Accountability, Representation, and Control in Wells Fargo - Case Study Example

Accountability, Representation and Control Name Institution Course Date Introduction Over the last few decades, there has been increased attention being paid to corporate culture, ethics and corporate governance due to increased incidences of corporate scandals perpetuated by executives and employees (Rezaee 2009, p. 3). In the early 2000s, quite a number of American companies were reduced from riches to rags due to corporate scandals chief among them being Adelphia Communications, Enron and WorldCom. Although the United States reacted to the scandals by introducing the Sarbanes-Oxley Act (SOX) to guard against corporate scandals (Marchetti 2005, p. 41), the recent involvement of Wells Fargo in a mega accounting scandal that affected the accounts of more than two million customers indicates that a lot steel needs to be done rather than just relying on SOX to ensure accountability and protect stakeholder interests. The scandal which was perpetuated by Wells Fargo employees is estimated to be up to the tune of $1.5 million and involved up to 5,300 employees of the bank (Scarcella 2017). The scandal that was perpetuated for more than five years involved Wells Fargo staff secretly creating new accounts for more than two million customers without their consent so that the employees and managers could get incentives. To conceal the scandal, the majority of the accounts were closely very quickly. Wells Fargo has so far been fined $185 by the Consumer Finance Protection Board (CFPB) for the misconduct (Wharton University 2016). This report analyzes Wells Fargo’s scandal in terms of representation, accountability and control. The report begins by describing the relationship between accounting representations and reality, financial statement and annual report and proceeds to analyze why the bank engaged in the fraudulent act. It will proceed to describe the role of discipline and self-discipline in the management of accounting system of Wells Fargo and then describe the parties to blame for the scandal, and how it was solved. The report will also describe the relevance of corporate governance to the problems faced by Wells Fargo. Finally, the report will analyze the limitations of accounting controls and their roles in the fraud at Wells Fargo. Representation Public companies are required by law to publish their annual reports at the end of the financial period. A financial statement is meant to show the true and fair position of a firm during the financial period under review. Annual reports are important documents for a company because they presents the reality and they help the stakeholders made informed decisions about the position of a company. Analysis of Wells Fargo’s 2015 annual report shows that the picture of a company that was in good financial health recording high revenue and profits. For instance, according to the company’s 2015 annual report, Wells Fargo posted a net income of $20,122 million (Wells Fargo 2016). Although the income marked a slight decline from 2014 where the bank’s net income was $25,513 million, the high income paints the picture of a company that was in good financial health and making huge profits (Wells Fargo 2016). Painting a good picture by showing an annual report that demonstrate good financial health of a company was important for Wells Fargo not only in building the confidence of its stakeholders, such as investors and suppliers in the bank, but also to make the bank attractive for customers so that they can be induced to buy more of the bank products. The more revenue the bank posted, the more the income generated and this translates to high investor confidence, which makes them more willing to invest more in the bank in the hope that high income translates to high dividend earned (Ian 2010, p.21). Although the annual report painted a good picture of the bank as if it was in good health, critical analysis indicates that the revenue posted were fictitious as the bank used cross selling as a strategy to make the bank look as if it was in good financial health, whereas this was further from the truth (Tayan 2016). Accordingly, analysis of the events that led up to the scandal indicates that Wells Fargo was involved in the scandal was the fact that the bank adopted a cross-selling target scheme that put a lot of pressure on branch employees. Cross –selling is a scheme that operates on the concept that the more products a customer had with Wells Fargo, the more information the financial institution had on the customer and this allowed the bank to make better decisions about products, credit and pricing (Dyché 2002, p. 16; Forte Consultancy Group2015, p. 58). Well Fargo also adopted cross-selling because customers with several bank products are more profitable. Therefore, the scandal at Wells Fargo was caused by the fact that the bank put pressure on its employees to cross-sell and cross-sell (Tayan 2016). The bank administered the cross-selling practice by offering financial incentives to the brunch employees to meet cross selling and high customer-service targets. Whenever cross-selling and customer service targets were achieved, the bank tellers were to get up to 3% bonus while personal bankers were to get a bonus of 15% to 20% (Wharton University 2016). Additionally, branch managers were assigned quotas by Wells Fargo for the number and product types sold. It is also noted that the bank managers set exceedingly high sales targets on employees in what is termed ‘eight is great’ scheme that involved setting a target for accounts for every customer at eight. This meant that Wells Fargo employees were expected to achieve the ‘eight is great’ targets in order to be given a commission or avoid losing their jobs. Setting such high performance targets placed a lot of pressure on both the branch managers and the employees of Wells Fargo to a level that, to meet the cross-selling targets sets so as to earn the bonuses and avoid termination, employees were forced to break the law by opening more than 2 million customer accounts and issuing credit and debit cards without the consent of customers (Scarcella 2017). The employees did this by forging customer signatures in some cases. Accordingly, it can be seen that the pressures put on Wells Fargo’s employees translated into a representation in the sense that they were forced to break the law by creating non-existent customer accounts just to paint a good picture of a company that is experiencing growth in customer numbers in the eyes of the investors and other key stakeholders, where as this was not the true representation of the bank’s customer numbers. Accountability Accountability is important in an accounting system and self discipline is paramount to ensure accountability. Accountability is particularly important for a bank to ensure that the interests of customers, investors and other key stakeholders are met. Budgets are some of the tools that banks like Wells Fargo use to promote accountability. Budgets promote accountability because it sets the expected performance targets for employees and managers as the actual results achieved is compared to the target set to see if there was underperformance (Kaplan & Anderson 2007, p. 91). Additionally, a budget acts as a yardstick for performance in real numbers. At Wells Fargo, however, the employees were given the target dubbed ‘eight is great.’ This implies that Wells Fargo’s employees were expected to sell at least eight products to every customer on average (Toomey 2016). Accountability comes in here in the sense that it was only when an employee manages to meet the ‘eight is great’ sales target that they were given bonuses and quotas, failure of which could result in termination. This placed a lot of pressure on the employees as it meant that they had to do everything possible to meet the performance targets failure to which they not only risk missing the bonus, but also losing their jobs. In a banking institution, employees are expected to place the interest of the customers first by being accountable to them. Indeed, there are indications that employees at Wells Fargo would have liked to ensure that the interests of employees are put first before personal interest. Unfortunately, because the bank exerted too much pressure on them by setting unrealistic sales target coupled with pressure to cross-sell, they had no option but to sacrifice customers in order to meet cross-selling and sales targets (Scarcella 2017). Indeed analysis of the way the scandal occurred indicates that the interests of the customer was secondary as the company placed the interests of the executives and the managers first by pursuing high returns at the expense of the customers, which amounts to unethical behavior. Following the discovery of the scandal that had been perpetuated for close to five years, employees were majorly blamed for the scandal. Indeed, analysis of the scandal justifies the blame placed on the employees because they allowed themselves to be driven by greed that saw them create fictitious customer accounts without their consent just to be able to get bonuses and retain their jobs. Employees have a responsibility to abide by ethical codes of conduct by ensuring accountability and protecting the interests of customers at all time, something they failed to do (Wharton University 2016). Therefore, they are largely to blame for the fraud. However, a detailed analysis of the parties involved in the scandal indicates that the entire blame ought not to be placed squarely on the employees. This is because not only were the low-level employees at fault, but also those at higher positions. In particular, the executive team and the board of directors of Wells Fargo are also to blame for the fraud (Berry 2016; Morgenson 2016). This is because they failed to effectively perform their oversight responsibilities to respond to the situation. One key person to blame for the scandal was John Stumpf who was the chief executive officer from 2007 to the time the fraud was detected. As the CEO of the company with an oversight role, and accounting officer, he is expected to have known about the fake accounts that were being created by the employees. Accordingly, it is for this reason that he was called to testify before the Congressional committee to explain what he know about the scandal (Scarcella 2017). The other senior executive to blame for the fraud is Tim Sloan, who was the chief operating officer and president of the bank at the time of the scandal. As the chief operating officer who monitors the operations of the banks and customer accounts, he either knew or ought to have known that employees were creating fake accounts, and as such is also to blame for the fraud (Morgenson 2016). Additionally, Carrie Tolsedt, the bank’s head of retail operation as a senior manager with oversight role over the retail banking operations also need to be questioned about what he knew about the fraud and is also to blame for the scandal (Toomey 2016). Lastly, the auditors, especially KPMG that audited the accounts Wells Fargo’s financial statements are also to blame for the fraud. Although the International Standards on Auditing 200 (ISA 200) does not require the auditors to detect frauds, auditors are required to detect errors and to bring to the attention of the management any incidence of fraud that might have come to their attention in the course of audit (Collings 2011, p. 11). Unfortunately, KPMG failed in their responsibility to help in fraud detection despite the fact that the fraud had been going on at the bank for close to five years under the watch of the audit firm (Toomey 2016). The failure by KPMG to report the fraud could be attributed to the long relationship that the audit firm has had with Wells Fargo considering that KPMG had been the bank’s auditor for several years. Accordingly, this raises the independence of KPMG with regards to its approach to the audit of the bank’s books of accounts. The scandal has been addressed by taking various actions. First, the company acted by firing more than 5,300 employees who were believed to have perpetuated the fraud. Additionally, a number of top executives such as the John Stumpf, Tim Sloan and Carrie Tolsedt have been forced to resign to allow for investigations. The bank has also taken measures by removing the fictitious customer accounts and paying a fine of $185 million (Berry 2016). The fraud also highlighted corporate governance problem at Wells Fargo. Corporate governance requires that the interest of all the stakeholders of key stakeholders are balanced, including shareholders, customers, management, suppliers, investors, government and the community (Rezaee 2009, p. 13). This requires demonstrating accountability and acting responsibly in the interest of the company and its stakeholders. Unfortunately, there was serious corporate governance problem at Wells Fargo as the executives and the board failed to act in the interest of its stakeholders by pursuing self interest. The main focus of the company’s board and executives was to get huge compensations and bonuses at the expense of customers, investors and other key stakeholders. For instance, at the time of the fraud, John Stumpf was pocketing US$19 million a year while Tim Sloan took home US$11 million and Carrie Tolsedt US$9 million (Berry 2016). Even as this happened, employees were being put under extreme pressure to cross-sell and meet sales targets and even threatened with termination, which amounted to unethical behavior on the part of the executives and the board. Control Instituting strong accounting controls is important in ensuring that company operations are executed in line with company principles. There are many accounting control models applied by companies in ensuring accounting controls. A budget is one of the accounting control models used by companies to control performance as a budget sets standards that are to be compared against actual results to see whether or not the variance produced is positive or negative. Activity-based accounting (ABA) is one of the most common systems of controls used by companies (Kaplan & Anderson 2007, p. 95). Despite the wide use of this system, the technique has its shortcomings. One such shortcoming is the fact that it creates pressure on employees because it aims at high efficiency and productivity, which employees might not be able to cope with. This is because ABA determines employee performance by comparing actual sales achieved with the standards set (Kaplan & Anderson 2007, p. 95). However, because only activities that are traceable to production are attractive in activity-based accounting, this creates ignorance of long-term development and loss of firm value. At Wells Fargo, the bank used sales incentives as the control mechanism. With sales incentives system, the low-level employees of the bank were given set sales target known as ‘eight is great’. With the ‘eight is great’ system, employees were given a target of eight accounts per customer regardless of the means they use to achieve the target failure to which they risked losing their jobs or missing out on the bonus and quotas (Berry 2016). With the sale incentive system, Wells Fargo did not take into account the interest of the employees nor did the company care about ethics as the main focus for the company was the achievement of performance target. The end result is that the sales incentive system created a lot of pressure on employees to deliver that prompted them to use shortcuts that include creating false accounts of customers and this demonstrates the shortcoming associated with this control method. It is obvious from the case that the fraud occurred because of limitations associated with internal control systems of Wells Fargo. The fraud at the bank occurred because of lack of proper risk management system. In order to succeed in today’s volatile and uncertain business environment, a company must ensure that there is a proper risk management system in place. Risk management refers to the measures instituted to identify, and mitigate uncertainties or to ensure resilience when an event occurs (Marchetti, A. M. 2011, p. 6). Enterprise risk management system is one of the most common models for risk management. Enterprise risk management (ERM) system is a risk management model use to plan, organize, lead, and control a firm’s activities so as to reduce the impacts of risk on a company’s capital ad earning (Marchetti 2011, p. 42). The fraud at Wells Fargo depicts a bank that had serious problems with its enterprise risk management system because it took a long time for the fraud to be detected. A lack of a properly functioning ERM system because the fraud could have been detected early before it got to the level it did (Marchetti 2005, p. 56). Besides, investigations conducted by the Congressional committee found that the bank had a weak internal control system that allowed the employees to falsify customer accounts without being detected. In fact, it was after the bank had been fined that Wells Fargo promised to build both compliant system and mediation system to mitigate against future risks. Conclusion Wells Fargo has become the latest giant companies whose corporate governance and cultures have come under questions in recent years as a result of engaging in fraudulent acts. The fraud at the company was caused by the fact that the company put employees under extreme pressure to cross-sell and meat high sales targets. Because employees wanted to get the incentives and to keep their jobs, they were forced to create false accounts to show that they are meeting the sales targets. Although a lot of blame was directed towards the employees, the executives and the board, as well as KPMG also ought to be blamed for the fraud. It also came out that the fraud occurred because of a weakness in the bank’s ERM system that allowed employees to engage in the fraud for long without detection. Going forward, Wells Fargo needs to begin by changing its culture, strengthen its leadership, promote corporate governance and ethics, enhance its internal control system, as well as promote external auditors independence through audit rotation after three years. 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