21 SepThe Bankers’ Plumber on Banking: the failure of culture and Internal Audit at Wells Fargo

Mea culpa. I missed something in last week’s post. Culture. The Wells Fargo misdeeds involved over 5’000 people; yes that means some processes failed, yes that means many people did not do their job properly. It also means that the organisation has a very serious outbreak of rotten culture. As the storm breaks out of the teacup on the Wells Fargo debacle, it is worth reflecting on the importance of culture.

To be sure, Wells Fargo is fundamentally a great bank and financially sound. 5’300 is a lot of people and a staggeringly long list of miscreants. However, WF has her 250’000 employees. 2% rotten apples does not a rotten institution make.

The malaise amongst those 5’000 is important to understand. It is at the same time both different and similar to other chapters in the Bankers’ Bumper Big Book of Bad Behaviour:

It is different from the UK cases of mis-selling of derivatives & PPI. In those cases, the clients were engaged, although asymmetry of skills and information led to widespread cases of clients entering into unsuitable transactions. That said, the WF case reportedly includes a few aspects of the mis-selling kind.

It is not the same as the rogue trader cases, such as Kweku Adoboli at UBS and Jerome Kerviler at SocGen. Those cases were not ones of widespread, deliberate mis-deeds. Adoboli and Kerviler were individuals who at least to some degree manipulated their banks’ systems to

hide their misdeeds and went largely undiscovered for an extended time because procedures which were likely adequate were not properly followed.

It is very similar to the problems surrounding fixing and manipulation in the LIBOR and FX markets. The same in the sense that those involved knew very well what they were doing was wrong and different in that there were vastly more people involved. The types of people failing were really very similar; those involved in the misdeeds and internal audit. The former were guilty of wrong doing and the latter guilty of not noticing. In both the LIBOR and FX cases, it is not clear that there was a single event that might have triggered exceptional interest from internal audit. In the WF case, there was a major sales campaign, tied to serious incentives for the staff involved. It would not be unreasonable to think that such an event might invite scrutiny from internal audit.

Culture is without doubt a vita attribute for any company to control. It is also:

1.Clearly a role of the board. See notes from the Bank of England, the UK Financial Reporting Council and the US Audit Committee Leadership Networks in North America (ACLN)

2.Not a responsibility which can be delegated

Internal Audit is a role which must be independent of every part of the organisation. The UK’s Institute of Internal Audit has a recommended best practice requiring the Head of Internal Audit to report to the Chair of the Board Audit Committee

The official reporting line is a matter of form. To ensure the Internal Audit audit function is effective, it also needs substance. The Board Member responsible fir Committee has to have frequent and extensive contact with the Head of Internal Audit.

I am indebted once more to former boss, friend, fellow advisor and mentor Itzi Klein for his clarity in pointing out the key lesson in this case and for sharing an anecdote from time as Chair of CLS Group; he would meet quarterly with the Head of Internal Audit. The person in that function reported that when a question about the frequency of contact with the Chairman or the Chair of the Audit Committee was asked at a city get together, he was the only one to put his hand up. The others had no contact.

Lessons learned: Over and above the process related issues I described last week, there were failings on two fronts here. The Board failed to manage culture and Internal Audit, one its resources failed.

Hot off the press on Sept 21: There is a third failing.  For it is always three. A smoking gun. The procedures surrounding the use of the Wells’ Fargo ethics hotline, the specific process to allow whistleblowers to alert the corporation to wrong doings, appear to have failed to protect the whistle blowers. Click here for the CNN story.

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