Federal Reserve Shackles Wells Fargo After Fraud Scandal

The Federal Reserve, which oversees Wells Fargo, said the bank needed to overhaul its risk management and strengthen its board’s oversight.

The Federal Reserve on Friday imposed unusually harsh penalties on Wells Fargo, punishing it for years of misconduct and barring it from future growth until the bank fixes its problems.

The central bank blasted Wells Fargo’s board for failing to oversee the bank, and it announced that the company would replace four members of its 16-person board by the end of the year.

The move, taking place on Janet L. Yellen’s last working day as the central bank’s chairwoman, is all the more extraordinary because it comes at a time when federal banking regulators appointed by President Trump are working vigorously to relax rules that were imposed in the years following the financial crisis.

The Fed’s punishment, a forceful intervention by the government into the affairs of a large company, means that one of the country’s largest and most powerful financial institutions will be unable to keep pace with its fast-growing rivals.

The decision by the Fed, one of the San Francisco-based bank’s main regulators, follows revelations over the last two years that Wells Fargo had deceived its customers by opening dummy accounts in their names and forcing some to take out unnecessary auto insurance.

“Until the firm makes sufficient improvements, it will be restricted from growing any larger than its total asset size as of the end of 2017,” the Fed said.

Wells Fargo said on Friday that it was working to address the problems, and the bank’s shares slid sharply in after-hours trading.

The central bank’s penalties are uncommon. The Fed’s regulators have routinely penalized banks for misconduct, but they have not previously imposed strict limits on a major bank’s growth.

The regulatory pendulum has recently been swinging in favor of big banks. President Trump and his advisers argue that regulators have gone too far in curbing banks’ activities.

Mr. Trump, however, has taken specific aim at Wells Fargo as a rogue institution. He wrote on Twitter in December that penalties against the bank “will be pursued and, if anything, substantially increased. I will cut Regs but make penalties severe when caught cheating!”

On a conference call with analysts and investors Friday night, Wells Fargo’s chief executive, Timothy J. Sloan, said the Fed’s actions related to past conduct that the bank was already taking steps to fix and that they did not affect the bank’s financial condition.

“We want to have this cap lifted as soon as possible, and we’re going to work very hard to make sure that’s the case,” Mr. Sloan said. He added that the bank remains open for business and will continue to make new loans even as the Fed’s limits remain in place.

Wells Fargo said it would submit a plan to the Fed within 60 days for improving its board oversight and risk management practices. It will also submit to an independent third-party review that will be completed by the end of September.

Wells Fargo officials expect that they will be able to get the restrictions lifted within the next year, which they believe will minimize the financial impact of the penalty, according to a person close to the bank.

The Fed’s action Friday stunned industry observers.

“I don’t remember the last time the board has ever done anything quite as dramatic as that,” said Evan Stewart, a regulatory lawyer at the law firm Cohen and Gresser, referring to the Federal Reserve Board. “It’s really quite a dramatic intervention by the major federal regulatory agency in the governance of a major bank.”

For years, Wells Fargo was the toast of the United States banking industry. It was showered with awards and praise for appearing to perfect the art of “cross selling,” in which it found creative new ways to peddle financial products to its existing customers. The bank’s savvy management of risk allowed it to avoid the worst of the financial crisis.

While others retrenched, Wells Fargo substantially expanded, snapping up ailing North Carolina lender Wachovia, in late 2008. That acquisition was engineered in part by federal regulators, who viewed Wells as one of the country’s strongest, best-run institutions.

That reputation has crumbled recently, though. Wells Fargo was found by regulators to have systematically created fake customer accounts and misled customers and government officials.

It is unclear what impact the Fed’s penalties will have on Wells Fargo’s future. The bank had nearly $2 trillion in assets at the end of 2017. Going forward, the Fed will not let Wells Fargo’s average balance sheet expand beyond that size, according to a senior Fed official. Because large banks’ assets tend to expand as the economy grows, the Fed believes that this limitation will be a significant constraint on the bank’s ability to grow.

One of Wells Fargo’s primary regulators, the Office of the Comptroller of the Currency, slapped significant restrictions on the bank last year, when it gave it a failing score on a key community lending metric. The low grade meant that Wells Fargo would need to clear extra hurdles to open new branches or otherwise expand its retail banking business.

Wells Fargo’s board has already undergone a makeover in the wake of the scandal, although half of its current board — eight members — were there at the time the scandal erupted. Wells Fargo on Friday night declined to say which four directors would be stepping down as part of the agreement with the Fed.

Wells Fargo’s current board chairwoman, Elizabeth A. Duke, took on the position last month, replacing Stephen W. Sanger, a 13-year board member who retired after a year filled with scandals. Two other longtime directors departed at the end of last year.

Last year, a longtime Wells Fargo investor, Gerald R. Armstrong, submitted a shareholder proposal calling for the bank’s directors to be replaced. His proposal was voted down. Mr. Armstrong welcomed Friday’s news. “I hope they bring in some very effective new directors,” he said.

A review that Wells Fargo’s board commissioned last year, conducted by four directors and the outside law firm Shearman & Sterling, found that lax internal oversight allowed problems to fester for years.

The Fed, in letters sent Friday to Wells Fargo board members, leveled harsh criticism on their oversight of the bank and made clear that more changes need to happen quickly.

“Your performance in addressing these problems is an example of ineffective oversight that is not consistent with the Federal Reserve’s expectations for a firm of WFC’s size and scope of operations,” wrote Michael S. Gibson, the Fed’s head of banking supervision, in a letter to John G. Stumpf, the bank’s former chief executive. Mr. Stumpf retired under pressure in the wake of the scandal with a pretax payout of more than $80 million in stock options and other compensation.

“The bank is lucky it is too big to shut down,” said Erik Gordon, a professor at the University of Michigan’s Ross School of Business. “A smaller bank might have lost its banking licenses.”

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