John Stumpf, head of Wells Fargo, should be glad the legal principles the U.S. Supreme Court imposed on Japanese general Tomoyuki Yamashita don’t cover banking. Else Stumpf’s goose would be cooked, along with other highly placed Wells Fargo managers.
He might still be forced out, because employees faked customer accounts to meet sales goals. (Wells Fargo is the largest bank in the Treasure Valley based on deposits, with 24 branches and 26 percent of the market.)
But most likely, Stumpf and other key managers will survive with jobs and wealth intact. That seems the rule in corporate business.
Yet there are legal, ethical and economic issues here.
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Generally, illegal actions by employees of large corporations do not trickle up to the corporate suite. Companies may be fined or may accept negotiated settlements without admitting guilt. (Wells Fargo is paying $185 million.) But executives seldom go to jail for things done on their watch.
There are exceptions.
After the S&L debacle, regulators made 30,000 criminal referrals. About 1,000 people were convicted of felonies. And occasionally individual financial traders are jailed for using inside information.
Yet there were no prosecutions resulting from the mortgage-backed securities debacle that arose in 2007. Some banks did agree to multibillion-dollar settlements, but no one was jailed.
Now, after Well Fargo workers fraudulently created 2 million customer accounts, the top executives seem unaffected. Was all this activity really due to the dishonesty of one manager of retail banking? Didn’t other top managers play a role? Didn’t they have a responsibility to know what was going on in their company? Didn’t they create incentives that led thousands of employees to open false accounts for millions of customers?
Now, reflect on who was harmed.
The customers for whom false accounts were opened are one group. Some suffered damaged credit ratings or were charged fees. Most did not, but they feel outrage about what was done in their name without their consent. So far they have gotten a pittance: $5 million of the $185 million settlement. But they may have the basis for a class-action lawsuit.
Then there are those who bought Wells Fargo stock assuming the company was being run honestly and not committing fraud. This group suffered the greatest pecuniary loss.
And there are citizens, growingly skeptical that “the laws be faithfully enforced.” This enforcement is increasingly haphazard when it comes to financial firms.
There are at least two economic issues here.
The first is the “principal-agent problem,” which arises when incentives are skewed so that an employee, an “agent,” fails to fulfill duties to best serve the employer, or “principal.” The stockholders in a corporation are the principals. Managers and other employees are agents. So are the directors, who are highly paid to ensure that management does, in fact, run the corporation to maximize shareholder benefit.
It is hard to argue that incentives set up by Wells Fargo that motivated employees to open fraudulent accounts furthered the interests of shareholders. Perhaps the directors are discreetly pressuring Stumpf. Perhaps the board will yet clean house, firing Stumpf and other key executives. But I wouldn’t bet on it. Principal-agent problems are a drain on economic efficiency and often seem intractable.
The other issue is limited liability. The modern limited-liability joint-stock corporation was an important advance in marshaling capital for productive ends. Sole proprietors and partners in business had unlimited legal liability for business actions. If a business failed to pay a loan, the individual owners were personally liable. If a business vehicle killed someone, individual owners were legally responsible for damages.
Limited liability in modern corporations means shareholders have no personal liability for debts or damages incurred by the company. They may lose the value in their stock, but no one can sue them for anything else. This limitation on liability removes a huge economic disincentive to people pooling their money to carry out large enterprises. The poor widow and Warren Buffett alike can invest their funds without worrying that they might lose all their other property in the event corporate managers make errors or do wrong.
Limited liability always referred only to the personal financial liability of shareholders. It never meant a corporation had exemption from financial obligations, tort liability or compliance with the law. In these, a corporation was like any other business.
In practical terms, however, the size and complexity of modern corporations means that assigning responsibility for misdeeds to specific individuals is problematic. Should Stumpf be personally liable if an employee driving a company car kills a pedestrian? Of course not. What if a loan officer alters a financial statement to grease a loan to a buddy? No. But what about something systemic, like 5,000 employees creating false accounts to avoid losing their livelihood?
Which brings us back to Yamashita.
This World War II general was executed by a U.S. military court because he commanded in the Philippines when Japanese forces committed terrible atrocities. Evidence was clear that Yamashita did not order atrocities, did not know of them ahead of time and, in many cases, did not have the means to stop them.
The Supreme Court refused to hear his appeal, though two justices dissented. He was arrested, charged, tried, denied appeal and executed in six months. Constitutional scholars today consider it a miscarriage of justice.
However, the general principle that military commanders are personally accountable for acts perpetrated by their subordinates was incorporated into international laws of war. The “I knew nothing” defense generally does not fly.
Stumpf continues to utter pieties about honesty and integrity at Wells Fargo. Like Yamashita, he argues that he did not order anything wrong and that he had no knowledge of it. This seems more valid for the old general than for the modern CEO. But don’t count on any change at the top anytime soon.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.