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Financial Reform Newsletter: What is the Point of Fining Wells Fargo $1 Billion?

Given that Its Shareholders Pay, What Is the Point of Fining Wells Fargo $1 Billion?  Punishment, Deterrence or Political Posturing?

No question Wells Fargo has engaged in massive illegal and even criminal conduct.  Its systemic, widespread, predatory conduct spanned decades and infected numerous business lines.  Frankly, the breakdown if not corruption in numerous levels of risk, legal, audit, compliance and, most importantly, management controls was so widespread as to be inconceivable.

For that, the OCC and CFPB have decided to extract another $1 billion in fines.  Regulators will again brag about how tough they are and how much they have “punished” Wells Fargo.  But, are they really being tough?  Who are they punishing and to what end?  James Stewart in the New York Times put it slightly differently, asking “Has Wells Fargo Been Punished Enough?”  These questions, however, cannot be answered until you answer, “what is the objective of the punishment?”

We believe the punishment for predatory, illegal and criminal conduct should be tailored and particularized in such a way as to deter it from being repeated by that particular company as well as other financial institutions.  That, however, requires meaningfully punishing both the institution and individuals, especially supervisors and executives (i.e., end the occasional scapegoating of junior staff).  Neither one alone is sufficient; both are necessary. 

In this case it’s difficult to see how another fine of $1 billion does either (particularly as it comes on top of substantial losses and costs already, as detailed by Mr. Stewart).  Today’s shareholders are going to pay the fine, but they are already victims of the bank’s failures and illegal conduct (even if one could argue that past shareholders benefited from the wrongdoing).  Are today’s shareholders going to be any more incentivized to monitor management and the Board than they were after the $185 million fine in September 2016 or the actions of the Federal Reserve in limiting the banks’ growth earlier this year?  Similarly, are the directors, CEO and management team going to say “oh, we get it now and have to clean up our act?”  We doubt it, although we see merit in the argument that the fines are so high now that no one can consider it just another cost of doing business and, therefore, must be avoided.

More importantly, while reasonable people might disagree about that, no one should disagree that the total failure again to punish a single individual is a dereliction of duty by the regulators and prosecutors.  The damage done to this bank and its customers was done by individual staff, supervisors, officers and executives.  Where is that punishment and accountability?  Until individuals – including most importantly supervisors and executives as well as those in risk, legal and compliance -- are meaningfully personally punished by fines, claw backs, industry bars, injunctions and other sanctions – including referrals for criminal prosecution where appropriate -- predatory and illegal conduct will continue.

So, don’t be fooled by the regulators’ claims about how tough they are and how much Wells Fargo has been punished.  It is simply not a punishment and certainly not a deterrent to allow corporate executives to use shareholders’ money to buy “get out of jail free cards” for themselves and everyone who engaged in the illegal conduct that gave rise to the fine in the first place.

One final point:  Acting CFPB Director Mulvaney is on a crusade to neuter if not destroy the agency he is charged with running.  It is not an exaggeration to say he is changing the CFPB from protecting ripped off consumers to protecting financial predators.  The CFPB portion of the latest Wells Fargo fine should not obscure his anti-consumer protection agenda and zeal.  One fine on one bank, however large, for years of egregious conduct is no badge of honor for an agency that has otherwise gone AWOL on its mission and duty to protect financial consumers.  That likely explains, as Bloomberg View’s Matt Levine points out, why the anti-consumer protector Mulvaney was so uncharacteristically modest when the announcing the historic fine.


The SEC Looks Like It Missed an Historic Opportunity to Protect Investors By Failing to Propose a Substantive “Customer Best Interests” Fiduciary Duty Rule

When you put your hard-earned money at risk by providing it to a broker for advice, shouldn’t he or she have to act in your best interest when giving you that advice?  That would be a fiduciary duty and we think that should be the law, but it is not.  The law today allows brokers to portray themselves as trusted advisers acting in your best interest, but they have no legal obligation to do so and, unfortunately, too many do not.  They sell products that generate big commissions and prizes for them, but carry huge fees and perform poorly for their clients.  A “best interest” fiduciary duty would prohibit that, but such a rule would hurt industry profits so they are fighting it tenaciously. 

That fight has been going on at the Department of Labor over the last five years regarding retirement investments.  It is now going to happen at the SEC regarding non-retirement securities investments because it proposed what it called “Regulation Best Interest.”  The title would make you think the SEC, whose primary mission is to protect investors, proposed an unambiguous requirement for investment professionals to act in the best interests of their customers.  However, the proposal appears to fall well short of that standard, relying too heavily on disclosure and other suboptimal measures like “title policing.”  While some provisions in the proposal may offer modest benefits to investors, the SEC appears to have missed an historic opportunity to finally establish a strong, clear, enforceable best interest standard for all advisers.  Nevertheless, we recognize that the devil is in the details and we look forward to reading the 1,000-page proposal with care and fully engaging in the upcoming rulemaking process with comments and advocacy aimed at producing an actual strong and enforceable rule requiring brokers to act in the best interests of their customers.   


As the markets if not the economy roar along, isn’t it time to start thinking about Countercyclical Measures for the inevitable downturn?

Wall Street’s biggest banks keep breaking records for revenues, profits and lending.  While all the banks’ first quarter results were uniformly pretty terrific, some were historically good.  For example, JP Morgan Chase’s net profit for just the first three months of the year were $8.7 billion, the largest quarterly profit for a U.S. bank in history. 

This proves yet again that the Dodd Frank financial rules enacted to protect Main Street jobs, homes and savings from another devastating crash are not hurting banks or the economy, contrary to what Wall Street and its lobbyists have claimed for years.  Unbelievably, that hasn’t stopped those same banks from seeking to weaken, sometimes substantially, those rules.  It is so mindless and unwarranted that even the Wall Street Journal editorial page has opposed some of the more egregious rule rollback requests:  “The Fed’s Capital Mistake.”

Deregulation under such circumstances is not only baseless, but dangerous.  Given that the current economic expansion will be the second longest post-war next month, it is only a matter of time before the cycle turns and a recession hits the US.  Frankly, that might have already happened if not for the sugar high induced by the $1.5 trillion tax cuts, the trillions in federal spending and the boost from deregulation (however otherwise ill-advised), but even that won’t forestall a downturn forever.  It’s not if, but when and probably sooner rather than later.  

The only question is how severe it will be when it hits.  That in significant part depends on the resilience of the financial sector and whether or not it’ll exacerbate the downturn.  That depends on how well capitalized and financially strong the country’s financial institutions are and that’s what the financial protection rules are aimed at: loss absorbing capital, liquidity, stress tests, resolution planning, margin and clearing for derivatives, prohibiting proprietary trading, limiting counterparty exposure, reducing short term funding, etc. 

There’s simply no denying that the weaker financial institutions are, the more they contribute to the downturn and make it worse or, as in 2008, catastrophic.  This is for two reasons.  First, weak banks fail and are a drain on the economy.  Second, and as important, weak banks stop lending to the real economy as they incur and write off losses and conserve and rebuild their capital.  This deepens the recession, hurting millions if not tens of millions of Americans.  Strong, well-capitalized banks lend through the upswing and downswing of a business cycle, but weak banks do not.

This is why countercyclical measures are so important.  In good times, banks should be required to increase the buffers so that they are more resilient when the inevitable downturn hits.  These are fantastic times for financial institutions and we are on the precipitous of a downturn.  This is exactly when countercyclical measures should be taken, when capital requirements should be increased and financial protection rules strengthened.  However, exactly the opposite is happening in the legislative and regulatory arenas.  That is dangerous and irresponsible. 


Standing Up and Speaking Up: Federal Reserve Governor Lael Brainard Speech on Countercyclical Measures, Just Days After a Rare Vote Against a Proposed Rule Weakening Regulation

Federal Reserve Governor Lael Brainard gave an important speech, entitled “Safeguarding Financial Resilience through the Cycle,” this week that touched on these subjects.  She discussed the possibility that the Fed could soon require banks to increase capital in response to risks building in the economy, stating:

“if cyclical pressures continue to build and financial vulnerabilities broaden, it may become appropriate to ask the largest banking organizations to build a countercyclical buffer of capital to fortify their resilience and protect against stress.”

She also correctly noted that “[i]n many respects, where we are today is the mirror image of where were just a decade ago.”  Just ten years ago – with ominous echoes of today -- too many who should have known better irresponsibly talked as if the business cycle had been repealed and that the good times were going to last forever.  They never do, which is why her warning is particularly relevant today:

“If we have learned anything from the past, it is that we must be especially vigilant about the health of our financial system in good times.”

She further observed “[h]istory suggests that a booming economy can lead to relaxation in lending standards and an attendant increase in risky debt levels” and she talked about the pernicious effects of other “competitive and cyclical pressures.”  She also reviewed several critically important financial protection rules like stress tests and capital, and concluded:

“Prudence would argue for waiting until we have tested how the new framework performs through the full cycle before we make judgments about its performance.  At this point in the cycle, it is premature to revisit the calibration of core capital and liquidity requirements for the large banking institutions.”

That is why she dissented the week before on a proposed rule “to tailor ‘enhanced supplementary leverage ratio’ requirements,” which, according to the FDIC, would allow the biggest banks to reduce their capital cushion by as much as $400 billion. 

Rejecting the dangerous siren song of deregulation irresponsibly sweeping Washington, Gov. Brainard is standing up and speaking up for sensible, common sense policies that were enacted just a few short years ago to protect our economy and all Americans’ homes, jobs, savings and so much more from another catastrophic financial crash.


In Memoriam, Lynn Stout

Lynn Stout was an internationally recognized legal scholar, writer and speaker who made countless contributions to corporate governance and fiscal policy.  She regrettably passed away too young on April 16th after a long struggle with cancer.

She was Distinguished Professor of Corporate and Business Law on the faculty of the Cornell Law School, and had previously taught at George Washington Law School, NYU Law School, Harvard Law School, and Georgetown University.  Her scholarly work focused on corporate governance, securities regulation, financial derivatives, law and economics, and moral behavior.  Her most recent book "The Shareholder Value Myth: How Putting Corporations First Harms Investors, Corporations, and the Public," was named 2012 Governance Book of the Year.

The book addressed the hazards of pursuing shareholder value, taking on the myth that sprang from the mind of economist Milton Friedman, who famously authored an op-ed in 1970, "The Social Responsibility of Business is to Increase its Profits."

She was also published in numerous law reviews, including “Killing Conscience: The Unintended Behavioral Consequences of Pay-For-Performance,” which appeared in the Journal of Corporate Law,

“The Toxic Side Effects of Shareholder Primacy,” in the University of Pennsylvania Law Review, and “The Legal Origin of the 2008 Credit Crisis,” in the Harvard Business Law Review.

Professor Stout also served on the Board of Governors of the CFA Institute, and on the Financial Research Advisory Committee to the U.S. Treasury.

She was a tireless advocate, an intellectual powerhouse and wonderful human being.  We will all miss her and her contribution to public life and the public interest.


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