How Wells Fargo could overcome a shareholder revolt

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Don’t expect much to change in the Wells Fargo boardroom — at least not right away — even if shareholders vote for a clean sweep of the board at the annual meeting next week.

Wells investors are expected to send a stinging rebuke to the board when they gather for the company’s annual meeting at a luxury beachside resort outside of Jacksonville, Fla., on April 25. It’s the first board election since the phony-accounts scandal unfolded in September, and influential proxy advisers are recommending that shareholders vote against half to all of the 12 board members up for re-election; the company has 15 directors overall.

In recent interviews, investors and governance experts said they expect the results to send a clear message of disapproval. Still, it is too early to say how many directors could lose their votes or face pressure to step down for failing to win a wide majority.

Perhaps a bigger question, though, is how exactly the embattled San Francisco company would respond. Overlooked in the drama leading up to next week’s vote are the hairy logistics that would likely follow a sweep of the Wells board.

No matter the outcome, turning over the board of a systemically important financial institution would take a considerable amount of time, observers said. The Wells board — which has wide discretion in managing its roster under its corporate bylaws and market customs — would likely stagger any departures over several months, if not years, to give the company enough time to recruit and train qualified directors.

In other words, even in the event of a landslide, throw-the-bums-out shareholder vote, expect business in the boardroom to operate as usual.

“You have a real challenge in terms of how much turnover you want in the board,” said Brian Tayan, a researcher at the Rock Center for Corporate Governance at Stanford University. “There’s no way they would be able to replace even 20%” of directors at a time, “given the complexity of the bank.”

Under Wells’ bylaws, directors must receive at least 50% of the vote in order to secure their election. Directors who fail to receive a majority are required to tender their resignations — which the board then has the power to reject.

In the event that several directors are voted down next week, Wells would likely come up with a plan to replace a certain number of members each year over a set period, observers said. As part of that plan, the company likely would make a point of emphasizing to frustrated investors that, while their dissatisfaction is clear, the process simply takes time.

Additionally, a large “no” vote next week would also kick-start a series of negotiations with major shareholders over potential board replacements. In contrast to the democratic voting rules that govern the election process, the selection of potential replacements happens in private, according to Charles Elson, director of the Weinberg Center for Corporate Governance.

“These things happen behind the scenes,” Elson said. “It’s all kind of a clubby world.”

The annual meeting comes nearly eight months after Wells agreed to pay about $190 million to settle charges that roughly 5,300 employees created about 2 million accounts to collect bonus pay. The revelations quickly snowballed into a full-blown reputational crisis, culminating in the resignation of former CEO John Stumpf, who was succeeded by Sloan in October.

Stumpf and former retail executive Carrie Tolstedt, who was fired in September, have together been forced to relinquish more than $130 million in stock pay.

The meeting will be held just two weeks after the board unveiled its highly anticipated investigation into the root causes of the sales scandal. The report, published April 10, placed the brunt of the blame on Tolstedt, arguing that the hard-charging executive knowingly withheld information about the spike in sales-related terminations from the board.

The report was written by a special committee of the board. All four directors on the committee — Stephen Sanger, Enrique Hernandez, Elizabeth Duke and Donald James — are up for re-election.

Any way you cut it, the possibility of a contentious vote at Wells is a historic moment for the industry— and will be closely monitored by board members at other big banks.

“I’ve never seen the whole board targeted,” Tayan said.

The closest and most recent example in banking came during the fallout from the so-called London Whale trading loss at JPMorgan Chase. Two members of the company’s risk committee, David Cote and Ellen Futter, stepped down, months after receiving lackluster support from shareholders. Cote is a former CEO of Honeywell in Morris Plains, N.J. Futter is the president of the American Museum of Natural History in New York.

Recommendations from influential proxy advisers — such as ISS and Glass Lewis — typically sway the shareholder vote by as much as 25%, according to Tayan, who cited academic studies. For instance, directors who normally win 100% of the vote usually receive around 75% as a result of a no-vote recommendation.

The casualty list will depends on where, exactly, shareholders assign blame on the board.

Glass Lewis recommended voting against several members of the company’s social responsibility committee, which is tasked with overseeing the company’s reputation. ISS, meanwhile, advised shareholders to vote against all directors except for CEO Tim Sloan, as well as two directors appointed in February, including former BNY Mellon President Karen Peetz.

“The question is, what was the directors’ role in this matter, and did they fail to act quickly enough or aggressively enough?” Elson said.

Investors appear divided on the question. The New York City Retirement System, which holds $594 million of Wells shares, is considering voting against members of the human resources committee among other directors, according to a source with direct knowledge of the situation. The HR committee oversees the company’s incentive compensation and company culture.

Meanwhile, Berkshire Hathaway— which owns a stake of about 10% — is planning to support all Wells Fargo directors up for election, according to a report in The Wall Street Journal.

Investors are divided on what, exactly, forcing a turnover at the board would accomplish. While some argue that the sales scandal points to the need for fresh blood in the boardroom, others noted that, after a monthslong reputational battle, it’s not as if Wells is in need of a wake-up call.

“If you were really trying to throw the bums out, the act of dismantling a board that’s in the middle of trying to restructure and reform could do considerable damage,” said Tim Smith, the director of environmental, social and governance engagement at Walden Asset Management in Boston.

Walden cut its Wells stake to about 25,000 shares after the scandal, Smith said. The firm is expected to vote against “some directors,” though it is still finalizing its vote, he said. Walden is affiliated with the Interfaith Center on Corporate Responsibility and is a co-sponsor of a shareholder proposal that calls for a report on risk management at the company.

Notably, directors who only win a slim majority would likely also face pressure to step down. Failing to win a strong majority would signal a lack of confidence among investors, experts said.

“Once you get under 75% there becomes this kind of agreed-upon procedure that the critics look at it more harshly,” Tayan said. “They see those votes as almost no votes.”

In its proxy, Wells noted that the board has taken steps to address the sales debacle, including commissioning an investigation. The company also permanently separated its chairman and CEO last year and appointed the two new directors.

“Our board continues to be committed to sound and effective corporate governance principles and practices, including board refreshment, board diversity and recruitment of new directors to complement the existing skills and experience” of other members, Wells said.

The investigation published last week still shows there is “some board culpability,” according to Mark Bradford, an attorney who handles employment issues at VLP Law Group in San Francisco.

The report, though mostly deferential to the board, criticized directors for failing to aggressively to beef up the company’s risk management procedures. The board also should have demanded more information from management when it began to see red flags, the report said.

“Nobody connected the dots anywhere, but that’s why you have a board in the first place,” Bradford said.

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