We’ve often talked here about the bank practice of extracting equity from customer accounts. Now comes a 90 page ruling from Judge William Alsup of the Northern District of California against Wells Fargo Bank, showing in detail exactly how the bank engaged in ”œgouging and profiteering” when it managed customer checking accounts. Nor is this one of those polite judicial rulings where the judge waits to the end to conclude whether or nor the defendant engaged in bad behavior. Judge Alsup is biting and nasty throughout his ruling, barely able to hold his disgust at what he concluded was a deliberate attempt by Wells Fargo to profit off a system that trapped customers into overdraft hell.
How the System Was Rigged to Create Overdrafts
Prior to 2000, Wells Fargo did its best to minimize overdrafts in customer accounts. Its computers processed all credits to the account first, followed by ATM withdrawals and debit card purchases, followed by checks and then Automated Clearing House transactions (the ACH is used by banks to process debits such as PayPal charges or monthly mortgage or rental payments where the customer has agreed to an automatic debit). In every step, Wells Fargo used low to high sequencing; the smallest debits would go first and the largest would go last. This entire process mimicked the way the consumer managed their account using a traditional checking account balance, which ranks all transactions in chronological order. When an overdraft occurred on the bank’s records, the consumer would have known had they been keeping their checkbook balance up to date.
In 1998 Wells Fargo announced it was merging with Norwest Corp., a bank conglomerate in Minneapolis that specialized in consumer banking. While the Wells Fargo name was retained in this merger, when it came to consumer banking the Norwest people were running the show. They ordered all Wells Fargo units to conform to the Norwest way of banking, which included the use of high to low sequencing when it came to processing checking account transactions. Wells Fargo California, which is the defendant in this case, began to comply in 2001.
From 2001 to 2002 Wells Fargo initiated three computer modifications for its checking account back office operations.
1) In April 2001 Wells Fargo began processing all debit card transactions on a high to low sequencing basis, meaning that overdrafts were much more likely to occur. Overdraft fees were $22 per overdraft, but whereas prior to the change the customer would have to pay this fee but once, afterwards the customer could incur dozens of overdrafts on a single day simply by charging items as small as a $3 coffee purchase at Starbucks. Wells Fargo put a cap on the total number of overdrafts allowed before it required the customer to pay up the balance; this was 10 overdrafts or $220 in total. Once customers fell into this overdraft trap, however, they were afterward assessed a fee of $33 for each future overdraft.
2) Later in 2001, a second computer change commingled all debit card transactions with all checks and ACH debts that were processed, and the entire pool of debits was put into a high to low sequence. This greatly expanded the possibility that large value debits would push customer accounts into overdraft.
3) In 2002, Wells Fargo added a new twist to its processing, called the shadow line of credit. This was a number assigned to each account that represented the total dollar amount of overdrafts the customer was allowed to incur at what is called the Point of Sale ”“ usually the cash register where a debit card was presented. Prior to this change, Wells Fargo rejected transactions at the Point of Sale if they created an overdraft, but now many more transactions were allowed to go through ”“ up to the credit limit – precisely because they created an overdraft. The shadow line amount was not communicated to the customer; in fact none of the bank’s promotional or legal material revealed the existence of the shadow line. Judge Alsup complained that even by the end of the trial, despite repeated requests, Wells Fargo refused to divulge to the court any details about the shadow line of credit concept, how it worked, or how if affected the plaintiffs. One can reasonably presume, therefore, that the shadow line of credit algorithm was designed to optimize the dollar amount of overdrafts the customer could incur, before the customer presented a real credit risk to the bank if it defaulted on paying its overdraft fees.
Management’s Real Intentions Were to Optimize Revenue From Overdrafts
In explaining these changes, Wells Fargo argued that these were all best practices within the banking industry, that its regulator (the Office of the Comptroller of the Currency) authorized banks to sequence checking accounts on a high to low basis, and that customer surveys showed customers were eager to get large overdraft privileges in order to avoid the embarrassment of having transactions rejected at the Point of Sale. Judge Alsup found that less than 25% of banks nationwide employed high to low sequencing, that the OCC did not authorize such sequencing (though to be sure, it never squelched the practice until Congress outlawed this method unless the customer agreed in advance), and that Wells Fargo could come up with no written evidence that customers demanded this overdraft service, or that Wells Fargo even took into account customer desires when it made these changes.
Instead, Judge Alsup referenced several memos from management written in preparation for these changes, identifying the fee revenue to be generated as a result of them. The first change was expected to produce $40 million in additional revenue in the first year, and the second and third changes an additional $40 million. Judge Alsup found that both of these projections were reasonable approximations of the new revenue actually achieved. Furthermore, these new revenue amounts were essential in converting Consumer Banking at Wells Fargo from a sleepy backwater that looked at overdraft fees as a penalty for bad customer behavior, into a supercharged profit center that looked at overdraft fees as a desired result to be optimized for each account. These management memos also noted that 4% of all retail customers generated 40% of all overdraft fees, and that these were valuable customers because of their earnings potential for the bank.
Misleading Customer Material
Judge Alsup also found that the way this process was explained to customers was deliberately misleading. New clients were given the legal Customer Account Agreement, a 60 page brochure in single spaced, 10 point font, which explained on page 27 that Wells Fargo ”œmay pay Items presented against your account in any order we choose.” When this was being distributed, Wells Fargo indisputably was already processing all debits on a high to low sequence after commingling, but the use of the word ”œmay” left consumers thinking nothing had changed in the processing methods. The bank’s own executives testified at the trial that they did not expect customers to have time to read the 60 page CAA, or understand it even if they did.
Second, the bank gave customers an easier to understand document without the legal jargon of the CAA, in which there was no reference at all to sequencing, so that the marketing material obfuscated deliberately the reality of overdraft charges. Third, it was only after a customer complained vigorously enough about their own overdraft charges that Wells Fargo sent them a letter explaining the true nature of the high to low sequence and its consequences. Fourth, at no time was the existence of a shadow line of credit revealed to the customer, which meant that Wells Fargo purposefully approved transactions it knew would create multiple overdrafts, but never told the customer at the time that such overdrafts would result.
As a final indignity, Wells Fargo emphasized in its marketing materials that good customers keep a traditional updated bank balance in their checkbook in order to avoid overdrafts. One of the plaintiffs in this class action lawsuit was a college student who opened her first banking account ever at Wells Fargo, and was given an ATM debit card, a credit card, a checkbook, and a savings account. She dutifully followed the prescribed checkbook balancing methods of Wells Fargo, but still fell into a sequence of overdrafts over several days that cost her hundreds of dollars and placed her in the $33 dollar overdraft fee category.
Judge Alsup concluded that it was impossible for any customer of Wells Fargo to control their balance and prevent overdrafts using the traditional checkbook balancing methods. Checkbook balancing is based on the chronological order of credits and debits as incurred by the customer, but without access to the precise high to low sequencing methods used by Wells Fargo, and without knowing the shadow line of credit available, a consumer had no way to control their account or prevent overdrafts.
Findings of Law
Judge Alsup concluded Wells Fargo engaged in unfair business practices under the California Business and Professions Code. The Code requires a business to operate in Good Faith and engage only in Fair Dealing, but Wells Fargo did neither when it reordered its sequencing of debits and then expanded the universe of possible overdrafts by commingling transactions and installing a secret line of credit. The bank also deliberately went out of its way to hide these practices from customers and confuse them about the overdraft process. This lack of appropriate information in the bank’s legal and marketing material meant that Wells Fargo deliberately deceived its customers into creating overdrafts. As such, under the Code, Judge Alsup found that Wells Fargo engaged in fraudulent behavior.
As injunctive relief, Judge Alsup ordered Wells Fargo to cease using high to low sequencing by the end of this year, and revert back either to low to high sequencing, or sequencing by chronological order, which is close to what the consumer uses. In terms of restitution, the law limits penalties to no more than the defendant has earned from its unfair business practices. Accordingly, Judge Alsup ordered Wells Fargo to return to its customers all overdraft fees assessed during the past 43 months, the period of time for which the court had access to data from the bank on its overdraft earnings. This will result in an estimated $203 million in repayments to be made by the bank to its customers.
What Have We Learned
We have seen how a large bank like Wells Fargo has put profit maximization as its greatest imperative, at the expense of its customers, and at the risk of acting in an unethical and fraudulent matter. Bank customers are no longer viewed as customers to be given a reasonable service at a reasonable price, but as revenue sources down to the microcosmic, one customer at a time level. It is not difficult to imagine that Wells Fargo nationwide has detailed internal information on the profitability of each one of the millions of people it calls a customer.
As Judge Alsup pointed out, the overdraft fee process became a big business at Wells Fargo ”“ the largest source of revenue for Consumer Banking. These fees hit the bank’s poorest customers who could least afford $200 penalty charges, because they couldn’t afford the $2,000 minimum balance necessary to avoid being overdrawn. It is to the bank’s discredit that Wells Fargo specifically targeted these hapless customers, deceiving them in the process, and nurturing them along as continuing sources of revenue due to the simple fact that they could not possibly manage their accounts to avoid overdrafts.
This ruling opens the door to similar suits against JP Morgan Chase, Citibank, Bank of America and other big banks that engaged in the same sequencing practices as Well Fargo. Some of these banks went further down the road of deception, by deliberately delaying credits to customer accounts for several days while large value debits kept piling up causing overdrafts.
It is also interesting that Judge Alsup is willing to fault the bank process of sending customers reams of tiny-print legal documents that nobody reads or can understand. No doubt the bank lawyers thought this document was a foolproof way to protect the bank in any lawsuit ”“ ”œsee, it says right here….!”. Judge Alsup was not fooled, particularly as the Wells Fargo executives involved testified that the bank did not expect customers to read or understand this document. It is time somebody called out American corporations on their propensity to hide behind such legal notifications and disclaimers.
It is also sad to contemplate that for almost all of the past decade the big banks have been perpetrating what we now see is an unfair and fraudulent business practice, without the slightest interference from the Federal Reserve Bank or the Office of the Comptroller of the Currency, the two major regulators who are charged with protecting consumer interests. This is yet another example of regulatory capture by the banking industry, with the consumer ”“ and in this case consumers who could least afford it ”“ on the hook for outrageous fees.
While the $203 million penalty looks formidable and should serve as a deterrent for any such future bank behavior, Judge Alsup provides us with a cautionary tale about what sometimes happens with these class action lawsuits. In December, 2002, a class action suit was filed against Wells Fargo over the bank’s refusal to reveal the existence of the shadow line of credit to customers. This case – Smith vs. Wells Fargo Bank – was finally settled in May, 2007 before Judge Ronald Prager of the San Diego Superior Court. Judge Prager ruled that Wells Fargo must pay $20 restitution to all the customers of the bank who were granted a shadow line of credit, and to pay the plaintiff attorney fees.
Judge Alsup tells us what happened next:
What Judge Prager did not know ”” since it only came to light in this
proceeding ”” was that Wells Fargo paid merely $2080 to 166 claimants. This is not a typo. Barely two thousand dollars were paid to class members. By contrast, Wells Fargo agreed to pay Finkelstein and Krinsk [the plaintiff attorneys] $2.2 million in attorney’s fees and costs.
Judge Alsup has promised he will follow through on the restitution requirements if his ruling survives appeal. Thank God for men like Judge Alsup, but notwithstanding the majesty and power of his office, he is one man against a corporate behemoth that so far has shown itself lacking in any moral scruples and willing and able to do whatever it wants.