The £1bn-plus HBOS Fraud Investigation That Lloyds Keeps Trying to Brush Under the Carpet

By Ian Fraser, a financial journalist who blogs at his web site and at qfinance. His Twitter is @ian_fraser

Lloyds Banking Group, the financial behemoth formed from the September 2008 “merger” of Lloyds TSB and basket-case Scottish lender HBOS, is a bank that never ceases to surprise me.

Take the bizarre contortions the bank has got itself into over the alleged £1bn plus Bank of Scotland Corporate fraud — something I’ve been following off and on since September 2008.

Since last summer, the matter has been the subject of a full-on criminal investigation, code-named “Operation Hornet”, led by the Economic Crime Unit of Thames Valley Police and the UK’s Serious Organized Crime Agency.

Hundreds of witnesses and suspects have already been interviewed, right up to the highest levels in the former HBOS, as part of what has been described as “the largest fraud investigation in UK history” by one of the police officers involved.

In the course of these investigations, several bankers and advisers have already been arrested, including Lynden Scourfield, who oversaw “middle-market high risk” lending for HBOS’s Bank of Scotland Corporate unit in southern England, until he left the bank in April 2007. Since his September 29, 2010 arrest, Scourfield has put on bail twice, but he has not yet been charged.

Four corporate advisors to the bank — David Mills, Tony Cartwright, Michael Bancroft and Marco Alessi — have also been arrested and bailed (twice).  These four “consultants” were all engaged by Quayside Corporate Services, a now defunct firm of turnaround consultants founded by Mills and ex-colleague Graham Hayes in 2002, apparently at HBOS’s behest.

The bank imposed Mills, Cartwright, Bancroft, Alessi and other turnaround consultants, including some of their close mates, as “shadow” directors, invariably with “full fiduciary powers”, on up to 200 of its own corporate and SME customers — often without the consent of the firms’ legitimate owners and managers.

Two of the individuals who were foisted by the bank on its clients — Bancroft and Cartwright — had a history of “defalcation” and embezzlement, having siphoned £1.5m out of Ritz Design Group PLC, a listed textiles group where Bancroft was chairman and chief executive and Cartwright was finance director until 1991. After this misappropriation was discovered, both directors left the company, which failed soon afterwards, and are understood to have gone into hiding in Ireland. The affair was “covered up” by the investigating accountants Touche Ross (now part of Deloitte), with virtually zero reference made to what happened so long as Bancroft and Cartwright repaid the money in full — which I believe ensured that neither was “struck off” by the Department for Trade and Industry, which meant they were able to become directors again in future.

In a statement issued on September 29 at the time of the first series of dawn raids and arrests in Operation Hornet, Thames Valley Police said:

The Thames Valley Police Economic Crime Unit (ECU) can confirm they are investigating corruption and large scale fraud in connection with HBOS. The case was referred to Thames Valley Police by the Financial Services Authority. A number of warrants were carried out addresses in Berkshire, Warwickshire and Cheshire today. Three people; two men aged 48, and 65, and a woman aged 48 have been arrested on suspicion of corruption and conspiracy to defraud and money laundering. They remain in police custody. The investigation is still in its early stages and Thames Valley Police will not be releasing or confirming any further information for operational reasons at this time.

So what actually happened? Well, between mid 2002 and December 2007, the alleged perpetrators siphoned some £1bn, largely lent by HBOS subsidiary Bank of Scotland Corporate, out of at least 200 victimized companies, in addition to expropriating physical assets worth scores of millions. Then, in a series of dodgy prepack deals from April 2007, Mills and other Quayside personnel were rewarded for their pains by being given first refusal on any surviving assets, with the blessing of leading accountancy firms such as PWC.

By the way, HBOS was effectively bankrupt and unable to lend from about January 2008, and only avoided total meltdown following the collapse of Lehman Brothers as a result of a state-supported rescue takeover by Lloyds TSB and massive government bailout, in September 2008.

I have explored the story in greater detail in my blog and in UK newspapers including The Guardian and The Herald but given the craven nature of most UK newspaper and broadcast editors, I’m afraid that it has been difficult to give this story more traction in the MSM.

The bank has changed its tune about the scandal several times since the scandal broke. For four years from 2006, when victimized firms first started complaining to former chief executive Sir James Crosby and, more vociferously from mid-2007, to HBOS chairman Lord Stevenson of Coddenham, to chief executive Andy Hornby and to other members of the HBOS board,  the bank’s consistent line can be paraphrased as “nothing untoward happened at Bank of Scotland Reading”.

If there was any blame at all, the bank sought to pin this on a single, autonomous, “rogue” manager (Scourfield, who resigned after a period of “sick leave” in April 2007). The bank has variously described Scourfield as having been “over-supportive”, and having indulged in “over-generous”, “unapproved” and “unauthorized” lending.

In a statement issued in November 2008 the bank said:-

We simply cannot comment on individual circumstances. However, we strongly believe that we have acted throughout in a fair and responsible way. Bank of Scotland deals in a sensitive and fair way with all of its corporate banking customers, including those experiencing difficulties. We stand by our customers and support them closely in managing their financial difficulties.

Yet in a briefing from the Financial Services Authority to the Treasury Select Committee, it was confirmed that the bank reported a “control” issue to the FSA in ”early 2007” and it is known to have been in a legal dispute with Quayside during 2007.

In view of the “regulatory capture” that existed in the UK financial services sector at that time (and probably still does, given the FSA’s astonishing failure to get to the bottom of this debacle which it claims it investigated in 2007 and then started investigating again in April 2009), and given the presence of former HBOS chief executive Sir James Crosby as deputy chairman of the FSA, it seems likely that as with the SEC and Madoff, the FSA chose to try and sweep the matter under the commodious Canary Wharf carpet.

If it did any investigation in 2007, it is a known fact that the so-called “Fundamentally Supine Authority” didn’t even bother to interrogate a single board director from any of the victimized firms and as usual, gave credence to spin and denials from disingenuous bankers. Since completing its HBOS takeover in January 2009, Lloyds has persisted with pretty much the same course.

However, five months ago, the bank surprised City-watchers by changing its stance towards the alleged massive fraud. During a meeting between the bank’s security and fraud department and members of Thames Valley Police and SOCA last August, a bank official, perhaps having reviewed new evidence, declared that the bank’s position was now that it was a “witness and a victim” (i.e., for the first time, the bank acknowledged that a crime had occurred).

But, subsequently, the bank sought to retract this stance, claiming it does not consider itself to be a victim after all!

The acknowledged victims, while not surprised by Lloyds’ bizarre contortions, are becoming increasingly exasperated that neither the bank nor the police seems willing to clarify the bank’s position.

Whilst they accept that it is not up to the police or the Crown Prosecution Service to decide who is or is not a victim of the alleged massive fraud, the procrastination and indecision by the Bank as to its own status is clearly not facilitating either the transparency or the speed of the criminal investigation, especially since the alternative to “victim” would mean that the bank considers itself to be a “conspirator”, something the customer victims — many of whom lost their livelihoods as a result of the alleged fraud — have always firmly believed to be the case.

The most sickening thing about the whole sordid debacle is that the alleged perperators have been able to buy and continue to fund the running costs of two mega-yachts in the Mediterranean Sea, having siphoned funds out of a state-rescued bank. And secondly, that the decent company directors, whose businesses and indeed lives have been destroyed, or harmed, as a result of the bank’s behaviour, continue to be persecuted, with one couple having been through 22 separate court hearings as the bank seeks to repossess their home, in the apparent hope of silencing them.

Despite all this Lloyds Banking Group seems remarkably optimistic that, if it is to be prosecuted for fraud over the BoS Reading debacle, the amount it will have to fork out in legal fees and in compensation for the victims is going to be negligible. In Note 23 of its recent 2010 results announcement the bank said:-

…during the ordinary course of business the Group is subject to other threatened and actual legal proceedings, regulatory investigations, regulatory challenges and enforcement actions, both in the UK and overseas.  All such material matters are periodically reassessed … to determine the likelihood of the Group incurring a liability.  In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed properly to assess the merits of the case and no provisions are held against such matters. However the Group does not currently expect the final outcome of any such case to have a material adverse effect on its financial position.

But then again, given the disingenuousness of the bank’s 2010 financial statements see yesterday’s Lloyds post, perhaps this too should be taken with a pinch of salt?