Does the Lehman Lawsuit Offer a Template for Suing Anglo Irish Executives?

Several pension funds are suing Lehman Brothers's former CEO Dick Fuld, CFO Erin Callan and other top executives in federal court in New York for misleading investors. The suit - which was filed over 2 years ago - is now going to trial as Judge Kaplan ruled in favour of the pension funds and denied a motion to dismiss holding that “It is entirely plausible to conclude that the misleading picture that Lehman portrayed played a material part in keeping its stock higher.” Therefore, the losses suffered by the investors might be attributable to the fraud. He also ruled that the suit “sufficiently alleges facts giving rise to an inference that these defendants were involved in setting Lehman’s risk policies and knew that the statements concerning enforcement of risk management policies were false.”

One wonders if there is sufficient evidence for similar legal action in respect of executives at Anglo Irish and other failed banks in Ireland. Executives at these entities also claimed that they were in good financial health until they collapsed. The Lehman ruling is available here.

Anglo Wins Fraud Lawsuit

A fraud action brought by a group of high networth investors failed at the High Court: Mr Justice George Birmingham today found there was no evidence of fraud by Anglo in relation to how the investment was promoted and managed and also dismissed all other claims by Mr McCaughey concerning the investment.

The judge said Mr McCaughey clearly "now regrets his investment decision but investor remorse does not provide a basis for a successful legal action".

"Had the hotels been disposed of at a time when they had increased in value very substantially and had a profit been recorded, his attitude might well have been different," the judge added. "Unfortunately that didn't happen and it appears that the plaintiff is now facing a loss on his investment."

"However, that is sometimes the lot of those who participate in high risk investments," he said.

In the absence of evidence - typically smoking gun emails or other documents showing fraud - it is very difficult for investors to win these types of cases. A large number of similar cases are now in the courts in the United States against virtually every major financial institution including Goldman Sachs and Bank of America. Many of these will suffer a similar fate as mere loss is not sufficient to hold the institution liable.

More Details on Anglo Fraud Emerge in AIB Investigation

It appears that the alleged fraud being investigated by AIB in Anglo's deposit book is very much the plain vanilla sort: "around €3m of money previously held in Anglo was unaccounted for.
It is believed the sum was stolen from a number of deposit accounts at Anglo by a former official at the disgraced bank.
The Anglo official, who was based in Dublin, is suspected of moving large sums of money between accounts to cover the thefts.
It is suspected he avoided detection by ensuring that funds were available for accounts that matured.
The man at the centre of the allegations has since died ..."

Anglo will probably claim that this is just a rogue actor. However, this raises questions about its supervisory practices and internal controls. The article is available here.

Jim Lacey of National Irish Bank Disqualified for 9 Years

The Irish Times is reporting that the former CEO of National Irish Bank has been disqualified for nine years. Such disqualification orders present a powerful tool for regulators, particularly where the evidence of wrongdoing falls short of the legal standard for criminal prosecution. They are also preferable when moral blameworthiness is less clear and criminal punishment might be unduly harsh for the wrongdoing asserted. Such orders are quite regularly employed in the U.S. and other jurisdictions and one can expect them to be used here with greater regularity if regulators follow through on their promise of tougher enforcement.

Today's order follows the decision of the High Court in April where it had made a finding that Lacey is "“unfit to be concerned in the management of company”, within the meaning of section 160(2)(d) and (e)."

Lacey's defence - like that of many CEOs before him - was that he did not know about the illegal acts or that the illegal acts were committed by rogue actors who were subordinate to him, without his knowledge. He also claimed that the bank was a large organisation and he could not be expected to know the minutiae of the day-to-day details concerning its affairs. He argued that there was a system of delegation in place and that the illegal acts had not been brought to his attention as such. Moreover, he claimed that the external auditors had not raised any concerns and that the board had not been accused of wrongdoing. This echoes arguments made by other CEOs in high profile U.S. cases like Enron where the CEO, Jeffrey Skilling, also claimed that the company's actions were legal and that any illegality had been without his knowledge at the instance of the CFO, Andy Fastow.
The court was not convinced by Lacey's arguments. In relation to the I-did-not-know defence, it said:
... the Inspectors Report, had found that branch audit reports were consistently critical of the standard of compliance with the legislative provisions and Bank procedures pertaining to the operation of non resident deposit accounts. The report referred to the Bank’s obligation to hold a non resident declaration in the form prescribed or authorised by the Revenue Commissioners pursuant to s. 37 of the Finance Act 1986, for each account designated by the bank as a non resident account.
The Inspectors referred to the deficiencies most commonly reported including the failure to produce non resident declarations forms at the time of audit; charities declarations rather than non resident declarations; obsolete, undated, not fully completed and containing incorrect account numbers. "

The court seems to be placing a lot of emphasis on the incomplete documentation. Since the incomplete documentation had been flagged in communications which included the CEO, the court ruled that he could not have been unaware of noncompliance with the bank's legal obligations.

Further, the court held:
"The Inspectors found that bogus non resident accounts were opened and maintained by the bank and were widespread in the branch network. They found that the opening and maintenance of such accounts by the bank constituted an unlawful and improper practice which served to encourage the evasion of revenue obligations by third parties, both on the funds deposited and on the interest earned. They concluded that up to May 1995, a year after the respondent ceased to be Chief Executive, senior bank management failed to inform branch staff in clear terms of the relevant provisions of the Finance Act 1986. They also failed to have a review conducted at that time to ensure that all existing non resident accounts were genuine. Senior management was aware of the existence of bogus non resident accounts. The Bank failed to account to the revenue for DIRT properly payable."

With regard to the CMI deposits, the evidence is a bit thin, and the necessary nexus might be weak:

"The Inspectors found that the respondent was aware of the level of deposits being made by CMI with the Bank and that he knew or ought to have known how the product was presented. He had to bear responsibility for the practice which served to facilitate customers of the Bank and others in evading tax."

On the issue of delegation, the court correctly ruled that delegation of duties did not entail delegation of legal responsibility:

"The court is not satisfied from the evidence of the respondent, that there was a proper system in place or that he properly supervised the delegation of reading the internal audit reports. Indeed, given their importance as a control of the performance of the branches, their limited number and relative brevity, it is surprising that he only read those few categorised as poor or unsatisfactory.
While the respondent was entitled to delegate it did not follow that he was not under any duty in relation to the discharge of that delegated function, notwithstanding that the person to whom the function had been delegated appeared both trustworthy and capable of discharging the function. Where a delegation had taken place he, as delegating Chief Executive and director, remained responsible for the delegated function or functions and had a residual duty of supervision and control."

So, the defendant's lack of knowledge defence did not persuade the court as he had been included in the communications although the lack of documentation/noncompliance issue had not necessarily been red-flagged as potentially illegal or criminal:
"The court is satisfied from the evidence given in cross examination that the respondent had notice of some of the reports such as to be aware of issues of non-compliance with DIRT legislation.
On this basis it seems to the court that the inference drawn by the Inspectors that the respondent should not only have been aware of the failure of the branches to hold properly completed non-resident account declarations but should also have been aware that bogus non-resident accounts existed throughout the branch network, was a proper inference.
From the evidence given in cross examination the court finds that the respondent was aware that non-compliance continued to a significant extent. The court also finds that the ignoring of an obligation to account for retrospective tax when the accounts were redesignated would seem to confirm a degree of complacency on the part of the respondent with regard to the implementation of the provisions of the Finance Act 1986. The court finds that the respondent failed as Chief Executive and as director of the Bank to exercise a proper duty of care in relation to tax compliance."

Nyberg Report Released

It's available here.

Anglo probe to be completed "by end of the year"

The Independent reports that the probe into Anglo Irish Bank is nearing its end:
The Director of Corporate Enforcement, Paul Appleby, and senior gardai confirmed last night that 90pc of their inquiries are complete.

Files on the main issues -- the €7.2bn 'back-to-back' deposit arrangement between Anglo and Irish Life and Permanent in September 2008 and the involvement of the so-called 'Maple Ten' group of investors -- were sent to the DPP before Christmas.
Last night, Mr Appleby disclosed that last week he sent another extensive investigative file to the DPP.

This relates to Anglo's provision of loans to the various investors so that they could buy Anglo shares in 2008.
He said the file contained about 8,000 pages over 17 volumes and pointed out that the Companies Act prohibited businesses from giving financial assistance for such purchases.
Senior Garda officers told the Irish Independent last night that they were now entering the "wrap-up" phase and pulling together the final strands of their inquiries to present a full picture to the DPP.

They said the lack of co-operation from some figures, who had not made themselves available for interview, would not hold up the completion of the files and that it was up to the DPP to determine whether to make a decision on charges in their absence.

This whole process has already taken too long. It would be surprising if the DPP did not already have a view about prosecution.

New Irish govt. to Introduce Anti-corruption Law

The Independent reports that "Tougher laws to tackle rogue bankers and extra powers for the Criminal Assets Bureau (CAB) are two key planks of the new Government's strategy to combat crime.

A new anti-corruption law is to be introduced to punish white-collar crime and end what Fine Gael and Labour described as the impunity from consequences for corporate behaviour that threatens the economy.
It is also intended to take steps to prevent convicted white collar criminals from transferring their assets to spouses and other family members and to give power to the CAB to pursue them for any financial gains or benefits deriving from the proceeds of their illegal activities."

The new law must also contain provisions for whistle-blower protection and create a hotline for tips. It is not sufficient to merely pass legislation. As the various reports into the performance of the Dept. of Finance and regulatory bodies have conclusively demonstrated, the problem is poor enforcement even of existing law. Poor technical capability has been a significant contributing factor to the under-enforcement problem. So, any new legislation must provide for appropriately skilled staff and resources. White collar criminals are not going to be lacking in good legal representation. Expecting the same old departments to fight them just with new laws that look good on the books is a bridge too far.

Financial regulation reform deal reached in the U.S.

The NYT is reporting that the Senate and House have reached agreement on financial regulation reform:
A 20-hour marathon by members of a House-Senate conference committee to complete work on toughened financial regulations culminated at 5:39 a.m. Friday in agreements on the two most contentious portions of the financial regulatory overhaul and a host of other provisions.
The agreements were reached after hours of negotiations, most of it behind closed doors and outside the public forum of the conference committee discussions. The approvals cleared the way for both houses of Congress to vote on the full financial regulatory bill next week.

The bill has been the subject of furious and expensive lobbying efforts by businesses and financial trade groups in recent months. While those efforts produced some specific exceptions to new regulations, by and large the bill’s financial regulations not only remained strong but in some cases gained strength as public outrage grew at the excesses that fueled the financial meltdown of 2008.

Interestingly, despite the efforts of lobbyists, the Volcker rule seems to have survived:
The rule, named for Paul Volcker, the former Federal Reserve chairman who proposed the measure earlier this year, restricts the ability of banks whose deposits are federally insured from trading for their own benefit. That measure had been fiercely opposed by banks and large Wall Street firms, who viewed it as a major incursion on some of their most profitable activities.

But the devil is in the details:
Banks managed to wrangle limited exceptions to the rule that would allow them to continue some investing and trading activity. The agreement limits banks’ investments in hedge funds or private equity funds to no more than 3 percent of a fund’s capital; those investments could also total no more than 3 percent of a bank’s tangible equity.

Other key provisions:

• Securities and Exchange Commission to have authority to require stockbrokers to protect their clients’ interest when recommending investments, potentially subjecting brokers to the same fiduciary duty as financial advisers.

• S.E.C. to complete a study within six months of the financial bill’s enactment to evaluate the effectiveness of current rules governing those who give financial advice to or sell securities to consumers.

The law is over 1500 pages long and certainly not cheap:
The Congressional Budget Office estimated that the financial regulatory bill would cost roughly $20 billion over 10 years. The conference committee agreed to pay for the bill by imposing an assessment on large financial institutions; the assessments would be made according to a “risk matrix” that charges higher amounts to riskier institutions.Mr. Frank said that the assessments — which Republicans called a tax — are an acceptable solution for “the collective errors of many in the financial institutions that caused this set of problems.”

Stay tuned for more on this topic in the coming weeks and months.

Debating Corporate Governance with Vincent Browne

You can watch the video here.

It was an entertaining debate about interlocking boards, concentration of board power in the hands of a few individuals in Ireland, social value of banking, whether directors are "part time"...

The context was a recent report by TASC about interlocking boards in Ireland showing that 39 individuals held more than 2 board appointments at 40 companies. It is a very useful piece of research and could be a good starting point for more work in that area.

Arrest of Sean Fitzpatrick

The media is in a tizzy today about the arrest of Sean Fitzpatrick. Via RTE:
Former Chairman and Chief Executive of Anglo Irish Bank Sean FitzPatrick has been arrested by members of the Garda Bureau of Fraud Investigation.

Mr FitzPatrick was arrested at his home in Greystones, Co Wicklow, at 6.30am.
Gardaí also searched Mr FitzPatrick's home.
He is being detained under Section 4 of the Criminal Justice Act 1984. His period of detention has since been extended on two occasions and he can now be held until 6.30am tomorrow morning.
Mr Fitzpatrick is being questioned as part of what gardaí describe as an investigation into alleged financial irregularities at a Financial Institution - understood to be Anglo Irish Bank.

Here are links to stories in the Irish Independent, Irish Times, and TV3.

Arresting the man is the easy part and I am surprised that it took this long. The real question is whether the prosecution has the nous to get a conviction. There are reports that the Theft and Fraud Offences Act is what is being used. Here's the relevant provision:
10.—(1) A person is guilty of an offence if he or she dishonestly, with the intention of making a gain for himself or herself or another, or of causing loss to another—

(a) destroys, defaces, conceals or falsifies any account or any document made or required for any accounting purpose,
(b) fails to make or complete any account or any such document, or
(c) in furnishing information for any purpose produces or makes use of any account, or any such document, which to his or her knowledge is or may be misleading, false or deceptive in a material particular.
(2) For the purposes of this section a person shall be treated as falsifying an account or other document if he or she—
(a) makes or concurs in making therein an entry which is or may be misleading, false or deceptive in a material particular, or
(b) omits or concurs in omitting a material particular therefrom.
(3) A person guilty of an offence under this section is liable on conviction on indictment to a fine or imprisonment for a term not exceeding 10 years or both.

The language is rather broad so hiding loans to mislead investors ought to be covered. But there are likely to be difficulties posed by the green light provided by Anglo's external auditors. After all, a CEO is entitled to rely on independent professional advice and is not expected to be an accounting or financial expert. If the auditors told him that transferring the loans was OK, can he be said to have acted "dishonestly"?

Fitzpatrick is also likely to have had legal advice on those transactions. What if the lawyers advised him that moving the loans off Anglo's books was legal?

Another complication is the knowledge of the financial regulator. If, as some reports claim, the regulator knew about the transactions and acquiesced in them, can it be said that Fitzpatrick acted dishonestly?

There are bigger questions about why loans to insiders were allowed in the first place. After the spectacular fall of Worldcom, this sort of thing should have been prohibited.

More Women in the Boardroom: New SEC Rules

I've blogged previously about the Norwegian law mandating representation for women on corporate boards. The Securities and Exchange Commission recently issued new rules requiring disclosure about diversity considerations in appointing directors. These rules come into force on February 28, 2010. They stop well short of the Norwegian idea, but must be regarded as a step in the right direction. Here's more from the SEC press release:
The SEC approved a rule that would require disclosure of whether, and if so how, a nominating committee considers diversity in identifying nominees for director.
If the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, the final rules require disclosure of how this policy is implemented and how the nominating committee or the board assesses the effectiveness of its policy.
Irish lawmakers must consider similar measures to enhance board diversity.

Norwegian Law Mandating Women on Corporate Boards

The NYT has a very interesting article on a Norwegian law mandating that 40% of corporate boards must be comprised of women. Initial responses to the legislation were hostile: Many prominent business leaders dismissed the 2003 law as a political stunt and argued that Norway, with just 4.8 million people, did not have enough experienced women to meet the quota. One chief executive of a software company told the business newspaper Dagens Naeringsliv that companies would have to recruit “escort girls” to meet the target.

Now, 8 years later, the article notes that "the share of female directors at the roughly 400 companies affected is above 40 percent, while women fill more than a quarter of the board seats at the 65 largest privately held companies."

Apparently this revolution in the corporate boardroom has not gone unnoticed: Spain and the Netherlands have passed similar laws, with a 2015 deadline for compliance. The French Senate will soon debate a bill phasing in a female quota by 2016, after the National Assembly approved the measure last week. Belgium, Britain, Germany and Sweden are considering legislation.

I am not usually in favour of government mandated behavioural change, but think that there may be something to this idea. Corporate boards are old boy's clubs and radical shake ups such as these might have some effect in overcoming groupthink problems. Without legal compulsion it is unlikely that the severe gender disparity will be corrected. As the article points out, in the European Union, 9.7 percent of the board members at the top 300 companies were women in 2008, versus 8 percent in 2004, according to the European Professional Women’s Network. In the United States, roughly 15 percent of the board members of the Fortune 500 companies are women, while at the top of Asian companies, women remain scarce: In China and India, they hold roughly 5 percent of board seats, in Japan, just 1.4 percent.

To be sure, quality issues are inevitable byproducts of such quickfixes. The article refers to a University of Michigan study which "found that the sharp increase in women as directors significantly reduced the average amount of senior executive-level experience on the boards at 130 of the biggest Norwegian companies."

Much more research is needed before firm conclusions can be reached. Are Irish lawmakers listening?

Interesting case on disqualification of directors

The Irish Times reported today that legal submissions have entered the home stretch in the case against former National Irish Bank CEO Jim Lacey. The application for disqualification was brought by the Director of Corporate Enforcement following an investigation establishing that NIB was involved in serious tax evasion and other illegal activity.

Disqualification orders have to be a strong component of the broader corporate governance architecture and a swift process is essential to prevent bad actors from harming more people. The article states that "Since leaving NIB, Mr Lacey said he had been heavily involved in various management and advisory positions in the State and private sector, nationally and internationally, and had discharged his duties in all cases “without even a hint of criticism”." It beggars belief that Mr. Lacey was hired by other employers (including the state) despite the adverse investigation report.

Walker Review of Corporate Governance in UK Banks

The final recommendations of Sir David Walker's review of corporate governance in UK banks were published today. You can watch a video clip here. The media has reported a variety of responses, ranging from predictable criticism from unions to cautious welcome from industry.

Here are the key general bits:
1. Walker rightly notes that "any undue hampering of the ability of bank boards to be innovative and to
take risks would itself bring material costs. It would check the contribution of the banks to wider economic recovery and delay restoration of investor confidence in banking as a sector capable of generating reasonable returns for shareholders."

2. In an apparent snub to those demanding more regulation, Walker seems to be saying that more is not necessarily the solution: "Good corporate governance overall depends critically on the abilities and experience of individuals and the effectiveness of their collaboration in the enterprise. Despite the need for hard rules in some areas, this will not be assured by overly-specific prescription that generates box-ticking conformity."

3. Walker is also absolutely right in highlighting the cost of regulation: "The behavioural changes that may
be needed are unlikely to be fostered by regulatory fiat, which in any event risks provoking unintended consequences. Behavioural improvement is more likely to be achieved through clearer identification of best practice and more effective but, in most areas, non-statutory routes to implementation so that boards and their major owners feel “ownership” of good corporate governance."

The main recommendations include:
1. "The FSA’s ongoing supervisory process should give closer attention to the overall balance of the board in relation to the risk strategy of the business, taking into account the experience, behavioural and other qualities of individual directors and their access to fully adequate induction and development programmes."

2. "The chairman of a major bank should be expected to commit a substantial proportion of his or her time, probably around two-thirds, to the business of the entity, with clear understanding from the outset that, in the event of need, the bank chairmanship role would have priority over any other business time commitment."

3. "The chairman of a BOFI board should bring a combination of relevant financial industry experience and a track record of successful leadership capability in a significant board position."

4. "The chairman of a BOFI board should be proposed for election on an annual basis. The board should keep under review the possibility of transitioning to annual election of all board members."

5. "The board should undertake a formal and rigorous evaluation of its performance, and that of committees of the board, with external facilitation of the process every second or third year. The evaluation statement should either be included as a dedicated section of the chairman’s statement or as a separate section of the annual report, signed by the chairman."

6. "The evaluation statement on board performance and governance should confirm that a rigorous evaluation process has been undertaken and describe the process for identifying the skills and experience required to address and challenge adequately key risks and decisions that confront, or may confront, the board. The statement should provide such meaningful, high-level information as the board considers necessary to assist shareholders’ understanding of the main features of the process, including an indication of the extent to which issues raised in the course of the evaluation have been addressed. It should also provide an indication of the nature and extent of communication with major shareholders and confirmation that the board were fully apprised of views indicated by shareholders in the course of such dialogue."

7. "The Code on the Responsibilities of Institutional Investors, prepared by the Institutional Shareholders’ Committee, should be ratified by the FRC and become the Stewardship Code."

8. "Fund managers and other institutions authorised by the FSA to undertake investment business should signify on their websites or in another accessible form whether they commit to the Stewardship Code."

 9. "Institutional investors and fund managers should actively seek opportunities for collective engagement where this has the potential to enhance their ownership influence in promoting sustainable improvement in the performance of their investee companies. Initiative should be taken by the FRC and major UK fund managers and institutional investors to invite potentially interested major foreign institutional investors, such as sovereign wealth funds, public sector pension funds and endowments, to commit to the Stewardship Code and its provisions on collective engagement."

10. "The board of a FTSE 100-listed bank or life insurance company should establish a board risk committee separately from the audit committee. The board risk committee should have responsibility for oversight and advice to the board on the current risk exposures of the entity and future risk strategy, including strategy for capital and liquidity management, and the embedding and maintenance throughout the entity of a supportive culture in relation to the management of risk alongside established prescriptive rules and procedures."

11. "In support of board-level risk governance, a BOFI board should be served by a CRO who should participate in the risk management and oversight process at the highest level on an enterprise-wide basis and have a status of total independence from individual business units. Alongside an internal reporting line to the CEO or CFO, the CRO should report to the board risk committee, with direct access to the chairman of the committee in the event of need. The tenure and independence of the CRO should be underpinned by a provision that removal from office would require the prior agreement of the board. The remuneration of the CRO should be subject to approval by the chairman or chairman of the board remuneration committee."

12. "The board risk committee (or board) risk report should be included as a separate report within the annual report and accounts."

13. "For FTSE 100-listed banks and comparable unlisted entities such as the largest building societies, the remuneration committee report for the 2010 year of account and thereafter should disclose in bands the number of “high end” employees, including executive board members, whose total expected remuneration in respect of the reported year is in a range of £1 million to £2.5 million, in a range of £2.5 million to £5 million and in £5 million bands thereafter and, within each band, the main elements of salary, cash bonus, deferred shares, performance-related long-term awards and pension contribution."

14. "Short-term bonus awards should be paid over a three-year period with not more than one-third in the first year. Clawback should be used as the means to reclaim amounts in circumstances of misstatement and misconduct."

15. "If the non-binding resolution on a remuneration committee report attracts less than 75 per cent of the total votes cast, the chairman of the committee should stand for re-election in the following year irrespective of his or her normal appointment term."