By Emily Glazer and Ryan Tracy

Wells Fargo & Co. chief Timothy Sloan received a terse call last Tuesday from the Federal Reserve and Federal Deposit Insurance Corp.: That afternoon the regulators would publicly announce the bank had flunked a vital test and would be slapped with first-of-their-kind penalties.

The failure of the bank's so-called living will test, even as four other big banks passed, kicked off the latest crisis for Wells Fargo, which is still reeling from its sales-tactics scandal. And it poses yet another challenge for Mr. Sloan, who only took the bank's helm in October after theabrupt retirement of former CEO John Stumpf.

Within hours of the call, Wells Fargo finance chief John Shrewsberry was on a plane to Washington, D.C. to meet with regulators, according to people familiar with the matter. Mr. Sloan jetted across the country the next day, the people added.

They left the talks believing regulators were concerned with the type of blueprint the bank was using to show how it would address a cataclysmic failure, the people said. At Wells Fargo, this involves multiple units of the bank being placed under bankruptcy protection or kept running on their own.

That differs from the models of the other large banks. These call for the bankruptcy of a firm's holding company, while individual units are kept running or sold off piecemeal.

Citigroup Inc. had success when outlining such a strategy to regulators this year. Bank of New York Mellon Corp. previously had a strategy similar to that of Wells Fargo,but switched to the latter approach. It passed regulatory muster last week.

Fed and FDIC officials previously have said they don't care what approach a bank chooses, so long as the firm meets legal requirements. And the failure letter the agencies sent to Wells Fargo didn't order it to change its bankruptcy approach.

Even so, Wells Fargo is now scrambling to address regulators' concerns. As a first step, it likely will move toward the model used by other banks, according to people familiar with the matter.

Another takeaway from the meetings for Wells Fargo: regulators thought the bank didn't devote enough resources to the test, or make enough changes to its approach when compared with other banks, some of these people said.

The living wills are a requirement of the 2010 Dodd-Frank law, which sought to prevent bailouts partly by forcing big banks to develop a plan for how they could go through bankruptcy without taxpayerassistance. The law directed regulators to judge whether plans are credible and gave them power to sanction, or even break up, firms that are found lacking.

So the failure has big repercussions for Wells Fargo. It is a fresh blow as the bank is trying to restore its reputation following a September regulatory settlement that alleged the bank opened as many as 2.1 million accounts without customers' knowledge.

More immediately, the failure marked the first time the Fed and FDIC have imposed penalties on a bank under the living-wills process. As a result, Wells Fargo is now barred from creating new international banking units or acquiring any nonbank subsidiaries. If regulators aren't happy with the response to be submitted by March 2017, they could cap growth at the bank and, in two years, force it to divest certain assets or businesses.

The rebuff was also a blow to Messrs. Sloan and Shrewsberry. The bank had said in a disclosure in October that Mr. Sloan, who was then president, would take a "more prominent role" in overseeing all recovery and resolution planning initiatives. Mr. Shrewsberry meanwhile leads the management governance committee related to living wills.

In their letter last week to the bank, the Fed and FDIC were highly critical of Wells Fargo's efforts. They said the firm "has not even completed an assessment" related to how it would keep operating critical services during a bankruptcy, for example. The regulators added that when it came to the bank's plan for potentially reorganizing legal entities it owns, "it is unclear whether or under what circumstances [Wells Fargo] would take action or what type of actions it would consider taking."

Even areas that Wells Fargo had said previously it was focusing on came up short. In October, the bank said it adopted a policy to monitor, oversee and govern its subsidiaries. But its legal entities planning ended up being a sore spot in its assessment.

It isn't that Wells Fargo has failed to focus on its living-wills process. In 2014, it was the sole big bank to receive a passing grade. But Wells Fargo didn't receive a perfect score. Regulators said the blueprint had shortcomings that needed to be addressed in its revised plan for 2015.

In early 2016 regulators failed that plan. One problem: it contained inaccurate information that later had to be corrected. Wells Fargo, along with four other banks, was told to resubmit the plan.

Wells Fargo spent millions of dollars on consultants and reassigned employees to different groups across the firm to work on this, people familiar with the matter said. And in October Wells Fargo disclosed information on its progress, saying it reorganized the office related to living wills and expected to double that staff over the next six to 12 months.

Less than two months later, regulatorstold Wells Fargo it was the only bank whose makeup test didn't merit a passing grade.

Write to Emily Glazer at emily.glazer@wsj.com and Ryan Tracy at ryan.tracy@wsj.com

(END) Dow Jones Newswires

December 21, 2016 02:47 ET (07:47 GMT)

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