With all of the recent press coverage from the Wells Fargo & Co. phony account scandal, you’d have to be living in a cave not to have heard about it. As the details come to light, I’m certain it will be a test case for how not to design an incentive-based compensation program. But, does it mean that incentive-based compensation is a bad thing? In my opinion, a properly designed program can be well within the measure of safety and soundness, can create proper inducements for the appropriate segment of your workforce, and, can avoid creating the negative results that were realized by Wells Fargo.
In our firm, Bank Compensation Consulting, one of the most common short-term, incentive-based compensation designs has at its heart a deferral component. When a participant obtains a bonus based on achieving the goals set forth in the design, all or a portion of that bonus is deferred until some point in the future, say, five years from earning it. The deferral component accomplishes a number of goals. For one, it creates a reason for the participating employee to continue to remain employed with the bank If the employee leaves the bank prior to receiving the deferral amount, it is forfeited. Also, it allows the bank to comply with clawback rules requested by the regulators. Since the unvested portion has not yet been remitted, it can more easily be “clawed back” should there be a violation of terms outlined in the plan document.
Would this deferral design have helped in the Wells Fargo situation? As of this writing, the answer to that question is unclear. I will say that, when I consider how many years I’ve been working with banks and non-financial institutions to implement incentive-based compensation programs, and I consider how many of those haven’t had the result that Wells Fargo has, I think the answer is clear. As a CPA who did his requisite time at one of the large accounting firms, I have to ask myself questions like: What types of internal controls exist at Wells Fargo? What management oversight is in place to ensure an employee can’t easily create a fake account? Weren’t there ‘red flags’? Certainly, when your inventory is cash, there is always an element of temptation that some people simply cannot overcome. But, the sheer volume of the fraudulent accounts created indicates, at least to me, that at some level Wells Fargo management was sending the wrong message to the staffers involved. The corporate culture in the division of Wells Fargo where this took place must have played an enormous role.
The fact that an incentive-based compensation program existed shouldn’t mean that its utilization was the culprit that induced employees to create fraudulent accounts. For me and my colleagues, we feel that the malleability of such programs is extremely advantageous when trying to encourage certain actions by one or a group of employees. However, care and experience should be used when creating a safe and sound incentive-based compensation design.
You might just want to get inside a cave if you were an executive at Wells Fargo right now. Designing an effective and safe incentive-based compensation program and making sure it’s implemented correctly is one way to avoid the glare of bad publicity.