Yves here. As much as the odds still favor clueless or complicit board members bearing no consequences of their misdeeds, the authorities in England are moving forward on the HBOS failure far more seriously than anything we’ve seen in the US. That is no small measure due to the fact that leadership of both the Bank of England and the FSA recognize that banks need to be curbed and have proposed and pushed hard for some serious remedies, such as a version of Glass Steagall (their more aggressive version was beaten back thanks to concerted lobbying by the banks and the Treasury).
Last Friday was an extraordinary day in the world of banking. First we had confirmation from Barclays, Lloyds Banking Group and Royal Bank of Scotland that they are doling out obscene sums in bonuses to executives, even as performance flags and share prices plunge. Then we had the ridiculous saga of the ISDA determinations committee confirming what everybody already knew; that Greece was defaulting on much of its €177 billion of debt pile (the world’s biggest sovereign default had been priced in to the extent it barely ruffled the markets). And then, at 1.40pm came the FSA’s HBOS bombshell.
In a 37-page report the FSA censured HBOS for “serious misconduct” which, in ‘FSA speak’, is about as strong as it gets. The regulator said that the Bank of Scotland, the brand that HBOS used for its corporate lending businesses, had broken Principal 3 of the FSA’s 11 principals of business. The Principal reads as follows:-
“3: Management and control – A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.”
The regulator said the Bank of Scotland “was guilty of very serious misconduct, which contributed to the circumstances that led to the UK government having to inject taxpayer funding into HBOS”.
If the bank was not now largely taxpayer-owned, the FSA would have imposed its largest ever fine – probably in the region of £50m-£100m – but given that taxpayers have already bailed out the morally bankrupt institution once, the regulator decided it would be unfair for them to have to do so twice. (Reading through the regulator’s 11 principles, it is astonishing that it’s taken the FSA so long. I was aware of most of its findings by May 2009 after researching a ‘File on 4‘ for BBC Radio 4, and could provide copper-bottomed evidence that HBOS has broken all eleven of the regulator’s principals).
The Telegraph’s Philip Aldrick explained the background:-
HBOS failed because it had terrible corporate governance, a neutered risk control function, and an odd personality cult around a rather quiet Scottish banker. In January 2006, Peter Cummings became chief executive of HBOS’s corporate division. It was a position he had effectively held since 1995 but the appointment made him a full board member. In the following two years, the period under investigation, his division amassed property assets and dangerous risks in almost equal quantities.
The FSA’s Final Notice document clarified what the ‘HBOS whistle-blower’ Paul Moore and others including myself have been banging on about for years. The HBOS risk management function had atrophied to the extent it had become a charade and as good as useless from about 2004 onwards. Interestingly that is also the date at which HBOS chief executive joined the board of the FSA (whilst retaining his day job). Intriguingly he was an appointee of the chancellor Gordon Brown, who is known to have been a close friend of his.
The report stated: “risk management was regarded as a constraint on the business rather than integral to it.” Aldrick added:-
Mr Cummings and his team were given carte blanche to behave as they wished. By March 2008, £34bn was exposed to just 30 clients – over half of whom were in commercial property… For any other bank, such “concentration risk” would have set the alarm bells pealing. At BoS, though, Mr Cummings treated risk management with derision.
The FSA report, signed off by Will Amos, the FSA’s head of enforcement and financial crime, detailed how Cummings created a “culture of optimism” (some would translate this as “a culture of self-delusion, insane hubris and rampant criminality”), how staff were incentivised to build revenue rather than to monitor risk, and how Cummings and colleagues were answerable to no-one. However, the fact the idiotic Lord Stevenson and morally bankrupt Sir James Crosby gave Cummings his head, and turned a blind eye while he ran amok, doesn’t excuse them of blame/responsibility.
The report spells out that inadequate management information was a major issue at Bank of Scotland Corporate (by which the regulator probably means it was easy for the likes of former managing director of corporate banking Ian Robertson — who stepped down in June 2007 and died in August 2010 — to bend the rules and enter transactions without their risk-managers and superiors even knowing!). On page 13 the FSA report states:-
4.27. In relation to the quality, reliability and utility of the available management information:
(1) the available management information was not sufficient for the purpose of conducting an effective assessment of the portfolio;
(2) the degree of manual intervention was a continuing and major risk;
(3) there was a continuing lack of metrics for the assessment of the effectiveness of the control environment; and
(4) a significant proportion of the portfolio had not been risk-rated.
4.28. As a consequence, the control framework was not effective throughout the Relevant Period. This directly impeded the ability of the business to assess, manage and mitigate credit risk.
Where Cummings and some of his colleagues were concerned, as I have said in earlier articles/blogs, the HBOS board, led by Lord Stevenson and Sir James Crosby made the fatal mistake of confusing genius with a bull market.
In about 2001, seemingly impressed by one or two successful deals Cummings had pulled off with TopShop owner Sir Philip Green, Stevenson, Crosby and the rest of the HBOS board gave him free rein to do pretty much whatever he wanted.
By 2007, the bank had became so dependent on the short-term profits his corporate lending department seemed capable of generating, they urged him to ratchet up the lending to a tight-knit group of property, retail and leisure entrepreneurs (most of whom would have struggled to secure funding elsewhere. I have explored those who benefited from Cummings’ largesse in greater detail in The hornet and the sting), even as cannier lenders were running for the hills. The FSA report said:-
“In the first half of 2007, group increasingly looked to the corporate division to make up for the underperformance of the retail division.”
Andrew Tyrie, chairman of the Treasury Select Committee, criticised the regulator for failing to publish the size of the fine it would have levied on Bank of Scotland parent Lloyds Banking Group. He confirmed to the Telegraph that the report raises serious questions about the role of the bank’s board, particularly the non-executives.
“From what we can tell, corporate governance was a shambles and needs thorough investigation.”
Now that the FSA has come out with this damning report, and given the widening Operation Hornet police investigation into alleged massive fraud, money-laundering, corruption and other criminality linked to HBOS, all the bank’s former directors including chairman Lord Stevenson are looking more exposed. The FSA confirmed that it continues to pursue various other “enforcement actions” into HBOS including into individuals.
It is noteworthy that the regulator redacted some sections of the “final notice” document, seemingly ones relating to the bank’s “group internal audit” function, which the FSA did say “failed to provide effective assurance in relation to Corporate throughout the relevant period.” This may well mean that individuals from HBOS group internal audit are suspects in the “Operation Hornet” inquiry.
I suspect that much more will come out of the woodwork about the activities of HBOS and the Bank of Scotland in the coming weeks.
Legal contacts tell me that the chances of former HBOS directors and executives being sued for every penny they own or serving long jail terms have risen dramatically as a result of yesterday’s findings. The FSA’s document also puts pressure on the UK government to finally release the contents of the Treasury’s “secret dossier” (which the Treasury has kept hidden and whose existence first emerged during Lloyds TSB’s 2008 acquisition of HBOS).
Yesterday, I spoke to Paul Moore, the former group head of regulatory risk at HBOS, a former barrister who was personally and unceremoniously dumped by the bank’s chief executive James Crosby in 2004 after he sought to alert the bank’s board to the craziness that was going on at HBOS. Disgracefully the bank then commissioned a wholly partisan report from its own auditors, KPMG, in a vain attempt to rubbish Moore. (The circumstances surrounding Moore’s dismissal and the way it was dressed up by KPMG and the bank’s former chairman Lord Stevenson, have yet to be properly investigated by the UK authorities). Moore said:-
“This means there should now be no holding back on a full investigation into all matters relating to HBOS, including my dismissal and the appointments of salespeople like Jo Dawson to senior risk management roles. The FSA Final Notice basically tells us there has to be a thorough judicial inquiry into the whole affair, in which people are compelled to give evidence orally, under oath, and to produce all the relevant documents, so we can have a proper transparent forensic investigation into who did what when. This would be along the lines I proposed a press release in March 2009. That really has to happen and if it doesn’t happen there’s something fundamentally wrong.”
“You could not have a finding of this seriousness in relation to FSA Principal 3 without enforcement action being taken against individuals. Off the top of my head, if Peter Cummings had behaved fraudulently then the enforcement action would be limited to enforcement action against him. But if the whole firm is in breach of principal three, as this report suggests, then you have to look more widely at who was responsible for that breach: in addition to Cummings, I would have thought it would include the chief financial officer, the chief executive, the chairman, the chairman of the risk committee of the corporate bank, the non-executives on that risk committee, the members of the group audit committee (who are also non-executives). The question then is: does it flow out to all the board directors or was it just this narrower group?”