Canary in the Coal Mine

BY Tim Weinhold

Americans recently found a new poster boy for corporate venality and misbehavior. And investors found a new reason to wring their hands. But let’s focus on the poster boy first.

As Chairman and Chief Executive of Wells Fargo Bank, John G. Stumpf presided over a years-long scam in which employees created millions of bogus accounts to meet aggressive sales goals (“eight is great”) set by the CEO himself. As a result, many customers were surreptitiously charged fees on accounts they had not requested and never knew they had.

This was especially likely for certain kinds of customers — Mexican immigrants who speak little English, older people with memory issues, college students opening their first bank accounts. According to Kevin Pham, a former Wells Fargo employee, “It was like lions hunting zebras. They would look for the weakest, the ones that would put up the least resistance.”

Not only were customers bilked out of fees, in an untold number of cases credit scores were damaged — almost certainly causing some unwitting customers to lose out on the opportunity to buy a house or get hired into a job for which they were otherwise qualified.

This all came to light in early September when the Consumer Financial Protection Bureau made public a consent decree in which the bank agreed to pay $185 million in fines for these activities, and to refund all fraudulent fees. The bank also acknowledged that it had fired 5300 low-level employees whom it deemed responsible for the illegal behavior.

Almost immediately, however, many current and fired employees contended that the real blame for the fraud was the bank’s unrelenting pressure to cross-sell, i.e., to get front-line workers to sell more and more products to the same customers. Many reported that workers who failed to meet the aggressive sales goals were routinely held up for ridicule, or threatened with termination, and that more than a few had been fired.

“You should resign. You should give back the money you took while this scam was going on. And you should be criminally investigated by both the Department of Justice and the Securities and Exchange Commission.”
Elizabeth Warren to John Stumpf, Chairman and CEO of Wells Fargo.

It also turned out that a number of frontline workers had over several years — and in one case as far back as 2005 — brought the fraudulent activity to the notice of superiors. Others reported the account fraud directly to the company’s ethics hotline. Two employees went so far as to write Stumpf directly. None of which prompted action by senior management, except to terminate the various whistle blowers.

But despite all the misbehavior on his watch, Stumpf probably could have avoided poster boy status if it hadn’t been for one thing — his inept, deer-in-the-headlights response to the very public whupping administered by Elizabeth Warren during his testimony before the Senate Banking Committee. Here’s how Warren began the interchange:

Mr. Stumpf, the Wells Fargo Vision and Values Statement, which you frequently cite, says ‘We believe in values lived, not phrases memorized. If you want to find out how strong a company’s ethics are, don’t listen to what it’s people say, watch what they do.’ So, let’s do that. Since this massive, years-long scam came to light, you have said, repeatedly, ‘I am accountable.’ But what have you actually done to hold yourself accountable?

Warren then forced an ashen-faced and fumbling Stumpf to answer three blunt questions:

Have you resigned as Chairman and CEO of Wells Fargo?

Have you returned one nickel of the millions of dollars you were paid while this scam was going on?

Have you fired a single senior executive?

Then in response to his evasive attempts to avoid giving the obvious ‘no’ answers, Warren delivered her blunt assessment: “gutless leadership.”

Unfortunately for Stumpf, it got worse. Warren drilled in on the real motivation for the intense cross-selling pressure at Wells Fargo — highlighting that Stumpf personally and consistently touted to Wall Street analysts that the bank’s ability to generate more than twice as many accounts per customer as its rivals was a key reason they should recommend the company’s stock. Not coincidentally, Warren pointed out that pumping the bank’s stock in this way put $200 million into Stumpf’s own pocket. And then concluded:

Here’s what really gets me about this, Mr. Stumpf. If one of your tellers took a handful of $20 bills out of the cash drawer, they would probably be looking at criminal charges for theft. They could end up in prison. But you squeezed your employees to the breaking point so they would cheat customers and you could drive up the value of your stock and put hundreds of millions of dollars in your own pocket. And when it all blew up, you kept your job, you kept your multi-million dollar bonuses, and you went on television to blame thousands of $12.00 an hour employees who were just trying to meet cross-sell quotas that made you rich.

This is about accountability. You should resign. You should give back the money you took while this scam was going on. And you should be criminally investigated by both the Department of Justice and the Securities and Exchange Commission.

As we all now know, just a few weeks later Stumpf did resign. He’s also noticeably poorer. He will get no severance payment from Wells Fargo, and a couple of weeks earlier he had agreed to forfeit $41 million in unvested equity awards. Still, Fortune magazine estimates he will take over $133 million into retirement. All of which — further confirming Stumpf’s poster boy status — prompted this tweet storm from Elizabeth Warren:

Stating the obvious, I also find the misbehavior (fraud and illegality) at Wells Fargo reprehensible, and find Stumpf’s initial attempts to blame the problem on 5300 supposedly rogue low-level employees shameful (though “gutless” works as well). But this piece isn’t motivated by a desire to pillory Stumpf or his bank. At that task Warren and a host of others have proven more than capable.

The Lesson for Investors

Rather, I’m interested in the lesson for investors. Between when the scandal became public on September 8th and the end of the month, Wells Fargo’s stock lost nearly 15 percent of its value, vaporizing well over $30 billion dollars of investor wealth. You can forgive investors who might view that as cosmically unfair. After all, they had invested their money in the country’s most valuable bank, and the only major bank to sail through the subprime mortgage debacle essentially unscathed. Moreover, Wells Fargo had positioned itself as focused on consumer banking and Main-Street lending, not the high-risk speculative trading of the other big banks.

Out of the blue we all discovered that your conservative, vanilla-safe bank had been cheating ordinary customers for years.

So good job, Wells Fargo investor, you committed your money to the only ‘Mom and apple pie’ big bank out there. You can sleep well at night. Oops, wrong. Out of the blue we all discovered that your conservative, vanilla-safe bank has been cheating ordinary customers for years. Even worse, senior management at least turned a blind eye to the fraudulent practices. More likely, they consciously encouraged the illegalities. As a result, wham — you and your investor colleagues are suddenly out more than $30 billion. A few more incidents like that and investing itself might start to resemble a spine-chilling minefield where hidden bombs go off frequently and without warning.

Oh, that’s right, investors have already suffered through lots of those minefield blow-ups. September one year earlier Volkswagen investors were feeling just as savvy and confident as were Wells Fargo investors this September. They had invested in what was considered one of the best car companies on the planet, inventors of the spectacularly successful ‘clean diesel’ automobiles. On the strength of those diesels, in fact, VW had recently become the number one car company in the world.

And then, wham, it all blew up. Volkswagen admitted it had been cheating customers and regulators for years. The company had rigged their engines to provide false results in emissions tests, understating by as much as 40-fold their actual pollution levels. ‘Clean diesel’ turned out to be very dirty diesel — and a very dirty deal for investors. In just one month, VW stock dropped 43%, handing investors a $35 billion loss.

Or consider what happened to Lumber Liquidators investors earlier that year. On March 1, 2015 the television news show 60 Minutes reported that Lumber Liquidators was selling Chinese-manufactured laminate flooring with toxic levels of formaldehyde, a known carcinogen. The company’s stock dropped more than 20% that very week.

What’s most scary for investors is that these giant losses occurred in what seemed like especially safe investments in industry-leading companies. And that they seemed to come with absolutely no warning.

Of course, the stock market often overreacts to sudden bad news. Plenty of investors decided to hang in there, hoping the storm would blow over. Bad idea. From the beginning of March to early August, Lumber Liquidators stock plummeted from $69.22 to $12.06 — an astonishing 83 percent drop in value. That’s a very big bomb.

Just to be clear, what’s most scary for investors in these cases is not the precipitous loss of value, bad as that is. What’s scarier is that these giant losses occurred in what seemed like especially safe investments in industry-leading companies. And that they seemed to come with absolutely no warning.

As noted, Wells Fargo was the country’s most valuable bank, and the one whose business model looked most conservative. Volkswagen was the world’s number one automaker with a reputation for world-class engineering. And Lumber Liquidators was the leader in what would appear to be an exceedingly safe industry — the sale and installation of wood-laminate flooring. That’s a business so conservative it’s downright dull.

Yet every one of these seemingly super-safe investments blew up badly — and, from the viewpoint of most investors, with absolutely no warning. After all, how could investors have reasonably known that Lumber Liquidators was importing flooring that violated U.S. safety standards? And if years went by without regulators discovering VW’s emissions cheating, how could investors have known about the problem? Similarly, how could investors have known that Wells Fargo was doing something as egregious and foolish as opening millions of fake accounts? All of which suggests that investing absolutely does resemble a minefield where hidden bombs explode with no warning whatsoever. Cosmically unfair.

The Selfishness Canary

Or maybe not. Maybe there was a clear warning in each of these cases. Switching metaphors (from minefields to mines), maybe in each case there was a canary in plain view warning of disaster to come. In which case, of course, investors would have no one to blame but themselves.

Prior to their blow-ups, the business models for Wells Fargo, Volkswagen, and Lumber Liquidators all seemed to be working well — all three companies were prospering. But, as investors should know full well, prospering today doesn’t preclude disaster tomorrow. More to the point, prospering may be the byproduct of serving customers and others well. In which case, a company can confidently continue to do more of the same because its business model prospers sustainably.

Alternatively, (seeming) prospering may come about precisely because a company is cheating its way to success. After all, why do the hard work of developing such compelling banking products that customers voluntarily choose to open additional accounts when you can just open fake accounts without their knowledge? Or why do the hard work of developing better diesel technology when you can just rig the tests? Or comply with flooring safety regulations when it’s so much cheaper just to cheat?

From an investor viewpoint, the problem with all these business choices is not that they fail to prosper. The problem is that they fail to prosper sustainably. Sooner or later there is a day of reckoning. Sooner or later something always hits the fan.

Right about now the thoughtful investor should be thinking, ‘I get that business models that cheat rather than serve customers are unsustainable. I get that investing in those sorts of companies ends badly. But I had no idea that Wells Fargo, or Volkswagen, or Lumber Liquidators was cheating. If I had known, of course I would have avoided those investments. So don’t tell me something I already know — ‘cheating is bad’ — tell me something useful.’

Fair enough. Cheating, and most other corporate misbehaviors, all originate from the same place — selfishness. When companies make it their priority to serve customers and others well, they tend to prosper, and to prosper sustainably. But when companies (senior management) make their own success their transcendent priority, misbehavior often follows. Why? In part, because it’s so easy to rationalize all sorts of ethically, even criminally, suspect behavior when one’s own success is the paramount objective.

But the full extent of the problem is deeper and more pervasive. It’s easiest to see this if we look at our own experience as individuals. All of us have encountered selfish people. The vast majority of them don’t intend to be hurtful, i.e., they are not purposefully aiming to harm us or others. Nevertheless, they are regularly hurtful, because they characteristically choose what is good for themselves with little regard for whether it harms others. This is the very essence of selfishness — pursuing one’s own self-interest at the expense of others.

And when we are on the receiving end of someone’s selfishness, how do we respond? We lose trust. We withdraw. If we’ve been hurt badly enough, we may seek some sort of payback. The very same thing happens when a corporation acts selfishly. Customers defect, employees disengage, and suppliers turn difficult and demanding. The effect is like sand in the gears. In turn, a business model slowly, or sometimes quickly, disintegrates.

Selfishness is the canary that warns of disaster to come . . . Selfishness works for awhile, but always proves toxic in the end. That’s true for people, and it’s equally true for companies.

Cheating may stay hidden for quite some time. The evidence suggests Wells Fargo had been opening bogus accounts for years. Ditto for Volkswagen’s emissions cheating. And the misbehavior at Lumber Liquidators lasted for years as well. But selfishness — a corporation treating its own success as paramount — that’s way easier to spot. In that sense, selfishness is the canary that warns of disaster to come.

When John Stumpf made pumping Wells Fargo’s stock price the principal thrust of his annual reports, and his quarterly analyst calls, he made clear that creating value for customers and others was not the bank’s priority. No, pumping stock price is an intrinsically selfish objective — it’s entirely about creating value for owners,1 not others. Whether outright cheating follows or not, investors can be assured that selfishness will bring a day of reckoning. Because whether one believes in a divinely ordered moral universe, or just in karma, the end result is the same: selfishness works for awhile, but always proves toxic in the end. That’s true for people, and it’s true for companies. Which means it’s high time investors paid attention to the canary.

Of course the thoughtful investor might counter, ‘Other than Warren Buffet, almost no one still makes decisions to invest, or not invest, in particular companies. Investing today largely means choosing which mutual fund(s) to own. In fact, I don’t even know whether my mutual fund(s) owns stock in Wells Fargo, or VW, or Lumber Liquidators. So your counsel really doesn’t help me much.’

To which there is a simple response: ‘You’re right — unless you’re a sufficiently thoughtful, and ethical, investor who chooses a mutual fund precisely because it understands the watershed difference between service and selfishness, between business models that prosper sustainably versus exploitively. That choice, of course, remains entirely in your hands.’


  1. In her excellent book, The Shareholder Value Myth, respected Cornell Law School professor Lynn Stout makes a convincing case that neither shareholders, nor anyone else, are the legal owners of corporations. That said, in the shareholder-centric version of business embraced in the U.S. since the 1980s, CEOs clearly act as if shareholders (senior management very much included) are the beneficial owners of public corporations.

Unless otherwise noted, Eventide is not an investor in companies discussed in this or other of our ‘faith and business’ columns, nor is there meant to be an endorsement, explicit or implied, of the entirety of any company’s business model, much less of all of a company’s business practices. Rather, aspects of the business model or practices of particular companies are discussed only to help illustrate contemporary examples of larger ‘faith and business’ topics.

The material provided herein has been provided by Eventide Asset Management, LLC and is for informational purposes only. Eventide Asset Management, LLC serves as investment adviser to one or more mutual funds distributed by Northern Lights Distributors, LLC, member FINRA. Northern Lights Distributors, LLC and Eventide Asset Management are not affiliated entities.

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