Board-Level People Risk – the HBOS Rights Issue

The 2008 HBOS Rights Issue
In April 2008, HBOS was on life support when, in a last throw of the dice, the Board decided to launch a rights issue to raise some £4 billion in capital. This was a spectacularly ‘bad’ decision, not because the issue was a complete flop with just over an 8% take-up, but because the prospectus that the Board approved was to put it mildly a ‘work of [half] fiction’, particularly as regards the level of provisions for credit defaults.

An Accident Waiting to Happen
The failure of the Halifax/Bank of Scotland (HBOS) has been well-documented not least in the two-volume report [1] by the UK Parliamentary Commission on Banking Standards which was titled ‘An Accident waiting to happen: The failure of HBOS’, the insightful book by Ray Perman [2] and this paper on HBOS’s recklessness [3].  In short, HBOS was a casualty of the Global Financial Crisis (GFC) that, after a £25 billion bail-out by the UK government, had to be forcibly acquired by the Lloyds Banking Group (LBG) in January 2009.

The failure of HBOS is a classic case-study in People Risk as the failure was due in large part by the Overconfidence and Hubris of the Board and senior management, who were ill equipped to indulge in the suicidal lending spree that led to the bank’s failure.

In 2012, the now-defunct HBOS was ‘publicly censured’ by the UK banking regulator, the also-defunct Financial Services Authority (FSA) for, among other instances of misconduct, issuing a prospectus without quantifying or commenting on the level of impairments that had been experienced since the last Annual Report. The FSA noted that normally a substantial fine would have levied in such cases of misinformation but as LBG was now in part-public ownership no benefit to the taxpayer would accrue by such a fine. The misconduct was then officially buried and no director was personally held to account for authorizing the prospectus.

In September 2014, an investigative article in the Independent on Sunday (IOS) newspaper reported that not only were the impairments underestimated but the prospectus did not disclose that, at the time of the rights issue, HBOS was in receipt of substantial funding support from the UK Government through its Special Liquidity Scheme (SLS).  I.e. the bank was on life support. On the face of it, this appears to a deliberate attempt to withhold important information from (new) shareholders. If directors did not know of the government’s support, they should have done. If they did know, they should have ensured that potential shareholders were give the full picture of the risks involved in purchasing the issue.

People Risk at the Board level
The FSA’s public censure of HBOS was that the ‘Firm’ had contravened regulatory requirements. But was it an amorphous entity, the Firm, which made the decision to issue a thoroughly misleading prospectus? No! The prospectus was approved by a group of real, flesh and blood people – the Board of HBOS. And we know who this Board was. It included the chairman Lord Stevenson of Coddenham, the chief executive Andy Hornby, the head of HBOS’s corporate bank, Peter Cummings and various other knights and commoners. While, the Board of HBOS was criticised by the FSA for its lack of banking knowledge, its non-executive directors were experienced directors in industry and should have known the rules concerning rights issues by any firm.

The situation was undoubtedly desperate, money was hemorrhaging from HBOS, the markets were in free-fall, the Government and the markets were on HBOS’s case, so it was obviously a trying time for the directors. But why did they decide to attempt one last bid for funds from the market and why did they resort to sleight of hand to do so? The directors put the survival of the company before the welfare of their existing and new shareholders, whom they were supposed as directors to protect! They resolved their conflict of interest (survival versus veracity) by opting to try to save their own skins.

We will never know the details of discussions and debate that led to this deeply flawed decision because such information is held to be secret. Despite the obvious recklessness of the decision, the directors of HBOS cannot be held collectively or individually accountable for taking this disastrous course. Like the secrecy of the confessional, Board discussions are held to be inviolate.

In other words, without changes to Corporate Governance rules, to ensure that Board decisions are made without behavioral biases and without conflicts of interest, People Risk, or the risk that people will make disastrous decisions, cannot be managed properly at Board level.

 

Postscript: In 2012, HBOS executive director Peter Cummings was fined £500,000 by the FSA and banned from working in the banking industry. He has the dubious distinction of being the only director to date who has been officially censured for the events that lead to the UK banking collapse.

 

References for HBOS
[1] UK Parliamentary Commission on Banking Standards (2013) ‘An accident waiting to happen: The failure of HBOS’, Vols I & II Parliamentary Commission on Banking Standards, published in April 2013 by authority of the House of Commons
[2] Perman, R (2013) ‘Hubris: How HBOS Wrecked the Best Bank in Britain’, Berlinn, Edinburgh
[3] McConnell P. J. (2014) ‘Reckless Endangerment – The Failure of HBOS’ Journal of Risk Management in Financial Institutions, Vol. 7 No. 2

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