Research and Commentary on the Legal Professions from Richard Moorhead
Posted on October 5, 2017
There is an absolutely fascinating story in today’s FT by Jonathan Ford about the ‘Quayside’ Scandal relating to Lloyds-HBOS. It raises a number of issues about the banks’ lawyers (in- and outside-house) and one about a Magic Circle firm and the legal regulatory framework. The story is essentially about how Lloyds, as it was about to take over HBOS, and Lloyds HBOS thereafter, dealt with former HBOS customers reporting fraud by an employee of the bank and corporate recovery agents appointed by the Bank.
One set of allegations was made to the Bank Chairman and included (to quote from the story), “falsification of business plans and the theft of fees …orchestrated by a corrupt HBOS banker based in the Reading branch, Lynden Scourfield, and his co-conspirator David Mills at QCS, [Quayside] which acted as a turnaround consultant to various HBOS business customers.” Those complaints were, according to the FT, brushed off. Many years passed but earlier this year Scourfield and Mills were convicted of fraud and given considerable jail sentences. The FT says the cost of the scam has been estimated to be up to £1bn.
According to the FT, “Lloyds showed little interest in finding out what happened. …other victims who unearthed evidence of wrongdoing were treated equally dismissively. Far from calling in the police or regulatory authorities, Lloyds maintained right up until the trial’s conclusion that its own internal inquiries had revealed no sign of any criminality.”
This is where it gets interesting from my point of view. Asserting that there is no evidence of criminality suggests an application of legal judgment. Which lawyers were involved in advising on that question, if any? What factual enquiries were made, and under whose direction? What limits were set on the investigation, if any? And so on. The likelihood is that such investigations involved in-house lawyers at the bank and, quite possible, external lawyers.
There is a suggestion that (some in) HBOS knew of the situation before the complaints. In early 2007, Paul and Nikki Turner had HBOS pull their loans, “without warning and the business into which the Turners had sunk all their savings collapsed”. The FT suggests this was at the time when, “Scourfield [was] on the brink of exposure after a new boss started looking into his activities.”
Again, according to the FT, the Turners gathered evidence and reported it to Lloyds’ chief executive. A different senior executive wrote back and, “dismissed their complaints, saying their claims about fraud had been investigated and rejected.” The bank then continued to try and repossess the couple’s home with 11 possession hearings until, “the judge finally suspended proceedings pending the conclusion of the criminal investigation into the fraud at Reading (which led to Scourfield’s conviction).” There is an interesting question as to what was raised about the (then alleged) fraud in the context of those proceedings, and what the lawyers for the Bank knew or were told when advancing those proceedings.
The dismissal of the Turner’s complaint was not quite on all fours with what the Bank’s position actually was, or at least, came to be. The FT report the Bank saying (it is not clear when), “While concerns . . . were identified, there was not sufficient evidence to establish criminal behaviour.” Whilst, in fact, the FT reporter opines: “Even before the takeover, its executives already realised they were dealing with more than just some rogue executive.” And, in particular:
Facing an audit in the spring of 2008, some HBOS executives in the group risk department were tasked with assessing the losses from the Reading scam. At the time, HBOS was thinking about raising extra capital (it subsequently launched a £4bn rights issue in April 2008). Their email exchanges, contained in an internal report that has been seen by the FT, are telling. An email in February 2008 from Peter Hickman in the group risk department talked about the importance of keeping the Reading losses well below the £285m level at which the bank’s accounting rules would kick in, deeming them material and requiring a note in the financial statements.
At an estimated £265m, they were already too close for comfort, thought Hickman. “Anything we can do to widen the gap between this loss and that limit will help us persuade the Audit Committee we should not disclose — something we seriously do not want to do — especially at the moment,” he wrote. Another email, from Ian Goodchild, then deputy head of group risk, referred openly to the “fraud”, which he estimated had already cost the bank about £200m in losses.
I am, of course, not an accounting expert, but I am not naïve enough to suggest that calculating the losses referred to was necessarily straightforward. The job that faced the Bank was not simply a matter of working out the losses and seeing if they topped the £265m figure. There would have been matters of judgment as to how to calculate a loss and whether to attribute it to the Quayside/Scourfield problem. But it would, I imagine, be well known to these individuals that the accounts and any associated reporting should present a true and fair view. And it is reasonable to think that an ethical (and perhaps, but I speculate, legal) obligation existed to apply a true and fair view when thinking about the disclosure thresholds the bank operated to. Their interpretation of the facts on the ground needed to be true, honest, fair, and reasonable. We do not know if it was, but doing everything one can to ensure the facts fit a picture of comfort is not, to my mind, consistent with wisdom or objectivity. It is, though, the kind of thing lawyers are often asked to do (or like to think of themselves as capable of). Under this view, facts are, to a point, simply ways of seeing the world, bargaining chips in an adversarial process: the banks with the knowledge against the World with its vulnerabilities.
Doing everything one can to ensure the facts look one way is not a sensible way to run a reporting regime or to manage information within an organisation, but it happens. An interesting question is whether that is a lawful approach or one that is professional or ethical. We do not know enough to judge, but we do know enough to wonder and ask questions. The insinuation of the FT story is that the judgments around disclosure thresholds were influenced by the knowledge that they “seriously” did not want to disclose the problem, which was being discussed by some at least as fraud.
Now none of the people named by the FT, as far as I can see, had legal positions in Lloyds or HBOS, but there is an interesting question raised by Mr Hickman’s role. I should emphasise here that we do not see the FT allege that he knew there was a fraud at the heart of this problem. His anxiety about disclosure may relate to other less noxious concerns. Disclosing a large financial hole in the business might be the only concern he was seriously worried about. But it is something which would bear investigation. I say it would bear investigation in part because Mr Hickman is a COFA, a Compliance Officer of Financial Administration in a Magic Circle Firm. He is also their Chief Finance and Operations Office (or was in June 2017, I cannot find a more current reference to him). COFAs (along with the legal counterpart the COLP) lead on risk and compliance in their organisations. The questions this raises for me are:
- Was this an issue disclosed to the firm when he was appointed, or did it arise from their due diligence? How thoroughly was it looked at?
- Was this a matter disclosed to the SRA then or subsequently as part of an assessment of the fit and proper person test?
- Is this a matter now under the firm’s or the SRA’s investigation?
I am really not insinuating massive problems here – we do not have anywhere near all the facts – but the FT story gives rise to enough causes of concern to suggest to me that this is something that should be looked at with reasonable alacrity. And while it is interesting that this story touches on the SRA’s regulatory regime in this way, it is probably not the most interesting lawyers’ ethics angle on the goings-on.
The FT criticises HBOS’s internal by its corporate financial crime prevention team in 2007 as inadequate and inconsistent. Given its focus on evidence and fraud, I would expect that to have involved in-house legal advice at the very least. They may have led on it. Similarly, an FSA official asks the question in 2009 of the Bank, “Who decided not to investigate?” It would be surprising if such a decision did not engage the Bank’s lawyers at some, if not several, stages. Again, they may have led.
Lloyds sought subsequently to offer reassurances to victims of the fraud that the Bank was “fully supportive” of a police investigation. Anthony Stansfeld, police commissioner for Thames Valley, sees things differently, according to the FT.
“If it hadn’t been for the unearthing of evidence by victims and whistleblowers within the banks, much would not have come to light,” he says of the investigation. “The treatment of whistleblowers, and the huge legal pressure they were then put under by the bank’s lawyers, has been disgraceful.”
There are not details here of the pressure, other than the number of possession hearings the Turners’ were subject to (housing lawyers would know better than me how unusual this was). An interesting question is whether any of the lawyers involved in bringing the possession hearing knew of the bank’s concerns about the fraud which contributed to the Turner’s debt, and perhaps was the cause of them being unable to pay. Put another way, more pointedly, but the facts seem to bear out (if the FT’s reporting is accurate): did any lawyers advising the Bank or its Board know that proceedings were being brought to recover the proceeds of fraud from one of the victims? That would be a very serious thing if shown to be true depending – perhaps – on how they dealt with that knowledge.
Then there is the issue of legal privilege. Recent court decisions on privilege have led to a good deal of rending of professional garments. The FT reports:
an internal police document. This is understood to accuse Lloyds of leading the investigating officers a “merry dance”; of claiming legal privilege over documents that were not entitled to be protected; of deluging the police with vast amounts of irrelevant information; and of “briefing witnesses” prior to police interviews as to what they could say without breaching the guidelines set by the bank and its lawyers. Lloyds claims it “always complied appropriately with requests for information from Thames Valley Police”, even on occasions writing to the force “to make clear that it wanted the investigation to continue”. A spokesperson points out that in the course of the inquiry, Lloyds shared about 600 lever-arch files with officers and “more than 150,000 electronic documents”.
I wonder how much of this documentation is really covered by professional privilege. The crime-fraud exception may well loom large here. The profession needs to be wary of aggressive use, and misuse (if that is what really happened – again we do know enough) of privilege if it wants to hang onto it, for the benefit of their clients.
The Bank is seeking to deal with these problems with the Corporate Classic- the independent investigation. In their favour, a former judge is conducting the investigation. Yet
Dobbs is assisted in the provision of the necessary documents by Herbert Smith, the bank’s own lawyers, who were closely involved in both the regulatory inquiry between 2009 and 2010 and Lloyds’ assistance with the Thames Valley investigation. This has raised questions about the Dobbs inquiry’s independence.
No kidding. It also raises, at the very least, a potential conflict of interest. The conduct of Lloyds during those investigations has been criticised. Dobbs is, it appears, ‘getting to the bottom of’ all these matters (and more perhaps). It is possible that Herbie’s advice or conduct will come under the spotlight. Indeed, it seems likely (fairly or unfairly). They might think they have done nothing wrong, but they cannot possibly independently advise the client in such circumstances. I would welcome a sensible explanation as to why this does not breach Chapter 3 of the Code of Conduct: “You can never act where there is a conflict, or a significant risk of conflict, between you and your client.” Because I think I must be missing something here. Few things in law are rarely so clear, but this seems to be one.