Wells Fargo's legal woes continue; The SEC asks more questions about its accounting for penalties and fines
Wells Fargo can't get out from under the cloud of its 10-year-old customer cheating scandal. Billions in costs have been booked but the SEC says its disclosures need a lot of improvement.
The SEC is still dogging banking behemoth Wells Fargo & Company with questions about its handling of the now 10-year-old customer cheating nightmare, first reported by the Los Angeles Times in 2013.1 The Consumer Financial Protection Bureau settled with the bank for a $185 million fine back in September 2016, but since then the bank has paid billions more to public and private punishers.
On June 14, 2023, the SEC issued a comment letter to Wells Fargo & Company (Ticker: WFC) requesting more transparency regarding the historical legal, regulatory, and customer remediation matters covered by a series of operating charges for $7 billion, $1.5 billion, and $3.5 billion in the years ended December 31, 2022, December 31, 2021, and December 2020, respectively.
In its June 29, 2023, response to the SEC, Wells Fargo provided details of several large cases that contributed to the $7 billion charge and noted that the bank does not generally break the accruals down by individual matters because it may “hinder …negotiations or settlement discussions” – an argument commonly used by companies to obfuscate disclosure of legal contingencies.
On October 24, 2023, the SEC issued a follow-up letter to Wells Fargo with three requests:
Provide a breakdown of operating charges separately for legal, regulatory, and customer remediation categories.
Provide more clarity regarding expenses for customer remediation matters and an explanation of whether new developments or updates to historical developments contributed to the operating charges.
Clarify why the $7 billion fiscal 2022 charge was more than twice the high-end earlier estimate of $2.9 billion as of December 31, 2021.
The third request may be explained with more context.
Accounting guidance states that a loss contingency should be accrued if it is both probable and reasonably estimable.
According to Wells Fargo, the bank records accruals — charges to expense that hit net income — at the lower end of the range for its losses that are both probable and reasonably estimable. Wells Fargo provided the following disclosure in the Legal Actions section (emphasis added) of its December 31, 2021, annual report:
We establish accruals for legal actions when potential losses associated with the actions become probable and the costs can be reasonably estimated. For such accruals, we record the amount we consider to be the best estimate within a range of potential losses that are both probable and estimable; however, if we cannot determine a best estimate, then we record the low end of the range of those potential losses.
However, as we discussed in our previous piece, investors are often left in the dark about the amount and the timing of the accruals for a specific case until the case is settled.
In addition, when a contingency is reasonably possible but not probable – an accounting term that implies that there is a less than 50% probability that the loss would materialize — the expected range of loss needs to be disclosed but does not need to be accrued. From the Wells Fargo 2021 Annual Report disclosure (emphasis added):
OUTLOOK. As described above, the Company establishes accruals for legal actions when potential losses associated with the actions become probable and the costs can be reasonably estimated. The high end of the range of reasonably possible potential losses in excess of the Company’s accrual for probable and estimable losses was approximately $2.9 billion as of December 31, 2021.
The $2.9 billion high-end loss estimate implies that should the plaintiffs prevail in all the cases included under the “outlook” section, the most the bank would have to record is an additional $2.9 billion in losses.
So, if the maximum exposure was supposed to be $2.9 billion, how did Wells Fargo end up with $7 billion in operating losses?
Let’s look at the breakdown of the $7 billion charge provided by Wells Fargo in response to the SEC’s comments but not in its 10-K filing for the year ended December 31, 2022:
According to Wells Fargo, the discrepancy between the disclosed $2.9 estimate and the actual $7 billion charge is attributable to losses that were not estimable – such as customer remediation charges. Customer remediation charges are what Wells Fargo eventually had to reimburse or pay as compensation to harmed customers.
In its response to the SEC, Wells Fargo elaborated on why the customer remediation loss amount was so difficult to estimate (emphasis added):
Customer remediation
The expense for customer remediation activities in 2022 predominantly resulted from the further refinement in third quarter 2022 of the scope of remediation for historical mortgage lending, automobile lending, and consumer deposit accounts matters. This further refinement led to the higher expense in 2022 and was not estimable prior to completion of the work in third quarter 2022. In addition, there were expense amounts for customer remediation activities in fourth quarter 2022 primarily related to the December 2022 CFPB consent order.
As discussed in our prior response letter, customer remediation matters often span multiple years, and typically require reviews and discussions with internal and external parties, including communications with our regulators, which may result in variability related to the timing and the determination of the amount of loss. These reviews and discussions may result in expansions of populations of affected customers and/or time frames, as well as changes to customer remediation payment amounts.
We establish an accrual for the probable and estimable costs related to each customer remediation matter, which amounts are refined over time in light of any additional information; however, given the complexity and unpredictability of these matters, it is not possible to determine the ultimate loss or reasonably estimate possible loss in excess of amounts accrued until these reviews and discussions are complete.
The conversation between Wells Fargo and the SEC illustrates the current limitations of the GAAP accounting standard that applies to these issues, ASC 450. Specifically, the standard allows for ambiguous disclosure and significant judgment and discretion when estimating loss contingencies despite the fact they often lead to material unexpected charges.
As reported for Market Watch — by co-author McKenna — after Wells Fargo’s $185 million settlement with the SEC in 2016, the impact of regulatory actions and investigations is notoriously difficult to estimate:
Given the uncertainty surrounding the outcome of most governmental investigations, the decision about when to disclose to the SEC and investors and the public can be difficult judgment calls for executives to make.
As we progress through the earnings season, the SEC’s comments to Wells Fargo about this case provide a helpful framework for evaluating the impact of legal contingencies.
More specifically, investors should consider the following questions when reviewing these disclosures, or the lack of disclosures:
What fraction of the legal costs has already accrued, and when were the costs accrued?
What is the high-end estimable loss, and does this estimate seem reasonable given the company’s and industry’s litigation environments?
The ability to estimate losses is likely to improve as negotiations progress and each side gets a better understanding of the other side’s arguments. How many legal cases are in the early stage, so the loss cannot yet be estimated?
How significant is the loss that cannot be estimated at the time of the filing?
Finally, this framework is generalizable to other companies with significant public or private litigation exposure. For instance, using Calcbench’s XBRL Data page, we identified at least 98 S&P 500 companies – including large banks such as JPMorgan Chase (Ticker: JPM) and Citigroup (Ticker:C) - that disclosed the range of possible losses in excess of losses that were already accrued. (Note that our search is not comprehensive because companies are inconsistent in tagging loss contingencies.)
Key Events (Source: Congressional Research Service, “Wells Fargo—A Timeline of Recent Consumer Protection and Corporate Governance Scandals”. Updated February 2020.)
The following provides a timeline of selected events since the Wells Fargo fake accounts scandal broke.
2016
September 2016: Wells Fargo pays $185 million in fines to the CFPB, OCC, and the City and County of Los Angeles for creating about 1.5 million unauthorized deposit and 623,000 credit card accounts in customers’ names without their knowledge. Wells Fargo also discloses that it previously fired 5,300 employees for their involvement in creating these fake accounts. In coordination with the Department of Justice (DOJ), the OCC assesses $20 million in civil money penalties against Wells Fargo for violating the Servicemembers Civil Relief Act (SCRA; P.L. 108-189). Violations include failure to accurately disclose servicemembers’ active-duty status to the court prior to evicting those servicemembers and failure to obtain court orders prior to repossessing 413 servicemembers’ automobiles. In November 2017, Wells Fargo admitted it had illegally repossessed another 450 servicemembers’ cars.
October 2016: Wells Fargo’s chief executive officer (CEO), John Stumpf, retires. Between forfeiture and clawbacks, he surrendered $69 million in compensation. Another key executive, Carrie Tolstedt, surrendered $67 million in compensation. Wells Fargo’s board names the chief operating officer, Timothy Sloan, as the new CEO.
December 2016: As a consequence of deficiencies in Wells Fargo’s “living will,” regulators restrict Wells Fargo’s ability to grow its business. P.L. 111-203 (often called the Dodd-Frank Act) requires certain companies to submit a living will to regulators to show how large banks would unwind themselves in the event of a large financial loss.
2017
March 2017: The OCC downgrades Wells Fargo’s Community Reinvestment Act (CRA) rating to “needs to improve,” from “outstanding” due to Wells Fargo’s discriminatory and illegal credit practices, including the fake accounts scandal.
April 2017: The Sales Practices Investigation Report (SPIR) issued by Wells Fargo reveals that the bank’s board of directors and bank executives knew of many of the issues underlying the fake accounts scandal as far back as 2002.
July 2017: Wells Fargo admits that it charged about 570,000 customers for auto insurance on car loans without verifying whether these customers already had existing insurance. As a consequence, up to 20,000 customers may have defaulted on their car loans.
October 2017: Wells Fargo admits it wrongly fined 110,000 mortgage clients for missing a deadline, even though the delays were the bank’s fault.
2018
February 2018: The Federal Reserve restricts Wells Fargo’s growth until it improves its governance and controls. Wells Fargo announces it will replace four members of its board by the end of the year. Wells Fargo—A Timeline of Recent Consumer Protection and Corporate Governance Scandals https://crsreports.congress.gov
April 2018: Wells Fargo, CFPB, and OCC reach a $1 billion settlement of issues related to Wells Fargo’s auto-loan insurance and mortgage practices.
July 2018: Reportedly, Wells Fargo refunded millions of dollars for charges related to add-on services, such as pet insurance and legal services, it added onto customers’ accounts without the customers’ full knowledge.
August 2018: Wells Fargo pays a $2.1 billion fine to DOJ for misrepresenting the type of mortgages it sold to investors between 2005 and 2007. Wells Fargo discloses that it incorrectly denied loan modifications for 625 people, 400 of whom had their homes foreclosed.
2019
Timothy Sloan resigns as CEO in March, after the OCC made a rare public rebuke of the bank. Throughout 2019 other key executives leave the company. Charles W. Scharf becomes the CEO and president in October.
2020
January 2020: The OCC issues lifetime prohibition from participating in the banking industry and new civil money penalties (CMPs) to two former senior executives; John Stumpf ($17.5 million) and Carrie Tolstedt ($25 million). OCC also issues other prohibitions or cease and desist orders along with CMPs to other former key executives. It is reported that the Treasury Department’s Office of Inspector General (IG) has been assessing OCC’s actions in connection with sales practices at Wells Fargo and expects to release its report sometime in 2020.
February 2020: Wells Fargo agrees to pay $3 billion to resolve criminal and civil investigations into its past sales practices to the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC). The SEC is expected to distribute about $500 million of the $3 billion to the investors. As part of the settlement, DOJ has agreed to defer prosecution for three years if Wells Fargo abides by certain conditions.
and they continue to be the greed incarnate that bad actors are.