The Consumer Financial Protection Bureau has celebrated the $100 million fine it has imposed on San Francisco bank Wells Fargo for its employees’ improper handling of customers’ accounts, including opening unwanted accounts and unauthorized transfers of funds between accounts. Up to 85,000 accounts may have incurred $2 million worth of unfair fees as a result. With restitution to customers and fines to other regulators, the bank has to pay $185 million total for its misdeeds.
One thing that is missing here is an appreciation of the biggest victim in this fiasco – the bank itself. What happened was not a deliberate attempt to sandbag customers by the bank’s owners, but a conspiracy to game the bank’s compensation program, which rewarded big sellers of its products, by the bank’s own employees.
In economics, this phenomenon has a name – the principal-agent problem. This problem arises when the agent (in this case an employee) of the principal (in the case the bank’s owners and investors like Warren Buffet, who lost $1.4 billion as a result of the scandal) acts opportunistically in self-interest against the interests of the principal.
Why then does the bank have to pay up? The fine will come out of the pockets of its owners, its customers (who will likely see increased fees as a result), and employees who did not engage in these harmful practices (who will see reduced pay raises) – all of whom can be seen as victims of the banks’ opportunistic employees. The answer is because the entire edifice of the employment relationship assumes that an employee is a servant doing his/her master’s bidding. That is why firms are vicariously liable for the actions of their employees.
Of course, the bank was negligent in its supervision of its employees, and so at some level the bank as an institution was indeed guilty of harm, and the fine should serve as an incentive to Wells Fargo and to other banks to police cross-selling more diligently in future. How can they do that? A problem with the corporation that I highlight in my recent study, “Punching the Clock on a Smart Phone App,” is that the nature of the employment contract hides information that is present in a commercial contract. This information can be revealed through use of markets. If Wells Fargo had employed internal markets, for instance, there could have been warning signs that certain branches were far out-performing others in a way that would have raised eyebrows and prompted quicker internal investigation.
If firms are to police against opportunistic employee behavior, they need a full range of information-gathering strategies at their disposal, including disaggregating the corporation. Yet all the regulatory pressure, particularly in the world of banking, has been towards greater agglomeration in corporate structures, which intensifies the lack of information that allows opportunistic behavior.
This is why the Wells Fargo scandal shouldn’t lead us automatically to assume that regulation is helping out the little guy, even though prima facie it seems that it did its job here. In general, if regulation could exacerbate the principal-agent problem, it is probably a bad regulation. We will need to keep an eye on how the CFPB proceeds from here, given its broad (and probably unconstitutional) powers.