The phony accounts scandal will likely reignite the debate over risk-taking and internal controls at big banks

It's often said that the regulatory response to a large financial scandal or series of frauds will be swift and sweeping and that it will do absolutely nothing to stop the next series of frauds or scandals.

That sentiment appears to be playing out in the banking sector, with news of the Wells Fargo phony accounts scandal. The massive-scale fraud took place right under managers' noses throughout the bank, even as large banks are still implementing the regulatory reforms required by the Dodd-Frank Act—Washington's regulatory answer the mortgage crisis when banks took foolish risks and failed to provide proper oversight.

To be fair, while Dodd-Frank didn't provide the mechanisms to stop something like the Well Fargo scandal from happening, the legislation did create the Consumer Financial Protection Bureau (CFPB), which led the investigation into the improper sales practices.

WellsFargo-branchThe Wells Fargo numbers are staggering: 5,300 employees fired, as many as 2 million phony accounts opened, and $185 million in fines. The bogus accounts scandal also comes just as banks were starting to regain the trust of the public in the wake of the mortgage crisis, which tanked the economy and tarnished the reputation of just about every big bank.

"Wells Fargo employees secretly opened unauthorized accounts to hit sales targets and receive bonuses," CFPB Director Richard Cordray said in a statement on the action against the bank. "Because of the severity of these violations, Wells Fargo is paying the largest penalty the CFPB has ever imposed," Cordray added. "Today's action should serve notice to the entire industry that financial incentive programs, if not monitored carefully, carry serious risks that can have serious legal consequences."

Too Much Sales Pressure

The Wells Fargo scandal is sure to reshape the discussion on how much regulation we should impose on the banking sector, and how well banks' systems of internal controls and risk management are functioning. In its brazenness, with so many people taking part in activities that are so clearly wrong, it's obvious that Wells Fargo suffered from a crisis of culture. It's hard to attribute bad behavior to "a few bad apples," when it involved thousands of employees.

The lesson here for all companies is that pressure and incentives on sales goals are an important part of the culture of an organization. Messaging and communications to employees, especially informal ones, that sales targets must be met at all costs will often override those that encourage employees to do the right thing. "This is very likely a case where there was a classic environment of pressure to achieve numbers, which caused employees to rationalize their fraudulent behavior," says Anne De Traglia, director of internal audit at United Airlines.

The scandal also serves as an important reminder to all companies: revisit your compensation and incentive plans. People will always do what you pay them to do.

In Denial?

For its part, Wells Fargo seems to be in denial about the underlying culture that is likely at the heart of the scandal. In a statement on the settlement with the CFPB and other regulators and authorities, the bank said: "Our entire culture is centered on doing what is right for our customers. However, at Wells Fargo, when we make mistakes, we are open about it, we take responsibility, and we take action. Today's agreements are consistent with these beliefs." Hard to see from the actions of employees that the bank is putting customers first.

"The culture was clearly massively flawed, despite what the CEO says," wrote risk-management expert Norman Marks in his blog, "Norman Marks on Governance, Risk Management, and Audit." "In fact, his statement reveals a lack of understanding not only of the word 'culture,' but also of the real problem. I am not sure how the board can have confidence in his ability to change the culture. The surviving employees will be in shock and so risk-averse that the bank will suffer enormously."

The scandal is in its infancy and we will surely learn much more about it in the weeks and months ahead. The big question is how pervasive these same practices were at other big retail banks, such as Bank of America and Citigroup. With the problematic practices so widespread at Wells Fargo, it's hard to imagine it wasn't happening at other big banks to some degree.

Depending on how much the scandal widens to other banks, there are likely to be calls for tighter regulation and better internal controls to guard against this type of behavior in the future. Those may be wise, but don't expect them to be the last word on major banking scandals.