Why Is Wells Fargo In So Much Trouble?

By Markets Fool.com

Wells Fargo (NYSE: WFC) is in the news right now, but not for good reasons. It was revealed earlier this month that employees at the nation's third-biggest bank by assets fraudulently opened 2 million customer accounts without customers' knowledge of or approval to do so.

Continue Reading Below

The Motley Fool's Gaby Lapera and contributor John Maxfield discuss the controversy in this week's episode of Industry Focus: Financials. Listen in below to learn the details of how Wells Fargo ran astray of consumer protection laws.

A full transcript follows the video.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

This podcast was recorded on Sept. 12, 2016.

Continue Reading Below

Gaby Lapera: Wells Fargo -- they found out that they had opened up to at least 2 million false accounts, accounts that shouldn't exist. They have been fined $185 million by a variety of agencies, and they have fired 5,300 employees in direct connection to this case. This is crazy! Oh my God!

I was just talking to a friend of mine and she's like, "I don't understand what the big deal is." We are going to tell you on this show why this is such a huge deal in case you don't already know. John, do you want to talk a little bit more about exactly what happened here?

John Maxfield: Yeah. Wells Fargo... You can think about banks. You can analogize them to retail stores. Right? These are stores where you walk into and people try to sell you things. Right? A bank branch isn't just a place where you walk into and you are going to cash a check and nobody's going to ask you to buy any additional products. The difference is that, because it's not a tangible product, it's not as obvious. In the banking industry, the best bank when it came to cross-selling additional products to customers that walk into its stores, not at its branches, it calls them stores, Wells Fargo was the best when it came to cross-selling products. In the most recent quarter...

Lapera: Wait one second.

Maxfield: Go on. Sure.

Lapera: Just so you guys know, bank products are considered things like mortgages, credit cards, checking accounts, savings accounts -- basically anything you would want to do at a bank. That is considered bank's products.

Maxfield: Right. Let's say you go into a bank. You want to cash a check. You're just minding your own business, you walk into a bank. You got a check from your aunt for your birthday. You need to cash it, get your $100, and go down to whatever, wherever it is that you want to spend your $100. While you are there, the teller would say like, "Oh, well, Gaby, would you also like to get a mortgage or an auto loan? Would you like to open another account? A savings account that you can supplement your checking account with?" A lot of times -- and we all know this, we all go into retail stores -- the customers say no.

This is a problem for Wells Fargo employees because its sales culture incentivized, in fact almost by the sounds of it, demanded that they constantly be selling these additional products. The problem is that there are not a lot of people walking into bank branches nowadays. The Wells Fargo employees, it sounds like, had to come up with a workaround. The workaround that they came up with was that they would sign customers up for accounts and credit cards and other types of banking products and services without the customer's approval.

Let me give you a very specific example. You go in. You say you don't want any additional products, but they actually sign you up for, let's say, an additional checking account. They didn't just stop at that. They would then go to your other account, the one that you had had for a while, that you had money in, that was authorized, that you would use. They would transfer, without authorization, money from that account into this new secret unauthorized account. The problem in that case is that in many instances, it caused those original accounts of customers to have insufficient funds fees. You are not only opening an unauthorized account, but you are also costing people money because you're moving their money without approval and that's causing their accounts to dip below the minimum balance.

Lapera: What's really interesting is that sometimes people would catch them and say, "Hey, I don't know where my money went, and I suddenly have this overdraft account. Fix it." Wells Fargo would go, "Oh, I'm so sorry," and fix it right away, but not everyone caught it.

Maxfield: That's right. In Wells Fargo, the way it works is, Wells Fargo would say, "Oh this was a one-off deal. It was a mistake. It wasn't intentional," but what we came to find out in the settlement, this behavior was actually systemic and spread across the entire company. One of the things that Wells Fargo tries to...the way they're trying to pitch this is, "Look, this behavior is the exception. It is not the general rule in terms of how we operate toward our retail customers." The problem with that position is that we are talking about 2 million unauthorized accounts. That is far too many for this to be some sort of isolated scheme.

On top of that and to your point, Gaby, while Wells Fargo fired 5,300 employees, it goes out and says, "That's just a fraction of the roughly 250,000 employees that we have at the bank. This is just a very, very small little group." If you actually look at where their employees are actually allocated, it's only 100,000 of them are in their stores. This means that more than 5% -- in other words, a very meaningful percentage of its employees -- in its retail stores were engaging in this type of behavior.

Lapera: These were the ones that were caught. These were the ones that someone audited and found. There could, potentially, be other accounts. Is that correct?

Maxfield: I mean, I suppose that's totally a possibility. The other thing to keep in mind to your point about that, these are not just allegations that are being made by the banking regulators. In fact, where we got those 2 million unauthorized accounts figure from was actually from an investigation that Wells Fargo did of this problem. This is coming straight from Wells Fargo. These aren't just allegations where you have to say Wells Fargo neither admitted nor denied. I mean, Wells Fargo, for all intents and purposes, has admitted what happened here.

Gaby Lapera has no position in any stocks mentioned. John Maxfield owns shares of Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short October 2016 $50 calls on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.