This is the first of a two-part examination of the UK Financial Services Authority’s (FSA) recent response to the collapse of the Royal Bank of Scotland. The second part is “If the FSA wanted a whitewash, PwC was well-placed to deliver it.”
The Financial Services Authority’s obsession with “light touch” regulation from 1997 to 2008 did more than anything else to transform London into the “Wild West” of finance in 2000–08. US investment banks dramatically built up their presences in the UK capital during that period. They knew they could rely on the FSA and other laissez-faire authorities along with fee-hungry professional services firms to turn a blind eye to things that would never be tolerated at home.
This was why the hugely toxic AIG Financial Institutions Group was based in London and why Lehman Brothers signed off its deliberately misleading repo 105 deals here using Ernst & Young and Linklaters to give it the stamp of approval. It is also why London came to be known as the “Guantanamo Bay of finance.”
The laissez-faire approach to regulatory policy—whose biggest cheerleaders other than the bankers themselves were Tony Blair and Gordon Brown—has massively undermined London’s reputation as a financial center as well as ensuring that Britain suffered a worse hangover from the global financial crisis than virtually any other state—with the possible exceptions of the US, Ireland, Iceland, and Dubai.
Given the manifest regulatory failures during credit bubble, it came as no surprise when last week the FSA declared that it had "closed" its inquiry into the Royal Bank of Scotland and exonerated the bank's entire board including the UK's 'pantomime villain' of the crisis, Sir Fred Goodwin. The regulator said all Goodwin and his boardroom chums had done was make a few "bad decisions" and that there had been no failures of corporate governance or, heaven forfend, fraud.
After a 17-month inquiry into RBS—orchestrated by accountancy firm PwC—the regulator declared in a press release:
"In May 2009 the FSA launched a supervisory investigation into RBS ... This work considered if regulatory rules had been broken and what, if any, action was appropriate. The review was necessarily extensive and looked specifically at the conduct of senior individuals at the bank, the acquisition of ABN AMRO in 2007 and the 2008 capital raisings. The FSA conducted the review with assistance from PwC.
"The review confirmed that RBS made a series of bad decisions ... most significantly the acquisition of ABN AMRO and the decision to aggressively expand its investment banking business. However, the review concluded that these bad decisions were not the result of a lack of integrity by any individual and we did not identify any instances of fraud or dishonest activity by RBS senior individuals or a failure of governance on the part of the Board."
Within hours politicians, media, and the digerati were baying for blood. Some suggested the FSA ought to go back to the drawing board and conduct a less partial investigation. At the very least, it was suggested the FSA should make its "review" of RBS's pre-implosion behavior public (it currently intends to keep it secret, saying the Financial Services and Markets Act 2000 requires this). Damian Reece, business editor of the Daily Telegraph summed up the mood:
"The review highlights the impotency of FSA-style regulation ... There was quite clearly a colossal failure in corporate governance ... I'm completely stunned by the FSA's finding that "we did not identify ... a failure of governance on the part of the Board." If RBS circa 2007 wasn't a failure of corporate governance then I really don't know what is."
Leading British politicians were no less aghast. In his blog Michael Meacher MP wrote:
"The FSA appears not just toothless, but gumless and jawless. Mismanagement on this gigantic scale cannot simply be written off with such Olympian insouciance. Either it must be severely punished or top executives should be personally tied into the consequences of their decisions."
The Liberal Democrat peer Lord Oakeshott said:
"This just won't wash ... You can't refuse to publish the report—redacted, if legally necessary—on the worst train-crash in British company history! How can we learn the lessons if we can't read the evidence?"
There are certainly reasons to doubt whether the FSA and PwC have really tried to get to the bottom of what caused RBS's £2.2 trillion October 2008 collapse.
In particular, one wonders how deeply they probed whether the Edinburgh-based bank's board—where key executive directors included Goodwin, Johnny Cameron, head of investment banking, and Guy Whittaker, finance director (who had joined from Citi in February 2006)—deliberately misled investors as it sought to raise more capital in 2007–08.
The bank had pumped up its balance sheet by feasting on hugely risky "toxic crap" including subprime-based derivatives in the US market in 2006–07. Indeed RBS once boasted it had become the number one player in the sector, ahead of the uber-reckless Lehman Brothers and Bear Stearns in 2007. Then RBS more than doubled its exposure to the asset class through the hugely overpriced €71bn acquisition of ABN AMRO. None of these actions could be considered as falling into the category of "good corporate governance."
It's also worth reminding readers that the bank's internal systems were so inadequate that internal auditors found it impossible to obtain data about its true exposures and risks. One ex-insider said: "Reported numbers for the bank’s exposure were regularly billions of dollars adrift of reality."
Soon afterwards RBS sought to patch up its tattered balance sheet by tapping investors for a further £12 billion of equity.
The bank's board issued a rights issue prospectus [PDF, 393 KB] (dated April 30, 2008). The prospectus, signed off by law firm Linklaters and accountants Deloitte, reassured investors that once the monster capital-raising was completed the bank would have enough working capital to survive without external support for at least one year (this is a topic I explored in an earlier post "Dog in the night time.")
Elsewhere in the prospectus the RBS directors—who included the Goldman Sachs International chairman Peter Sutherland, former AstraZeneca boss Sir Tom McKillop, and former Treasury mandarin Sir Steve Robson—insisted their working capital statement was “unqualified by risk factors.”
Yet, five and a half months later RBS was bust, its shareholders (especially those who had partaken of the rights issue) had lost their shirts, and had to be bailed out with a £45bn capital injection from the UK government plus government-provided liquidity support as part of a £1.3 trillion rescue package for the UK banking sector.
As one of my lawyer friends puts it, the veracity of the working capital was “unequivocally disproved by the banks’ own subsequent actions." So doesn't this mean the RBS board must either have been negligent or fraudulent? Not according to the FSA whose press release clearly states it had not identified any corporate governance failures at the bank. (There are other known instances where, by any objective criteria, the bank's board misled investors but I don't have the space to list them here).
So why is the FSA seeking to fob us off with what appears to be a cack-handed attempt at a whitewash? I suspect that, given its complicity in RBS's collapse, the FSA is actually running scared.
Remember that under leaders including Howard Davies, John Tiner, Calum McCarthy and Hector Sants, the Canary Wharf-based regulator became very much a creature of the banking sector. During the credit bubble, all a bank boss like Goodwin had to do was click his fingers, and UK politicians like Gordon Brown and regulators like John Tiner came running.
Remember also that the FSA was responsible for a catalog of errors without which RBS would have been unlikely to have collapsed. The regulator:
- Turned a blind eye as RBS allowed its balance sheet to become overleveraged in 2003–07;
- Sanctioned the £20bn NatWest takeover in 1999–2000;
- Sanctioned 27 other overpriced deals, many of which exposed the bank's UK depositors to unnecessary risks;
- Greenlighted the seriously deranged €71bn takeover of ABN AMRO in October 2007 (months after the credit crisis had set in and by which time the Dutch bank had a negative value following its proclivity for feasting on toxic crap offloaded by savvier Wall Street institutions);
- Sanctioned what was either a negligent or a fraudulent rights issue prospectus.
So could the FSA's press release be part of some sort of elaborate charade designed to rewrite recent financial history and divert attention from its own leading role in the Edinburgh-based bank's collapse? The conspiracy theorist in me certainly makes me wonder.
(In a recent House of Lords hearing, leaders of ‘big four’ audit firms, including PwC boss Ian Powell, admitted that they deliberately misrepresented the solvency of client banks from December 2007 onward, apparently on the premise that the UK government had told them bailout money might be made available in the event of a failure. This made me wonder how independent PwC really was when it was probing for corporate governance failures at RBS, a theme I've explored in another blog post, “If the FSA wanted a whitewash, PwC was well-placed to deliver it”).
Further reading on corporate governance in the banking sector
- Viewpoint: Lessons from the Credit Crisis: Governing Financial Institutions, by Jay W. Lorsch
- Viewpoint: Ethics and Finance, by Sir John Stuttard
- Viewpoint: Regulation, Corporate Governance, and Boardroom Performance Must Be Shaken Up If We Are to Avoid Another Financial Crisis, by Stewart Hamilton
Tags: banking , capital adequacy , financial crisis , Financial Services Authority (FSA) , PricewaterhouseCoopers (PwC) , regulation , Royal Bank of Scotland (RBS) , UK