Class actions likely to end in pyrrhic victories for Lloyds & RBS shareholders

Shareholders in Lloyds and RBS will get their day in court. That will at least enable them to vent their frustrations and further expose the stupidity of the boards and executives who presided over the catastrophic drops in the value of their investments, but both actions are likely to result in pyrrhic victories.

For the Lloyds shareholders it has been a struggle to get this far.

Last week Lloyds Action Now, which represents several thousand small investors, filed its lawsuit alleging that the then management misled shareholders before the 2008 acquisition of HBOS by withholding information about the true state of the collapsed bank. The action is against Lloyds as a company, but also names the then chairman, Sir Victor Blank, and chief executive, Eric Daniels. The bank considers the claim to be baseless and has said it will defend it “robustly.”

RBS shareholders are suing over the £12 billion rights issue the bank made in 2008, alleging that they were also misled into investing because they were not given a complete picture of the state of the bank. RBS will contest the action.

For the Lloyds shareholders it has been a struggle to get this far. They have had no support from institutional investors and had to work hard to raise the money to fund their court costs. They are claiming £4 billion in compensation, but if their legal team is successful in obtaining a “litigation order” enabling other small shareholders to join the action, the potential claim could rise to £12 billion.

The eventual losses of HBOS totalled a staggering £54 billion.

The essence of their case is that the acquisition documents did not disclose that HBOS was being kept alive only by the life support system put in place by the Bank of England, which lent it £25 billion, the US Federal Reserve, which lent another $18 billion and Lloyds itself, which lent HBOS £10 billion. The extent of the two central banks emergency liquidity only became known months after the event, and by then Lloyds had swallowed HBOS and was discovering the true horror of the loan book it had taken on. The eventual losses of HBOS totalled a staggering £54 billion.

The case will be hard to prove. A similar class action in the US, was led by the tireless Albert A. Ross, a retired sailor who relied upon the dividend from Lloyds as part of his pension and claimed he lost more than $300,000 on his investment as a result of misleading statements by Lloyds, Daniels and Blank. However, last year he lost an action in a New York court and a subsequent appeal also failed.

In an opinion the appeal judges said that allegations that that the bank intentionally misled shareholders to persuade them to accept the deal had not been substantiated. “These assertions do not plead an intent to deceive … Because it would hardly make economic sense for defendants to consummate an acquisition detrimental to Lloyds, a strong inference of fraudulent intent cannot be drawn simply from this timing.”

Central banks like to keep their “lender of last resort” actions secret 

Lloyds presumably did know about the emergency funding from the Fed and the Bank of England, which was made in September 2008, the month before the deal was announced, but did not disclose it to shareholders. It may not have been at liberty to do so – central banks like to keep their “lender of last resort” actions secret for fear of provoking a run on the recipient bank and making a bad situation worse. Lloyds own loan to HBOS was exposed in the Sunday Times in early November, weeks before the shareholders meetings which approved the deal.

HBOS was starved of cash because the international wholesale money markets, on which it was vitally dependent, had shut it out. It was convinced that this was its real – in fact its only – problem and persuaded Daniels and Blank that a short term injection of liquidity would see it through. Neither Lloyds, nor HBOS itself recognised that there was a deeper, potentially fatal issue.  Bad debts resulting from profligate and reckless lending were going to destroy HBOS’s capital, including the proceeds of the 2008 rights issue.

Daniels could make a statement that Lloyds-HBOS would have a “a robust capital position” because at the time he did not know what he was taking on. As the New York judge said, generalised, sincerely-held opinions about a business – such as Lloyds’ claims that the HBOS acquisition was “a fantastic deal” and the combined bank would have “very strong liquidity” – do not amount to a guarantee to shareholders.

Blank and Daniels can be accused of naivety and possibly incompetence, but neither of those are criminal offences