Brought to account
Date: 23 September 2011
Authors: Patricia Leonard
Issue: Vol 161, Issue 7482
Categories: Opinion, Banking
Banks in Britain, and abroad, have been subject to a fresh onslaught in recent weeks. British banks have found themselves subject to expansive and costly litigation, investigations by the Serious Fraud Office (SFO) and responding to the Basel III rules.
Three British banks—RBS, Barclays and HSBC—are among the 17 being sued in a multibillion pound lawsuit for allegedly mis-selling mortgage-backed securities by the US Federal Housing Finance Agency (FHFA). These were filed just as the limitation period was coming to an end and took the market by surprise, causing an immediate drop in share prices.
Some of the banks involved are already negotiating in the US with the attorneys general of all 50 states because of an investigation addressing mortgage abuse, making it more unlikely that a global settlement can be achieved. That these settlement negotiations are taking place in the US before a full investigation into mortgage abuses has even been completed shows how willing banks are to stave off costly litigation as soon as possible, despite robust denials of any malpractice. However, banks—both in the UK and the US—will be reluctant to pay out for a settlement if there is the risk of further payments to other government or regulatory agencies, such as the Serious Fraud Office (SFO) in the UK.
Regardless of whether the claims brought by the FHFA have merit, the 17 banks involved (and this number is likely to grow) will face a costly bill in terms of defending these claims or trying to come to an economic settlement. Even if the claims are successfully defended, there will be substantial legal fees and business costs (in terms of diverted resources) which cannot be fully recouped. In light of the size, number, and value of the claims, some banks may consider it more prudent to fund a settlement, albeit an expensive one, rather than spend years litigating.
The impact of this type of litigation cannot be underestimated. It is likely to produce fundamental changes within the banking system. Banks will need to focus on their decision-making policies and structures—to stave off any future threat of costly and protracted litigation. The banks are facing a new era in civil and regulatory investigations and litigation—there is greater willingness to make a clear distinction between people and institutions. The FHFA has specifically named current and former senior executives of the banks as defendants. Individuals, therefore, may find themselves liable for negligent or fraudulent mis-selling of mortgage-backed securities and paying the price for their involvement. Even if an allegation is against an individual only, there will still be repercussions for banks as they will need to manage potential conflict.
Following swiftly on from the FHFA’s litigation, the SFO is currently examining multiple deals involving some of the biggest UK banks, to establish whether they fraudulently misrepresented deals to clients and counterparties in the UK. The SFO has spent the previous two years investigating the sales of asset-backed securities after advice from senior financial figures. Although no official investigation has yet been opened in relation to any company, the SFO is appealing for whistleblowers to provide evidence.
In the short term, the influx of recent regulatory and litigious activity is negatively impacting upon share prices in the sector, not least because investors are now uncertain about the ultimate ambit of any particular bank’s liabilities.
On a more medium to long term basis, banks will have to deal with the implementation of Basel III, designed to prevent the repeat of another financial crisis, which will oblige them to raise hundreds of billions in fresh capital. Banks will have to devote considerable time and resources to be able to implement and manage these changes.
Predictions
The current litigation and ongoing investigation may give rise to further lawsuits, from specific investors. The FHFA lawsuits (especially the extensive discovery which is likely to take place) and any formal SFO investigation may expose evidence which prompts private institutions or investors to bring their own claims against the banks. However, the pressure brought by recent developments is unlikely to produce the type of collapse we saw in 2008. Banks have fewer assets exposed to shocks on the banks’ balance sheets and higher capital and liquidity buffers. Therefore, although recent developments are likely to reduce banks’ profits and create a period of uncertainty, banks will not revisit the period of extended crisis experienced three to four years ago.
Patricia Leonard is a barrister in the commercial litigation team at 7 Bedford Row.
Website: www.7br.co.uk
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