A series of scandals has sparked a crisis of confidence in Wells Fargo, the nation’s third-largest bank whose roots harken back to the Gold Rush era when it provided financial services to miners in the Wild West. The most recent scandals — which included falsifying and accessing without authorization more than 2.1 million deposit and credit card accounts — has led to one of the biggest stains on the bank’s reputation in its 165-year history.

Last fall, Wells Fargo agreed to pay $185 million to regulators to settle charges of manipulating and creating false accounts in its Community Banking division. It fired 5,300 employees who were implicated, as well as the CEO and other executives. In late July, the bank admitted that it took out auto insurance on behalf of 570,000 car loan customers without telling them, resulting in higher payments and some vehicle repossessions. Its plan to make customers whole would cost $80 million, plus any fines.

The fallout continues. Last week, Wells Fargo disclosed in a Securities and Exchange Commission filing that it is expanding its probe of these falsified and manipulated accounts and warned that there could be a “significant increase” in the number of compromised accounts. Also this past week, it agreed to pay $108 million to the government to settle a 2006 lawsuit alleging that it overcharged veterans in refinancing loans. This week, the bank is facing new charges that it did not refund insurance premiums when consumers paid off their auto loans early, according to The New York Times. Multiple lawsuits were filed.

“It is a very serious set of violations that calls into question whether Wells is in fact too big to manage well,” says Peter Conti-Brown, Wharton professor of legal studies and business ethics. “The problem is either outright fraud from the highest levels or a broad indictment of the Wells Fargo governance system.… The idea that Wells management initially advanced — that this was just a few bad apples — doesn’t add up anymore.”

The bank said these scandals could cost the company $3.3 billion more than what it anticipated, according to an SEC filing. Wells Fargo can afford to pay: It reported 2016 net revenue of $88.27 billion and net income of $20.4 billion or $3.99 per share, with nearly $2 trillion in assets. But the damage goes beyond finances.

“The fine is not the real damage to the company,” says Wharton accounting professor Wayne Guay. “The damage to the company is the [negative] publicity that they have received over the last several months — the CEO got fired, several executives got fired, several executives had to give back millions of dollars in compensation. There was a serious overhaul in the organization and presumably there’s been some goodwill that has been seriously damaged with respect to customers and shareholders.”

Indeed, the scope of wrongdoing is troubling — in the fake accounts debacle alone, thousands of employees had engaged in improper activities that affected millions of accounts. “This offense is clearly pretty egregious. We have not seen similar things in similarly large banks in the U.S. yet,” says Wharton finance professor Itay Goldstein. “Maybe this is just the first one to be revealed and others will follow. We can only wait and see. It definitely seems like there is a serious problem in Wells Fargo and they need to be working hard to fix it.”

Since the scandals emerged, the market has been punishing the bank. “Before the crisis, Wells was the most valuable bank in the world,” says Wharton finance professor Richard Herring. “Since then, its price-to-book value ratio has fallen by 31%. Moreover, Wells has been losing market share to other banks not tainted by this scandal.” In February, the number of checking accounts opened at Wells Fargo fell by 43% from a year ago while credit card applications declined by 55%, the bank reported.

Herring adds that Wells Fargo’s board was reelected in the spring by the “thinnest margin in recent history. Indeed, if the board had not gained the support of Warren Buffett, the single largest shareholder in Wells Fargo, many members of the board would not have been reelected.” Shareholders are right to be concerned about the board’s failure of oversight. “No bank wants to be caught up in this kind of scandal,” he says. “It undermines confidence, which is the most important asset of a bank.”

A ‘Controlling’ Executive

Founded in 1852 as Wells Fargo and Company, the firm provided financial services by steamship, stagecoach, Pony Express, railroad and telegraph. It served pioneer miners, merchants and ranchers in the West — buying and selling gold, offering money orders, traveler checks, fund transfers and others. Wells Fargo’s legendary stagecoaches, which remain part of its logo, at one point traversed 2,500 miles from California to Nebraska and Arizona to Idaho. By sticking to its roots in the West, it survived the Great Depression and two World Wars. The bank focused on consumer banking, auto and home loans as well as small business lending and did not get into complex securities.

“It is a very serious set of violations that calls into question whether Wells is in fact too big to manage well.”–Peter Conti-Brown

Since 1960, Wells has embarked on a merger and acquisition spree that enabled it to expand beyond the San Francisco area. Among its biggest deals were the $11.6 billion takeover of First Interstate Bancorp in 1995, the $31.7 billion merger with Norwest and the $15.1 billion acquisition of Wachovia in 2008, which gave Wells Fargo a major presence coast-to-coast. The purchase of Wachovia gave Wells Fargo an investment banking business but also brought headaches. In 2010, Wells Fargo agreed to make loan modifications worth $2 billion to California homeowners who took out adjustable rate mortgages from Wachovia and World Savings but could not afford payments once interest rates reset. Wachovia bought World Savings prior to its sale to Wells Fargo.

Today, Wells operates more than 8,500 locations and boasts an ATM network of 13,000 with offices in 42 countries and territories. It employs 271,000 people full time and serves one in three U.S. households, according to an August 4 SEC filing. Wells is also one of the most diverse U.S. banks: Nine of the 15 directors on its board are women or minorities. And until now, it had enjoyed a relatively solid reputation. “Given the very surprising scandal from a team that was held in the highest regard and trust, we believe that providing more disclosures beyond very high level metrics is one of the changes that will give more confidence,” states a recent JPMorgan Chase analyst’s note.

So what really happened at Wells Fargo? Thus far, the most detailed explanation comes from the bank itself — on the biggest scandal of falsifying accounts. It hired a law firm to conduct a probe and the results were published in a report in April. The board has expanded the scope of the investigation and the review is expected to be completed in the third quarter.

According to the April report, a confluence of factors caused the wrongdoing. Wells has a culture of independence: Its internal mantra to division heads is to “run it like you own it.” The decentralized set-up ensured that control resided in the hands of division chiefs, who presumably knew what their market needed because they were closest to them. But it also became a weakness because autonomy led to wrongdoing — with poor oversight from the corporate office until it was too late.

In the fake accounts debacle, wrongdoing occurred in the Community Banking division, where employees were given tough sales goals to meet. Some low-level managers also encouraged workers to create bogus accounts, the report said. Employees were afraid they would get fired if they missed their targets, even though senior managers privately believed only 50% of the regions could meet them. Some managers would call employees several times a day to check on their sales.

The head of the Community Banking division was Carrie Tolstedt, whom the bank described as a “controlling manager who was not open to criticism” and “notoriously resistant to outside intervention and oversight.” But she had the ear of CEO John Stumpf because her unit drove at least half of bank revenue.

Stumpf was a champion of decentralization and cross-selling of additional products to existing customers. Indeed, Wells Fargo was known for its above-average ability to cross-sell products and services. Ironically, this prowess turned out to be its undoing when combined with an aggressive sales culture. “They were the envy of the banking industry for their ability to cross-sell products to their customers,” Herring says. “It would have been productive for the board to inquire why they were so successful at cross-selling, but I suspect this got little to no board attention because it was assumed to be a strength based on the Wells culture.”

“No bank wants to be caught up in this kind of scandal. It undermines confidence, which is the most important asset of a bank.”–Richard Herring

As for Stumpf, the bank said he didn’t move quickly or far enough to change errant sales practices, which first came to light as far back as 2002. Instead, these practices were seen as “tolerable,” “minor infractions” and “victimless crimes” that were handled by increased training, stepped up detection of wrongdoing and firing of offenders. But he didn’t make systemic changes.

Stumpf “failed to appreciate the seriousness of the problem and the substantial reputational risk to Wells Fargo,” the report said. The board pointed out that it first noticed these sales practices as a “noteworthy risk” in 2014, the year after a Los Angeles Times expose. In 2015, the city of Los Angeles sued the bank. Federal probes followed that led to a settlement in September 2016.

Wells Fargo fired Stumpf (Morningstar’s 2015 CEO of the Year) and Tolstedt, plus other senior executives. It has taken back $41 million in unvested equity awards from Stumpf and $19 million from Tolstedt, and canceled their bonuses. Wells Fargo also took away Tolstedt’s $47 million in outstanding stock options and Stumpf’s $28 million in incentive compensation. However, both still leave the bank with tens of millions.

As for the auto loan insurance debacle, if the fees led to more revenue for the bank and perhaps bonuses to officers, then they “blunt the initiative to verify that the client is not already insured elsewhere,” says Krishna Ramaswamy, Wharton professor of finance. Further, when bank officers know the processes, rules and products better than the customer, it leads to the possibility of abuse because the client doesn’t know enough to challenge what they’re told, he adds.

Wells Fargo’s board also shares the blame. Abuses in the car loan division were known by the board in 2016 but they were disclosed only last month. “It wasn’t disclosed for over a year, only after it becomes apparent that lawsuits and The New York Times (which broke the story) will reveal the details,” says Wharton accounting professor Daniel Taylor. “Back in September 2016, Wells just settled the fake accounts scandal, and management also had this issue on their hands.” If directors were aware of the issue in 2016 and did not disclose it, he says, directors may have breached their fiduciary duty to shareholders.

Jail Time for Executives?

To the public, it might seem that Stumpf and other implicated executives got off easy despite the scope of the wrongdoing. Would putting executives in prison curtail bad behavior? “Undoubtedly, it would,” Herring says. “Unfortunately, decision-making within banks is often so complex that it is difficult to identify the specific individual who should be held accountable.” Adds Guay: “Getting the CEO fired is one thing; finding them criminally responsible for that crime is another issue entirely. In the Wells Fargo case, you would have to show basically beyond reasonable doubt that the CEO was aware of what was going on.”

If prosecutors go after a CEO, he or she will hire the best lawyers to fight a case in court that could drag on for years, says Guay, who is an expert witness on corporate governance and executive compensation cases. And in the end, prosecutors might not even win. That’s why the government prefers to settle quickly with companies caught in improper activities — and companies usually also pay without admitting wrongdoing. To admit guilt is dangerous for companies because it opens the door to potential other litigation down the road.

“It’s not as sensational as putting people in jail and fining companies, but it’s a lot more effective.”–Wayne Guay

“For non-lawyers among us, this is a frustrating outcome,” Herring says. “The costs of pursuing a prosecution are so heavy and, given uncertainty about rulings by judges and juries, the expedient course of action is to reach an agreement in which the corporation does not admit having violated the rule but, nonetheless, pays a substantial penalty or restitution. The public sees through this convention and so it does not protect the bank’s reputation, but it certainly does leave the public with the impression that justice has not been served.”

At least, oversight of financial firms has intensified. Herring says all major institutions must now show three lines of defense: those actions responsible for ensuring compliance with rules and policies at the line of business and those responsible for independent risk management oversight, as well as creating an independent internal audit function to monitor the effectiveness of the first two lines of defense. “These three lines of defense are monitored carefully by the bank regulatory and supervisory authorities.… The hope is this heightened oversight within banks and by regulators will deter this kind of bad behavior.”

Taylor says that the frequency of corporate scandals shows the need for stronger consumer protections. “There have been recent calls for relaxing consumer protections and defunding consumer protection agencies,” he says. “It’s pretty clear, without getting into specific protections, that there is a need for consumer protection agencies.… Without those protections, there will be significant customer abuses.”

Taylor says the banking industry has been consolidating and getting less competitive, further opening the door to consumer abuses. He also notes that fines should be higher because repeat offenses imply the penalties are not a sufficient deterrent. If a company repeats offenses in the same area, it suggests that there is a clear corporate culture problem. “If the problem is systemic, then a CEO resignation isn’t going to change the culture, especially if the replacement is internal,” Taylor says.

A Better Way

Guay sees a better solution: “If we’re going to try to think about how to prevent these kinds of things from happening in the future, to my mind that’s the place to focus (executive compensation and corporate governance structures). Relying on regulators, relying on the court system, those things might have some marginal benefit, but making sure the board of directors has the right internal controls, the right risk management and corporate governance in place, that’s going to be the single biggest, most important thing we can do to make sure that these things don’t happen.… It’s not as sensational as putting people in jail and fining companies, but it’s a lot more effective.”

“It definitely seems like there is a serious problem in Wells Fargo and they need to be working hard to fix it.”–Itay Goldstein

The board’s main tools are structuring and setting compensation for senior executives and firing managers who don’t live up to board expectations, Herring says. Executives then are responsible for setting up incentive systems and oversight to ensure that employees are acting in the best interest of the bank. While this system of governance can break down at different points, “it is generally quite resilient and adaptive in responding to errors.”

Boards are quite effective in dealing with problems once they are identified, and business units that suffer losses receive heavy scrutiny, Herring says. “A more insidious problem is that boards seldom focus on areas that are quite profitable, but they should. The only way the bank can be more profitable in one line of business consistently is if it really has some advantage that no other competitor can gain, has had an incredible string of luck or is doing something unethical or implausible.”

Wells Fargo’s board is trying to right the ship. It named COO Tim Sloan to the CEO job and replaced two directors. The bank’s 15-member board now has 14 independent directors and one insider, Sloan. The roles of CEO and chairman have been separated, and by-laws have been changed to make sure the chairman is an independent director. Wells Fargo also ended the sales program at the Community Banking division — linking incentive compensation to customer service instead of sales. It is centralizing the control functions and has created a new Office of Ethics, Oversight and Integrity. Also, whenever a new account is opened, the customer gets an email notification. Credit card applications also will need documented consent, the bank said.

Will these measures work? Time will tell but at least Wells Fargo is taking the right steps to clean up the mess. “The board of directors is making a very conscious decision to try to put better internal controls in place,” Guay says. “And that’s where you would expect these things to get started — the board of directors.” When unsavory activities happen in a company, people get fired or replaced and an internal probe ensues. “The board of directors have to pick up the pieces and move forward.”