Key to Wells’ deal with Fed: accountability

A couple of weeks ago, Wells Fargo executives — including CEO Timothy Sloan and finance chief John Shrewsberry — were in Washington on unpleasant business. The Federal Reserve planned to impose tough sanctions on the San Francisco bank for years of misconduct and the shoddy governance that allowed it.

The executives’ mission, according to three people directly involved in the negotiations, was to avoid further shaking investor confidence in the bank and its management team.

Officials at the central bank had a different goal, according to people familiar with their thinking. They wanted to send a message to the Wells board that it would be held responsible for the company’s behavior.

After three weeks of frenzied negotiations, a deal was announced Friday night that represented a milestone in the evolving relationship between regulators and banks. Wells Fargo, one of the country’s largest banks, was banned from getting bigger until it can convince regulators that it has cleaned up its act.

“We cannot tolerate pervasive and persistent misconduct at any bank,” Fed Chairwoman Janet Yellen said in a statement. It was her last act at the Fed; hours later she finished her four-year term.

As part of Friday’s announcement, the Fed and Wells said the bank would replace four members of its 16-member board, although the changes weren’t mandated under the consent order.

The settlement is an attempt by the Fed to impress upon banks that their boards of directors should be vigorous, independent watchdogs — and if they fail, there will be consequences. That reflects a shift from regulators’ historically hands-off approach to corporate boards, and the boards’ role is likely to grow in importance as regulators appointed by President Trump and Republicans in Congress generally loosen the reins on big banks.

Yellen’s successor, Jerome Powell, was the top Fed official overseeing the negotiations with Wells Fargo, and he is likely to maintain the Fed’s emphasis on holding bank boards accountable.

“Across a range of responsibilities, we simply expect much more of boards of directors than ever before,” Powell said in a speech in August. “There is no reason to expect that to change.”

This account is based on interviews with six people involved in or briefed on the negotiations, representing both the bank and the Fed, who were not authorized to speak publicly about regulatory matters.

Wells originally got into trouble in 2016 for charging millions of customers for bank accounts they did not want and for auto insurance they did not need. The bank was repeatedly penalized and fined by regulators.

Executives had convinced themselves last year that they were out of the woods, according to the people familiar with their thinking, who weren’t authorized to speak publicly about interactions with regulators. But that illusion was shattered in September, when Yellen said the bank remained under investigation.

In early January, Wells officials heard from the Fed that the central bank planned to impose stiff new penalties. Executives were furious that the proposed sanctions seemed more draconian than those imposed on banks that nearly cratered the global economy a decade earlier, according to people familiar with the thinking of top bank executives.

Then, on conference calls and face-to-face sessions in Washington, the negotiations began.

One crucial participant was Wells’ general counsel, C. Allen Parker. His advantage was that he was new to Wells, not part of what one bank adviser called the “ancien regime.” He joined last spring after more than two decades at Cravath, Swaine & Moore, a law firm where he had been the presiding partner.

Another was Elizabeth Duke, a former Fed governor, who became chairwoman of Wells’ board in January, well after the scandal came to light.

The lead officials for the Fed were its general counsel, Mark Van Der Weide, and Michael Gibson, director of supervision and regulation.

In a twist, the official that Trump had nominated to the Fed to play the lead role on regulatory issues was sidelined. That official, Randal Quarles, vice chairman for supervision, had recused himself because he had been a longtime investor in Wells.

After an opening round of talks, Wells concluded that the Fed wasn’t likely to budge on its central demand: that the bank put the brakes on any growth until it proved that its governance was substantially improved. That meant the bank wouldn’t be able to increase the assets — like loans or investments — it was holding above its current level of about $2 trillion.

Wells wanted wiggle room. Executives negotiated to have the assets calculated over a rolling two-quarter average. That meant they could swell above $2 trillion at times, as long as they dropped lower at other times.

The top priority for Wells was that the order be lifted quickly, said participants in the talks. The bank’s negotiators wanted the Fed to commit to a speedy timetable for reviewing its progress. The Fed responded that it wanted Wells to move quickly, which Wells officials interpreted as meaning the Fed would act swiftly, too.

The future of the bank’s board was a thornier issue.

Wells had already replaced about half of its scandal-era directors.

The Fed wanted more change, according to people familiar with the central bank’s thinking. The regulators had taken notice of public anger about the government’s past practice of taking actions against corporations without holding people responsible. Sen. Elizabeth Warren, DMass., had met twice with Yellen last year to push the Fed to force out Wells’ directors, according to a participant in the meetings. Warren also made the argument to Powell, the incoming Fed chairman.

While not adopting Warren’s suggestion, Fed officials emphasized to Wells the importance of “refreshing the board,” said people who participated in the negotiations.

Bank executives responded that they planned to replace four more directors. That would leave no more than three directors who had been around during the misconduct.

That appeared to satisfy the Fed.

In a hastily convened conference call Friday night, Sloan, Wells’ current chief, tried to reassure analysts and investors that the bank would be able to maneuver around the asset cap by selling certain assets and continuing to lend to customers.

He estimated on the call that the Fed’s order could shave up to $400 million off the bank’s 2018 profits. That represents less than 2 percent of what Wells earned last year.