The Power Few of Corporate Compliance

• Publication year: 2018
• Citation: Vol. 53 No. 1

The Power Few of Corporate Compliance

Todd Haugh
Indiana University Kelley School of Business, thaugh@indiana.edu

THE POWER FEW OF CORPORATE COMPLIANCE

Todd Haugh^*

[Page 129]

Corporate compliance in most companies is carried out under the assumption that unethical and illegal conduct occurs in a more or less predictable fashion. That is, although corporate leaders may not know precisely when, where, or how compliance failures will occur, they assume that unethical employee conduct will be sprinkled throughout the company in a roughly normal distribution, exposing the firm to compliance risk but in a controllable manner. This assumption underlies many of the common tools of compliance—standardized codes of conduct, firm-wide compliance trainings, and uniform audit and monitoring practices. Because regulators also operate under this assumption, what is deemed an "effective" compliance program often turns on the program's breadth and consistent application. But compliance failures—lapses of ethical decision making that are the precursors to corporate crime—do not necessarily conform to this baseline assumption. As with other aspects of criminal behavior, unethical and illegal acts in business may follow a "fat-tailed" distribution that makes extreme outcomes more likely. This volatility, exhibited both in the frequency of compliance lapses and the intensity of their harm, is a function of how individual decision making interacts with the complex networks within corporations. By

[Page 130]

failing to recognize this phenomenon, the compliance and regulatory community has mistargeted its efforts, focusing too much on the trivial many while not paying enough attention to the "power few"—those influential individuals within companies that foster extreme compliance risk. Using the Wells Fargo fake accounts scandal as a backdrop, this Article explains how corporate compliance has failed to consider the effects of the power few, how that failure has limited compliance effectiveness, and how corporate compliance and business regulation may be properly reoriented through an increased focus on behavioral ethics risk management.

[Page 131]

I. Introduction..........................................................................132

II. The Current Understanding of Corporate Compliance......................................................................138

A. THE BASICS OF COMPLIANCE..........................................139
B. THE TOOLS OF COMPLIANCE...........................................140
C. THE HOMOGENIZATION OF COMPLIANCE........................147
D. THE FLAWED ASSUMPTION UNDERLYING COMPLIANCE .. 154

III. The Reality of Corporate Compliance Failures ....158

A. FAT-TAILED DISTRIBUTIONS, POWER LAWS, AND NETWORK THEORY........................................................................158
B. THE ROLE OF POWER LAWS AND NETWORK EFFECTS IN UNETHICAL DECISION-MAKING AND CRIMINAL BEHAVIOR ..................................................................................... 165
C. CORPORATE COMPLIANCE FAILURES AND THE POWER FEW AT WELLS FARGO..........................................................170

1. Pre-scandal Compliance Program........................... 173
2. A Growing Compliance Failure ............................... 175
3. The Power Few Explanation.................................... 179

IV. Power Few Implications for Corporate Compliance .. 181

A. THEORETICAL IMPLICATIONS—A MORE NUANCED UNDERSTANDING OF THE ROLE OF BEHAVIORAL ETHICS IN COMPLIANCE.................................................................181
B. PRACTICAL IMPLICATIONS—REMAKING COMPLIANCE PROGRAMS ACCORDING TO A BEHAVIORAL ETHICS RISK MANAGEMENT PARADIGM.............................................187

1. Identify Employee Ethics During the Hiring Stage . 188
2. Identify the Power Few in the Organization ........... 190
3. Ethical Training ...................................................... 193
4. Select Behavioral Compliance Ambassadors.......... 194

V. Conclusion............................................................................195

[Page 132]

I. Introduction

Wells Fargo has long been considered one of America's most respected companies. This is partially a function of history. The bank survived the end of the Gold Rush, the San Francisco earthquake, and the Great Depression to become the third largest U.S. bank and the seventh largest public company in the world.¹ But Wells Fargo's reputation has had just as much to do with its ability to navigate modern banking. This was most apparent during the financial crisis, when, unlike its largest competitors, it eschewed many of the exotic mortgage products that precipitated the crisis, instead focusing on "bread-and-butter-banking."² Although it lost market share for years, when the mortgage crisis hit, the bank was largely unaffected.³ American Banker commented that Wells Fargo was the "big bank least tarnished by . . . scandals and reputational crises."⁴ Fortune put it more bluntly, saying the bank had a "history of avoiding the rest of the industry's dumbest mistakes."⁵

That all changed when the Consumer Financial Protection Bureau (cFBP) announced it was entering into a consent order with Wells Fargo for "the widespread illegal practice of secretly opening unauthorized deposit and credit card accounts."⁶ Although details are still emerging, the outlines of the scandal are clear. From at least 2011, branch-level employees, primarily in Southern California and Arizona, were pressured by superiors to aggressively

[Page 133]

cross-sell to existing customers; to meet sales targets, employees opened unauthorized customer accounts in violation of internal rules and, likely, criminal law.⁷ The bank's trusted business strategy—cross-selling traditional banking products to its customers—had become a source of rampant fraud.⁸

while any corporate scandal involving a company of wells Fargo's size and stature would be noteworthy, the scope of the wrongdoing is what has caught the public's attention. The CFPB's order revealed that over 1.5 million accounts were opened without authorization, 85,000 of which incurred some $2 million in fees.⁹ it is now believed that upwards of 3.5 million fake accounts were created.¹⁰ Even more alarming, thousands of employees appear to have been involved.¹¹ wells Fargo fired 5,300 employees from the community banking division for manipulating accounts.¹² By any estimation, the scope of the wrongdoing, and the $100 billion it cost shareholders, was "staggering."¹³

Not surprisingly, everyone sought answers as to how something like this could happen at one of America's most well-regarded banks. Multiple congressional committees questioned John stumpf, Wells Fargo's then-CEO.¹⁴ After hearing his testimony, lawmakers declared that the cause of the bank's problems was its "broken culture."¹⁵ Although stumpf initially fought this assessment, the

[Page 134]

bank seems to have acquiesced. According to a report issued by Wells Fargo, the firm is instituting a number of changes aimed at improving its culture, including eliminating sales goals for retail bankers, requiring employees to take ethical sales training, establishing a new "Office of Ethics" that reports to the board of directors, and hiring outside "culture experts" to identify problems.¹⁶ These steps, it is contended, will help repair the "issues that contributed to the breakdown in Wells Fargo's . . . culture" and prevent them from happening again.¹⁷

Unfortunately, that is unlikely. The reason is not because the bank's corporate culture was healthy; it was most certainly deficient. And it is not because the bank's proposed solutions are foolish; they follow what many consider to be purposeful compliance practices. Indeed, the company's focus on incentives and culture is consistent with the ethics and compliance movement that many see as critical to effective corporate governance.¹⁸ Yet it still will not be enough to prevent a similarly staggering scandal from occurring in the future at Wells Fargo or any other company.

Why that is forms the core of this Article's thesis. Modern corporate compliance is built on the assumption that unethical and illegal conduct occurs more or less predictably. That is, while corporate leaders may not know exactly when, where, or how compliance failures will occur, they assume that unethical or illegal conduct will happen according to a "normal distribution."¹⁹ Bad acts will occur here and there, and in line with historical trends, but extreme and pervasive wrongdoing is unlikely. Thus, it is believed, the company will face compliance risk, but in a manner that is manageable.

[Page 135]

This assumption underlies many of the common strategies used to effectuate compliance (for example, codes of conduct, compliance training, employee monitoring, and business process auditing), strategies that are almost always standardized across the company. That is because corporate leaders are trying to reduce compliance failures en masse, targeting wrongdoing so as to prevent the "typical" lapse, all based on the belief that extreme failures are unlikely. Regulators reinforce this assumption—indeed, they actively perpetuate it—by crediting as "effective" those compliance programs that focus primarily on wide scope and consistent application.²⁰

The assumption, however, is wrong. As with other aspects of criminal behavior, failures of ethical decision-making within companies—the precursors to compliance lapses and corporate crime—do not necessarily follow a normal distribution. Instead, unethical employee conduct is just as likely to follow a skewed, or "fat-tailed," distribution.²¹ This means there are not necessarily typical compliance failures to guard against; there are likely to be many small ones, some larger ones, and occasionally extremely large ones that destroy significant corporate and societal value. It also means that accurately predicting the probability and...