.

Something else that I haven't seen touched on is the simple fact that WFC has touted its account growth and cross-selling for years, but what happens next week when the thousands and thousands of employees that used to cross-sell for a living now have no incentive to do so? If the culture at WFC branches was do whatever it took to make numbers and get paid, when the total opposite is the new reality, I have to think the bank's beloved cross-selling efforts will fall off a cliff. People aren't going to go after something the same way they used to if you suddenly aren't paying them for it any longer. It doesn't matter whether you're selling deposit accounts or TVs or hot dogs; people will do what you incentivize them to do, and if you incentivize them to do nothing, well, you can fill in the blanks.

Finally, we learned yesterday that Stumpf and Tolstedt are having enormous sums of compensation taken away as a result of this scandal. This is yet another piece of evidence that makes me think the Board has uncovered evidence that this wasn't as simple as just some bad eggs, as Stumpf has maintained. After all, if the Board thought Stumpf was innocent and wanted him to stay, would they take $40M+ from him? That seems unlikely because if the goal was just a public showing of a hand-slapping, they could have taken much less. The sheer magnitude of the number suggests to me that the Board isn't amused. Of course, time will tell but for now, it certainly doesn't look good for Stumpf.

In addition, Tolstedt received an even larger reduction in pay as she will no longer receive any sort of severance or bonus for this year and has given up another $19M in unvested equity awards. Again, the sheer size of the punishment here is huge and suggests that the Board has cause to be angry. If it turns out that there were somehow 5.3K bad eggs that didn't have WFC's goals in mind - something I find absolutely impossible to believe - then the punishments handed down to Stumpf and Tolstedt are way out of line. That's what makes me think this scandal goes straight to the top or at least close to it.

I've seen others compare WFC's current scandal to JPMorgan's (NYSE:JPM) London Whale episode from a while back, but the two couldn't be more different. JPM had lax oversight that allowed one individual to take too much risk. WFC (apparently) had a culture of such aggressive selling that fake accounts were okay. And there were over five thousand people involved in the WFC scandal compared to one lone individual for JPM. Comparing them is absolute nonsense as the only similarity is that both companies happen to be banks.

The thing is that despite all the evidence that WFC has cultivated a culture of doing whatever it takes for years and years, the stock has barely moved. I understand Wells has a long history of being an extremely well run bank, but if illegal behavior was not only ignored but encouraged, I don't know why anyone would want to own this stock. And with Stumpf having lost so much of his compensation, does he have a lot of incentive to stay on? After all, what was taken from him is forward looking, not a true claw back. That means he can keep what he has whether he keeps working or not and indeed, if he does keep working, it will be for a pittance relative to what he's used to be earning. I don't see any good scenario here for WFC, and given all of the things that would have to go right for WFC for it to escape unscathed, the chances are almost nil. With the class action lawsuit, the DoL inquiry and the mess with the rescinded compensation, WFC is a disaster and shouldn't be anywhere near $45. Investors are ignoring enormous red flags to their detriment.

Disclosure: I am/we are short WFC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.