Well Fargo's case

The Wells Fargo unauthorized accounts scandal first became public in the Los Angeles Times (Reckard 2013). The Los Angeles City Attorney filed a complaint https://filedn.com/lOJqn8isbUNJvUBnJTlV5OS/OTHER%20DOCUMENTS/New%20folder/ADDITIONAL%20PDFS/PRESS%20RELEASE%20MAY%205%202015%20FILING%20LAWSUIT%20AGAINST%20WELLS%20FARGO.pdf (May 4, 2015).The fraud began by 2002 and continued to 2016. Hundreds of thousands of bank employees opened 3.5 million accounts, issued products or services, or transferred customer funds, without the customer's consent.Senior executives set intentionally unrealistic sales goals and placed unreasonable pressure on rank-and-file employees to meet those goals. They intimidated and badgered employees, subjecting them to hazing-like abuse, and threatened to terminate and actually terminated employees for failure to meet the goals. Senior executives believed that the more accounts, products and services per customer, the greater the bank's profitability and executive compensation would be.

In the first part of the fraud, Wells Fargo and its senior executives perpetrated a consumer fraud, which is a fraud that victimizes consumers. It includes identity theft, elder fraud, advance fee schemes, credit card fraud, mortgage fraud, collectibles fraud, and fraudulent business practices. In the second part of the fraud - since Wells Fargo did not disclose its consumer fraud - Wells Fargo and its management perpetrated a financial reporting fraud.

By 2021, Wells Fargo had settled its lawsuits but many of the proceedings against its management and board of directors are still ongoing. The Securities and Exchange Commission (SEC) is litigating against Head of Community Bank Carrie Tolstedt for unspecified disgorgement and monetary penalties (SEC 2020). The Office of the Comptroller of the Currency (OCC) is also litigating against Tolstedt for $25,000,000 (OCC 2020). Furthermore, it is seeking an additional $5,000,000 from Community Bank Group Risk Officer Claudia R. Anderson (it already collected $5,000,000), an additional $5,000,000 from Chief Auditor David Julian (it already collected $2,000,000), and an additional $1,000,000 from Executive Audit Director Paul McLinko (it already collected $500,000) (Wack 2021a). Members of the board are being sued for having produced a biased report whitewashing themselves of responsibility for the scandal (Wack 2021b).

Contingent Liabilities.

Companies scrutinize their potential liabilities. Some events are determined to be probable to cause the company to pay out a material amount of cash in the future. These are liabilities, unless the company cannot determine the amount or at least a reasonable range (in which case it is a contingent liability). For some events, it is remote that the company will pay out cash. Then these are not liabilities; they are ignored as immaterial. There are also contingent liabilities. This is when it is reasonably possible that the event will result in the company paying out a material amount of cash in the future. Because of the uncertainty, line item inclusion is not required. Instead, footnote disclosure is required.

Materiality.

Senator Elizabeth Warren wrote that "your firm's failure to identify the illegal behavior at Wells Fargo raises questions about the quality of your audits..." (Warren, et al. 2016). KPMG's CEO admitted the audit firm knew all about the consumer fraud since at least 2013. However, she argued KPMG did not need to ask the management of Wells Fargo to disclose the consumer fraud because KPMG believed that the consumer fraud was not material when KPMG signed its audit opinion on February 24, 2016 (Doughtie 2016). Senators Warren and Markey disagreed and asked the Public Company Accounting Oversight Board (PCAOB) to investigate KPMG for its audits of Wells Fargo (Warren and Markey 2017).

The PCAOB states that a fact is material if a reasonable investor would regard the fact as having significantly altered the total mix of information made available (PCAOB AS 2810).In the past generation, a wider group of people has also become regarded as stakeholders of a public corporation: a firm's employees, its customers, its suppliers, its regulators, and the communities affected by the firm. These additional people, because they are stakeholders, are also entitled to correct financial reporting.

The key events and quantifiable costs to Wells Fargo for the unauthorized accounts scandal are listed below:

Quantifiable Costs	Key Events
	LA Times article about the unauthorized accounts published December 21, 2013.
	Investigations by LA City Attorney, CFPB, and OCC begin after LA Times article.
	LA City Attorney complaint filed May 4, 2015.
$142,000,000	Wells Fargo customer complaint filed May 14, 2015. Settlement July 8, 2017.
$185,000,000	Settlement with LA City Attorney, CFPB, and OCC on September 8, 2016.
$1,000,000,000	CFPB and OCC additional settlement on April 20, 2018.
$3,000,000,000	Investigations by SEC and DOJ begin Fall 2016. Settlement February 21, 2020 includes deferred prosecution agreement.
$480,000,000	Securities class action filed September 26, 2016. Settlement on September 4, 2018.
$394,000,000	Deceptive unneeded car loan insurance class action filed July 30, 2017. Settled June 6, 2019.
$575,000,000	Fifty states and District of Columbia begin investigation in Fall 2017. Settled December 28, 2018.
$5,776,000,000

The LA City Attorney sought $5000 per unauthorized account, which later were estimated to total 3,500,000. Thus, he sought penalties of $17,500,000,000. Later, the Federal Reserve and the OCC imposed restrictions on Wells Fargo that reduced its ability to grow, and the Department of Justice (DOJ) imposed a deferred prosecution agreement, also limiting Wells Fargo's ability to grow. As a result, Wells Fargo stock performed far worse than any of its industry sector competitors and has continued to underperform through 2021.

Many of the materiality factors discussed above related to the Wells Fargo scandal are qualitative rather than quantitative, but some quantification is possible. The $5,776,000,000 in direct costs shown above for the settlements, compared to the $22,894,000,000 of net income of Wells Fargo for the year ended December 31, 2015, represent an overstatement of net income of 25%. The $17,500,000,000 in penalties demanded in the May 4, 2015, LA City Attorney complaint represent an overstatement of net income of 76%.

Audit Evidence.

Auditors of public companies must obtain reliable evidence. The PCAOB's AS 1105.08 states that "evidence obtained from a knowledgeable source that is independent of the company is more reliable than evidence obtained only from internal company sources." AS 1105.29 states that "if audit evidence obtained from one source is inconsistent with that obtained from another, or if the auditor has doubts about the reliability of information to be used as audit evidence, the auditor should perform the audit procedures necessary to resolve the matter and should determine the effect, if any, on other aspects of the audit." Wells Fargo's auditor did not appear to have relied on any evidence other than that provided by Wells Fargo and its law firms. Consequently, the auditor concluded that the materiality threshold for footnote disclosure of the pending lawsuits and investigations regarding the unauthorized accounts scandal was not met.

Illegal Acts.

Auditors of public companies that discover an illegal act must do as follows:

"(b)Required response to audit discoveries

(1)Investigation and report to managementIf, in the course of conducting an audit pursuant to this chapter to which subsection (a) applies, theregistered public accounting firmdetects or otherwise becomes aware of information indicating that anillegal act(whether or not perceived to have a material effect on the financial statements of theissuer)has or may have occurred, the firm shall, in accordance with generally accepted auditing standards, as may be modified or supplemented from time to time by theCommission

(A)

(i)determine whether it is likely that anillegal acthas occurred; and

(ii)if so, determine and consider the possible effect of theillegal acton the financial statements of theissuer,including any contingent monetary effects, such as fines, penalties, and damages; and

(B)as soon as practicable, inform the appropriate level of the management of theissuerand assure that theaudit committeeof theissuer, or theboardofdirectorsof theissuerin the absence of such a committee, is adequately informed with respect toillegal actsthat have been detected or have otherwise come to the attention of such firm in the course of the audit, unless theillegal actis clearly inconsequential.

(2)Response to failure to take remedial actionIf, after determining that theaudit committeeof theboardofdirectorsof theissuer, or theboardofdirectorsof theissuerin the absence of anaudit committee,is adequately informed with respect toillegal actsthat have been detected or have otherwise come to the attention of the firm in the course of the audit of such firm, theregistered public accounting firmconcludes that

(A)theillegal acthas a material effect on the financial statements of theissuer;

(B)the senior management has not taken, and theboardofdirectorshas not caused senior management to take, timely and appropriate remedial actions with respect to theillegal act; and

(C)the failure to take remedial action is reasonably expected to warrant departure from a standard report of the auditor, when made, or warrant resignation from the audit engagement;

theregistered public accounting firmshall, as soon as practicable, directly report its conclusions to theboardofdirectors.

(3)Notice to Commission; response to failure to NotifyAnissuerwhoseboardofdirectorsreceives a report under paragraph (2) shall inform theCommissionby notice not later than 1 business day after the receipt of such report and shall furnish theregistered public accounting firmmaking such report with a copy of the notice furnished to the Commission.If theregistered public accounting firmfails to receive a copy of the notice before the expiration of the required 1-business-day period, theregistered public accounting firmshall

(A)resign from the engagement; or

(B)furnish to theCommissiona copy of its report (or the documentation of any oral report given) not later than 1 business day following such failure to receive notice.

(4) Report after resignation

If aregistered public accounting firmresigns from an engagement under paragraph (3)(A), the firm shall, not later than 1 business day following the failure by theissuerto notify theCommissionunder paragraph (3), furnish to theCommissiona copy of the report of the firm (or the documentation of any oral report given).

(c)Auditor liability limitation

Noregistered public accounting firmshall be liable in a private action for any finding, conclusion, or statement expressed in a report made pursuant to paragraph (3) or (4) of subsection (b), including any rule promulgated pursuant thereto (Section 10A of the Securities Exchange Act of 1934)."

Question:

6) Read the auditor's opinion on Wells Fargo's December 31, 2015 financial statements (available at https://www.sec.gov/Archives/edgar/data/72971/000007297116001045/wfc-12312015xex13.htm). What opinion was given (unqualified, qualified, adverse or disclaimer)? Do you believe this was the right opinion to give? If not, what opinion should have been given?Explain the reasons for your answers.