Go to jail, do not pass go, do not collect several million pounds! British bank executives who contribute to failure to be locked up

2015 was a dire year for the corporate performance of many of the large interbank FX dealers which dominate the skyline of London’s ‘Square Mile’ and Canary Wharf.

Indeed, Barclays, Citi, Credit Suisse, Deutsche Bank, Standard Chartered and HSBC all recorded a very difficult year, some sustaining losses running into the billions of dollars which resulted from lackluster performance, as well as the cost of settling class action lawsuits and regulatory penalties from Swiss, British and US authorities for the rigging of FX benchmarks as the case against six major banks came to a close in November 2014.

Throughout the year, disastrous balance sheets blighted the desks of senior executives who tried to keep the large institutions on an even keel.

Today, British Chancellor of the Exchequer George Osborne has unveiled a draconian new law which will criminalize senior executives of banks who contribute to commercial failure, and provides legislation which would result in the courts being able to hand down jail sentences of up to seven years.

Senior executives in banks, building societies and what the British government considers to be important investment firms will be held liable under a criminal prosecution for offencese which include taking a decision which causes their institution to fail, being aware of a risk that a decision could lead to institutional failure or what is termed as conducting themselves in a way that is “far below that which could reasonably be expected of a senior manager in that position.”

Once bitten. Twice Shy

In 2015, for the first time since the financial crisis of 2008, banks in Britain are showing signs of difficulties, and losses running into billions are being recorded, some of which are as a result of the conduct of the institutions – the FX rate rigging penalties being an example – and the regulatory authorities are now taking action as this is remeniscent of the days of RBS having been brought to near collapse by Fred Goodwin’s aggressive expansion program in the first decade of the Millennium.

Mr. Goodwin’s strategy of aggressive expansion primarily through acquisition, including the takeover of ABN Amro, eventually proved disastrous and led to the near-collapse of RBS in the October 2008 liquidity crisis. The €71 billion (£55 billion) ABN Amro deal (of which RBS’s share was £10 billion) in particular stretched the bank’s capital position – £16.8 billion of RBS’s record £24.1 billion loss is attributed to writedowns relating to the takeover of ABN Amro.

It was not, however, the sole source of RBS’s problems, as RBS was exposed to the liquidity crisis in a number of ways, particularly through US subsidiaries including RBS Greenwich Capital. Although the takeover of NatWest launched RBS’s meteoric rise, it came with an investment bank subsidiary, Greenwich NatWest.

RBS was unable to dispose of it as planned as a result of the involvement of the NatWest Three with the collapsed energy trader Enron. However the business (which became RBS Greenwich Capital) started making money, and under pressure of comparison with rapidly growing competitors such as Barclays Capital, saw major expansion in 2005-7, not least in private equity loans and in the sub-prime mortgage market. It became one of the top three underwriters of collateralised debt obligations (CDOs). This increased exposure to the eventual “credit crunch” contributed to RBS’s financial problems.

Subsequently the British government purchased a 58% stake in RBS, with the taxpayer now bearing the burden of any losses which would affect the share price of the London Stock Exchange-listed company.

Mr. Goodwin was not prosecuted nor held accountable other than having had his title rescinded, and was actually allowed to retire, keeping his vast pension.

At the time, treasury minister Lord Myners had indicated to RBS that there should be “no reward for failure”, which is rather different to today’s criminalization of failure.

The nationalized stake in RBS continued to increase after Mr. Goodwin’s departure, and in August 2015, the British government sold £2.1 billion of shares in bank at a loss. This equated to the sale of a 5.4% stake at 330p a share, a 7.6p discount the previous day’s

At the time, Chancellor Osborne faced criticism for selling the shares at well below the price of about 500p that the Labour government at the time paid for them. The 170p difference represented a loss of about £1.07bn on the shares sold which effectively is taxpayers’ money. This transaction took the government’s stake in RBS to 73% at which it stands today, however the company’s shares are now worth half of what the government paid in 2008.

Now with substantial losses being recorded by firms such as Deutsche Bank (which is German but conducts most of its interbank business from London) and Credit Suisse to the point of attracting comments from government ministers in Deutsche Bank’s case and recording the loss in the case of Credit Suisse, it is likely that this new law will make those in positions of power sit bolt upright and consider the consequences of their corporate steerage in light of being held personally accountable.

Lord Myners’ “No reward for failure” becomes George Osborne’s criminalization of failure.

Mr Goodwin’s pension entitlement, represented by a notional fund of £8 million, was doubled, to a notional fund of £16 million or more, because under the terms of the scheme he was entitled to receive, at age 50, benefits which would otherwise have been available to him only if he had worked until age 60.

Sir Philip Hampton, RBS’s chairman at the time, stated that as a result Goodwin is drawing £693,000 a year (later revised to £703,000 due to Goodwin working an extra month in the new financial year), and disclosed that under the RBS pension scheme Mr. Goodwin was entitled to draw the pension already, at age 50, because he had been asked to leave employment early, rather than having been dismissed. A pensions expert suggested that this meant Goodwin had received a substantial payoff from his early retirement, as it would cost around £25 million to buy such a pension and his pension ‘pot’ amounted to £16 million.

When the matter became public in late February 2009, Mr. Goodwin defended his decision to refuse to reduce his pension entitlement in a letter to Lord Myners on 26 February, pointing out that on leaving in October 2008 he had given up a contractual 12-month notice period worth around £1.29 million and share options worth around £300,000. In March 2009 Lord Myners revealed that part of the reason Goodwin’s pension was so large was that RBS treated him as having joined the pension scheme from age 20 (instead of 40, when he actually joined) and ignored contributions to his pension from previous employment.

This of course is just one example, as many bank executives of that era which created the need for nationalization of the banks and poor corporate performance simply moved on, collecting their bonus on the way out.

Chancellor Osborne has today publicly stated that the strict new rules show that the government “has learnt from the lessons of the past”.

“We have reformed Britain’s banking regulation to help build a stronger and safer financial system and introduced new rules that mean individuals working in UK firms face some of the toughest sanctions in the world. It is absolutely right that a senior manager whose actions causes their bank to fail should face jail.” George Osborne.

The new regulations were first recommended by the Parliamentary Commission on Banking Standards (PCBS), a body that was formed after the financial crisis to spearhead reforms in the City. Things are indeed somwhat different today than they were at the time of the financial crisis, as in 2013, the British government separated the regulatory body which previously oversaw all aspects of financial services into the Financial Conduct Authority (FCA) for non-bank entities, and the Prudenial Regulation Authority (PRA) for banks instead of the Financial Services Authority (FSA) which oversaw all financial markets activity except for that of retail banks which were overseen directly by the Bank of England.

Also coming into force today is the new Senior Managers and Certification Regime (SM&CR), which will hold top employees at banks, building societies, credit unions and Prudential Regulation Authority (PRA) regulated investment firms to adopt “statements of responsibility” and hold most senior staff accountable for misconduct at their institution.

Just as last week FinanceFeeds took a look at how the US banks had become almost monopolies in the last twenty years, condensing from 37 to just 4 institutions through M&A, it looks as though leaders of some of Britain’s esteemed institutions could be participating in a very different kind of monopoly; that being not purchasing hotels in Mayfair, but instead going to Pentonville jail.