Give Lloyds’ shareholders a refund

Anthony Hilton
26 Nov 2009

I can understand why the Governor of the Bank of England Mervyn King and Chancellor of the Exchequer Alistair Darling thought it best to keep secret the injection this time last year of £60 billion of emergency capital to ward off the possible collapse of Royal Bank of Scotland and Lloyds/HBOS.

Their responsibility was to try to prevent a systemic collapse of the UK financial system. At a time of near panic in the financial market news of such a massive bailout could very easily have caused what they were trying to prevent.

But while their responsibility is to the country, what about those people whose responsibility is to the shareholders? Where were the auditors, the lawyers and the plethora of other advisers, all of whose jobs are ultimately about investor protection? They happily took fees in connection with the Lloyds £5 billion rights issue which was under way at that time. Did none of them think shareholders who were being asked to put more money into the organisation had a right to know that it was about to collapse without this emergency aid? Did the advisers not think it a material fact in helping shareholders decide on whether or not to pour good money after bad? Can they really argue with a straight face that a bland clause 200 pages into the prospectus which talked vaguely about the usefulness of central bank support in difficult times is an adequate way to describe £25 billion of emergency loans? Alternatively if they did not know about the loan, given we were in the middle of a financial crisis, should they not have thought to ask in order to discharge their responsibilities?

If shareholders had known about the emergency finance it would have brought home to them the parlous condition of their investment and the rights issue would probably have failed. The fact that all the money they put in then has gone down the drain, as proved by the terms of the current fundraiser, suggests it deserved to fail. That being the case, perhaps the accountants and lawyers involved with the fundraising will explain why anyone who put money into that rights issue last year should not now be refunded out of the advisers' pockets.

The alternative at the time would have been for the rights issue to have been abandoned by the Lloyds board, who could have decided that it was immoral to ask shareholders for money when they were prevented from telling them the full truth.

They could easily have decided their shareholders were not primarily there to be fleeced, because all they had to do instead was ask Mervyn for another £5 billion to make up the shortfall. Given the tens of billions he had already handed over, he was hardly likely to refuse.

Reform to tackle risks and egos

Sir David Walker's reforms to the governance of banks which are published today rest on three pillars.

The first is about making the company boards work better. Non executives have to be more challenging to the executives, put in more time and understand the business better. The chairman has to be satisfied that his board really is fit for purpose — and if it is not then he becomes the fall guy. In future, he or she will be up for election every year.

The second pillar is about shareholders. Some engage with the companies in which they invest, but others don't. The pressure is now on for them to behave like owners. Their recently unveiled code of conduct will be passed to the Financial Reporting Council for monitoring and enforcement. It will probably want to consult on it again — perhaps to defuse any potential tim bombs —but after that will use its considerable authority to encourage compliance. Fund managers are going to come under the cosh as never before.

That at least is the theory, and there seems no reason either why these two pillars should not apply to all listed companies, not just banks.

It could be a significant step forward in governance — not one that will prevent all future crises but significant for all that.

Alternatively, it may fail, as all previous initiatives have failed, to change fund manager behaviour. But the implications of that are quite profound. If one says these proposals will make no difference we are in effect saying that the problem of agency — where neither executives nor fund managers act in the best interests of the owners — is insoluble. That is a pretty big leap to take without at least making an effort.

The third pillar is about risk and the need for banks to have a risk officer whom important people listen to. Well insurance companies have one of those, the chief actuary, and the lessons of failures in that industry such as Equitable Life suggest it is not enough. Making risk a specific responsibility of one person means everyone else ignores it. It becomes the province of the anoraks. The fact is that banks' business is risk so that risk has to be owned by the chief executive and seen to be owned by him and be his central responsibility.

Short term, while memories of this crisis are fresh, we won't have a problem. But long term, when the juices start flowing and egos re-emerge, nothing else will work.