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Is It Time for the CFPB to Regulate Retail Bank Employee Compensation?

posted by Adam Levitin

It doesn't take a genius to figure out that incentive-based compensation like the type featured in Wells Fargo's current and previous consent orders has the potential to encourage fraud and steering of consumers into inappropriate products in order to make sales numbers. Here's the thing:  there's little regulation of retail banking employee compensation. Instead, banks are relied upon to self-regulate, to have the good sense not to have unduly coercive incentive compensation and to have internal controls to catch the problems incentive compensation can create. But when a leading bank like Wells Fargo repeatedly fails to have good sense and to have sufficient internal controls, it suggests that it might be time for more directed regulation that will create clearer lines that facilitate compliance.  

The CFPB already regulates the compensation of mortgage originators (loan officers and brokers), limiting compensation based on loan terms to 10% of total compensation. But this regulation applies only to mortgage loans. There's no regulation of retail banking employee compensation generally.  And there are some big wholes in the CFPB mortgage loan officer compensation regulation. In particular, the CFPB's regulation does not cover compensation based on the number of loans made or the size of the loans, only on the terms of the loans. That leaves the door open for banks to set up compensation schemes that pressure employees to engage in fraud to meet quotas and get bonuses. 

So what can be done going forward?  

The good news is that CFPB has the authority (I believe) to regulate broadly in this area under its UDAAP power. Indeed, the "abusive" part of this power, which has come under so much criticism from Republicans, was actually designed to address this very problem.  12 U.S.C. § 5531(d)(2)(C) provides that 

(d)Abusive.  The Bureau shall have no authority under this section to declare an act or practice abusive in connection with the provision of a consumer financial product or service, unless the act or practice—

...

 (2) takes unreasonable advantage of—
...
 
(C) the reasonable reliance by the consumer on a covered person to act in the interests of the consumer.
When a consumer is steered into a higher cost product because of a compensation arrangement, or even steered into a product in the first place because of a compensation arrangement, the lender may be taking unreasonable advantage of the consumer's trust in the bank to serve his interests. This provision was drafted with the problem of mortgage brokers' compensation through yield spread premiums in mind, but the logic applies equally to non-mortgage products and to the compensation of any bank employees with authority to open accounts. It's great that the CFPB has used its enforcement authority to address the problem with Wells Fargo in particular, and the consent decree should send a clear message to the entire retail banking industry regarding compensation arrangements, but this might be an area where the CFPB should consider a broader rule-making, not least because bright lines will eliminate any uncertainty about what is an abusive practice.
 
Now you might say, "Come on Adam, consumers know that they're in a completely mercenary commercial relationship with their banks. They'd be fools to trust them, so there's no reasonable reliance on the bank acting the consumer's interest. The "abusive" power simply doesn't fit here." Maybe. But if that's right, what does that say about the retail banking industry? It's certainly not how the retail banking industry likes to portray itself. Consider the rhetoric in John Stumpf's written testimony to the Senate Banking Committee. He talks about customer "relationships," and "responsibility to our customers". Heck, this all went on in Wells Fargo's "community banking" division. This jargon of retail banking is designed to convey the idea that banks are not just in a completely mercenary relationship with consumers, but are actually in a quasi-fiduciary relationship, in which the consumer can rely on the bank for advice and to act in the consumer's interest. Indeed, that's what many consumer want from their bank. And I think many bankers sincerely believe in this model of banking. But the cynic in me recognizes that it is also a useful anti-regulatory talking point: the banks can argue that they don't need to be regulated because they'd never do anything against the interests of their valued consumers. Here's the thing. Talk isn't always free. If the retail banking industry wants to portray itself as being in a "relationship" with its customers, then it can hardly complain about customers relying on it to act in their interests.
 
The CFPB has some strategic decisions about whether it wants to do a broader rulemaking in this area or do ersatz rulemaking via enforcement. (I leave to one side the question of what such a rulemaking would actually look like.) I would understand the CFPB being reluctant to take on anything else given the rule makings currently its plate. But this is a great opportunity to do a rulemaking that starts to explicate the "abusive" power, and it is also an opportunity for establishing that banking is not just another line of business, but a particular type of limited franchise that comes with certain responsibilities, including acting in the interest of the consumer.
 
Indeed, this suggests a very simple legislative response to supplement any CFPB response. Amend the Consumer Financial Protection Act to include a new section that provides, "A Covered Person or Service Provider has a duty to act in the interests of the consumer." Then authorize CFPB rulemaking to implement that provision.
 
Update: James Kwak has a great piece about the Orwellian language used by Wells Fargo. I say hold 'em to it. 

Comments

What bothers me here is we have to question where CFPB was when the LA Times brought this situation to light of day? The settlement seems minuscule in light of fraud by the mischief of management.

Despite all the ramping up of the regulatory regime post Enron, things have gotten worse instead of better. In fact is the government the problem and not the resolution?

Most of this stuff could be seen by a blind man eg simple frauds. It is obvious the banksters have gamed the system. We have to recognize what exactly will address the problems now apparent to us. Congress, prosecutors, regulatory, judiciary, executive has all failed us. What do we do now knowing our protocol has failed?

In Ohio, is ORC 2935.09 a mechanism for remedy? If the officials tasked with compliance with the law-----do citizens have a remedy?

I agree that the problem is that you don't expect to get ripped off by your banker but you do expect to get ripped off, say, by your used car dealer. You also don't expect your doctor to guide you to treatments because of cash but they often do. It seems to me there is no reason to treat banks and doctors/lawyers/retail stores selling store cards any differently here. What wells did is far from abnormal. It is inherent in commission sales.

To put this on "commission sales" is a mistake. The is nothing wrong with commission sales. The problem here is one that is inherent in Anon's comment. Every body is selling something be it a plumber, clergy, lawyer or a candle stick maker. The problem at Wells and others that have gone awry is the fact that Stumpf et al forgot where his bread is buttered........in a satisfied customer, not in monkeys-business designed to desensitize investors to lose focus on benefits to customers instead of share price. The customer better be happy and receive benefits which is at the core of any successful business.

In short they are not doing it in all businesses. The free market has a way of weeding out bad actors in short order via customer reaction. For sure they the financial services industry has evolved to a point where screw the customer is SOP. They have designed the Model accordingly.

Let's not forget the investors in all this. As in the GSE Business Model when did it dawn on investors that the Model was "fatally flawed"? Were investors lulled into looking the other way just because they were getting a check every month? After all, investors had a mechanism via the Model to recoup their losses on a Model that wrought worldwide devastation. Of course, by design in the event of implosion they knew that the taxpayers would pick up the shortfall.

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