Wells Fargo Incentives Lead to Fraud

Wells Fargo, one of the largest banks in America, was fined $185 million for the company’s fraudulent selling practices. A Wall Street Journal article¹ reports, “Federal regulators announced that Wells Fargo opened as many as two million deposit and credit-card accounts without customers’ knowledge.” Many former employees of the bank attribute the widespread fraud to the incentive structure and the pressure received from managers to reach the company’s ambitious sales targets.

Wells Fargo has been envied by its competitors for its high return on equity, with greater relative profits than other leading financial institutions such as J.P. Morgan. This success is a result of the focus on cross-selling more products (i.e. different financial services) per customer, a strategy it has faithfully followed since 1999.

However, some managers’ fierce dedication to this strategy led many lower level employees to create dummy accounts. Sales progress was closely monitored, requiring updated reports several times a day. Not meeting your targets was not something to be taken lightly, as many lower and mid-level managers lost their jobs due to their inability to consistently achieve their goals.

The account representatives and account managers also felt immense personal pressure to achieve sales goals due to the monetary incentives attached to their targets. With low base salaries those bonuses became very significant and highly desirable. A Harvard Business Review article³ explains how this type of incentive structure entices employees to make minor ethical compromises which then escalate and spread from there. The article reads:

“Consider the following sequence: A bank account manager, under pressure to make a sales goal to receive his bonus, pushes a customer to add a credit card, even though the account manager knows it’s not in the customer’s interest. Still short of the goal, the account manager asks his friends and family to open accounts. (The accounts are to be closed shortly thereafter.) With the goal still not achieved, the account manager opens accounts without asking customers and transfers a small amount of money. (The accounts are closed shortly thereafter and the money is transferred back.) As soon as the account manager gets away with the first unethical act, it’s not a big step to the fraudulent ones. The justification moves from ‘it’s legal’ to ‘no one is harmed’ to ‘no one will notice.’ When such practices are tolerated, they escalate in severity and spread throughout the organization.”

Wells Fargo’s CEO, John Stumpf, accepted full responsibility in his congressional hearing last week.² Over the past five years the bank has fired 5,300 employees for their involvement in fraudulent practices and has hired consultants from PriceWaterhouseCoopers and Accenture as well as several law firms to investigate the situation. However, it seems as though all that effort was too little, too late. 

Mr. Stumpf has received a lot of heat for this scandal, including requests for his resignation and calls for top executive’s compensation to be paid back to those negatively affected. Some have even questioned his competency as the CEO of such a large bank. The WSJ article¹ previously mentioned goes on to state, “In the 2010 annual report, Mr. Stumpf said he often was asked why Wells Fargo had set a cross-selling goal of eight retail banking products per customer. “The answer is, it rhymed with ‘great,’ he wrote. ‘Perhaps our new cheer should be: ‘Let’s go again, for ten!’” 

The bank said it will “scrap all product-based sales goals in its retail branches starting January 1.”¹  It is unclear why they are waiting until next year to implement this change aimed to alleviate the pressure experienced by employees that led them to these illegal practices.  Hopefully this scandal will help other companies see more clearly that extreme commitments to aggressive goals can potentially lead to fraud.

1.     http://www.wsj.com/articles/how-wells-fargos-high-pressure-sales-culture-spiraled-out-of-control-1474053044

2.   http://www.wsj.com/articles/wells-fargo-ceo-stumpf-i-accept-full-responsibility-for-unethical-sales-practices-1474326173

3.   https://hbr.org/2016/09/wells-fargo-and-the-slippery-slope-of-sales-incentives

Volkswagen Cheats the Emissions Test and Gets Caught Big Time

The Volkswagen scandal has been all over the news the past several days (TIME, CNN, Economist). In summary, Volkswagen committed a massive fraud by installing a chip in at least 11 million of their diesel cars that slowed down emissions only when the car was plugged in to the emissions machine. Then as soon as the test was finished and the car was unplugged, the car emitted anywhere from 10 to 40 times the amount of nitrogen oxides than what the test results showed. The amounts emitted normally by the car far exceed environmental regulations in the United States. (For more information on the story, see the video below.)

Would You Break the Law for $1 Million?

A survey was recently conducted in Korea where participants were asked if they would break the law in order to gain the equivalent of $955,000 (USD). Surprisingly, nearly one in four responded that they would. The study showed that people in their twenties were even more likely to break the law for $1 million (nearly one in three respondents in their twenties said they would). If this holds true throughout the world, we could potentially see more frauds committed as the younger workforce reaches stages in their careers where they have the pressure and opportunity to commit fraud.

Check out the article in the Wall Street Journal and ask yourself the same question – would you break the law for $1 million? Hopefully the number of people who answer yes to this question gets smaller and smaller over time.

Insider Trading: Employing Mob-like Tactics to Realize Tremendous Profits

An article from earlier this year on fortune.com said that “more than half of the best-known white-collar inmates… are in prison because of insider trading.” What causes people to risk being one of the next infamous white-collar inmates by committing insider trading? For most people it’s because of the unbelievably high profits. But just how profitable can insider trading be, and how do people get away with it?

The Cost of Loss [Guest Post]

Fraud affects everyone. According to a recent survey, US businesses lose an estimated $400 billion due to fraud each year. The Association of Certified Fraud Examiners found that one in four employees commits fraud at some point in their careers, and a quarter of those employees worked for their employer for more than ten years! Every industry feels the loss associated with fraud, and the public often foots the bill. Despite the best efforts of auditors and accountants to detect fraud, the losses remain steady from year to year. As a question of forensic psychology, what motivates loyal and otherwise trustworthy people to take dishonest advantage of employers? Regardless of individual circumstances, we find surprisingly similar motives and means.

More on the Cheating Scandals in Public Schools

Imagine if the response to Enron and WorldCom was to say that business leaders are set up to commit fraud because the market is too interested in accounting information so we should have businesses report less economic data about their performance. According to an article in The New Republic, that is essentially the reaction by some in education to the recently reported cheating scandals in Atlanta and elsewhere. Here are a few quotes:

Taxi Cab Fraud in Las Vegas: The Fraud Triangle

FraudBytes encourages guest posts. The following post was written by Professor Jason L. Smith, PhD, CPA, who teaches and researches about fraud at the University of Nevada Las Vegas.

A recent article by E.C. Gladstone in the Las Vegas Sun details allegations of taxi cab fraud as drivers are taking tourists on “long hauls” around Sin City in order to meet aggressive fare quotas.  Although the author makes no explicit reference to the Fraud Triangle, each of its three elements – pressure, opportunity, and rationalization – are clearly evident in this intriguing description of a serious problem in a city with more than 2,200 taxis serving more than 35 million visitors each year. Below is an analysis of how pressure, opportunity and rationalization all exist in this industry and lead to the fraud detailed in the Las Vegas Sun article.

Scientific Fraud: Autism and Child Vaccines

CNN is reporting that researchers are labeling academic research that linked autism to childhood vaccines as "fraudulent." Here is a quote:

Documentary of the Crazy Eddie Fraud

A documentary of the Crazy Eddie fraud has recently become available on YouTube (clips embedded at the end of this post).  Sam Antar, Crazy Eddie's former CFO described the motivation behind the fraud as follows (via White Collar Fraud):

Game Theory, The Cycling Mafia, and Lance Armstrong

Michael Shermer has completed the Race Across America several times and was one of the founders and early directors of the race. In addition, he founded the Skeptic Society and writes a column for Scientific American nearly every month. He is also an adjunct professor of Economics at Claremont University.

Shermer wrote an editorial today in the LA Times that uses concepts from game theory to explain why pro sports turn to doping to begin with. It's fairly intuitive and sounds a lot like the analysis I gave when Floyd Landis first came out with his revelation. While Shermer doesn't use the fraud triangle, he talks a lot about incentive and opportunity. Here is his reasoning: