RBS Case Study PDF

The Royal Bank of Scotland (RBS) and the Financial Crisis Background: The Royal Bank of Scotland (RBS) was one of the UK's largest and most prominent financial institutions leading up to the global financial crisis of 2007-2008. The board of directors played a pivotal role in making critical decisio...

The Royal Bank of Scotland (RBS) and the Financial Crisis Background: The Royal Bank of Scotland (RBS) was one of the UK's largest and most prominent financial institutions leading up to the global financial crisis of 2007-2008. The board of directors played a pivotal role in making critical decisions that would ultimately impact the bank's financial stability and the interests of its shareholders. UK Duty of Care, Skill, and Diligence: In the United Kingdom, the legal framework for corporate governance is underpinned by the UK Companies Act 2006, which outlines a director's duty of care, skill, and diligence. This duty is a fundamental aspect of director responsibilities, emphasizing that directors must act with the level of care, skill, and expertise that is reasonably expected of someone in their role. Board of Directors' Role and Decisions: RBS's board of directors was responsible for overseeing the bank's operations and making key strategic decisions. Sir Fred Goodwin was the CEO of RBS during this period. He played a significant role in the bank's expansion and decisions leading up to the financial crisis. Sir Tom McKillop served as the Chairman of RBS in 2007. The Chairman is responsible for overseeing the board and ensuring that the board functions effectively. RBS had several non-executive directors on its board, many of whom were experts in various fields. These individuals were expected to provide independent oversight and governance of the bank's operations. The board included directors with extensive experience in banking and finance, which was crucial given RBS's status as a major bank. During the financial crisis, the board faced several crucial decisions, including: • • • • Assessing the bank's exposure to subprime mortgage-related assets. Deciding on the extent of capital infusion required to shore up the bank's financial position. Approving the acquisition of ABN AMRO, a significant deal that increased the bank's exposure at a critical time. Application of UK Duty of Care, Skill, and Diligence: The duty of care, skill, and diligence under the UK Companies Act 2006 required RBS's directors to act prudently and with a reasonable level of expertise. It was expected that they would exercise due care and attention in assessing the risks and opportunities. Questions: Imagine you are a group of corporate governance experts tasked with analyzing the RBS case to understand how the business judgment rule and director duties, as outlined in the UK Companies Act 2006, played a role in the bank's near-collapse. 1. Did RBS's directors demonstrate reasonable care, skill, and expertise in managing the bank during the financial crisis, or were there areas where their decision-making process may have fallen short based on the UK's legal standards? 2. Do you believe that the directors should be held personally liable for the bank's near-collapse? Provide arguments using business judgment rule. Patisserie Valerie Scandal (2018) Patisserie Valerie is a chain of cafes that operates in the UK. The chain specializes in cakes, and its menu included continental breakfasts, lunches and teas and coffees. Trading in the shares of Patisserie Holdings, the parent company of Patisserie Valerie, were suspended on 10 October 2018 following the discovery of fraudulent accounting irregularities. The company admitted to the market that it had discovered ‘accounting irregularities’. The CFO, Chris Marsh, was suspended from his role. Later that day, it came out that the business owed HMRC £1.4 million in tax. On 11 October 2018, the company announced it was heading for bankruptcy. There was a “material shortfall between the reported financial status and the actual financial status of the business” and that without an immediate injection of capital, the company couldn’t continue trading. An immediate assessment of the company’s financial position showed that instead of having £28.8m in the bank, it was actually £10m debt. Forecast earnings for the year to September 2019 have been downgraded from £31m to £12m. On 12 October 2018, the CFO, Chris Marsh was arrested on charges of fraud and a police investigation was launched. In November 2020, Grant Thornton, the UK’s sixth-largest accounting firm, was fined with £2.3m lawsuit. Patisserie Valerie’s liquidators sued the firm because, as auditors of the bakery chain for twelve years, Grant Thornton “failed to see or reveal a severe manipulation of its books”. The regulator also imposed a £87,750 fine on David Newstead, who led Grant Thornton’s audit, and banned him from carrying out statutory audits for three years. The fines related to Grant Thornton’s clean audit opinions on Patisserie Valerie’s accounts for the three financial years to 2017 Bernie Madoff In 2008, Bernie Madoff’s hedge fund empire was exposed to be another Wall Street fraud and the largest Ponzi scheme in history. This story is also unique in that it wasn’t ordinary people but wealthy investors and fund managers that were fooled and suffered losses. Madoff posted impressive, but fictious returns for his hedge funds. Supposedly he was investing in blue-chip shares, and then engaging in portfolio hedging by buying options on the S&P 500. The fact that his funds appeared to generate steady returns with low volatility meant he had a steady flow of new capital flowing into them. Very few investors ever withdraw their money, so he was able to maintain the illusion for a very long time. Eventually in the wake of the 2008 global financial crisis it became clear that the charade was about to collapse. In total, investors lost $64 billion, though the money never really existed in the first place. The Ponzi scheme Madoff perpetrated paid early investors “profits” that were actually sums that more recent investors had given him to invest. Like all Ponzi schemes, the incoming investments eventually failed to cover the fake profits that previous investors came to expect. Rather than investing the money he received from clients, Madoff deposited it in banks and pocketed as much as $483 million in interest. Some believe the fraud began in the 1980s, which would mean he kept the scheme going for as much as 20 years. Red flags were also raised by investment advisors and traders long before the fund collapsed, but the SEC ignored their warnings. It also appears that some investors knew the returns were too good to be true but allowed greed to cloud their judgement. In 2009, Madoff was sentenced to 150 years in prison and required to forfeit $170 billion. In 2020, Madoff requested compassionate release due to failing health but was denied; he passed away in prison on April 14, 2021. Enron Scandal (2001) Enron was a high-flying energy services company and a darling of the stock markset in the last 1990s. When it eventually collapsed shareholders lost as much as $74 billion. The CEO, Jeff Skilling and the CFO, Andrew Fastow, used an array of dubious accounting practices to inflate revenue and hide debts. The result was that the company appeared to be the most profitable company in history, when in fact it was saddled with debt. The appearance of a healthy balance sheet and large revenues allowed Enron to easily raise more capital to keep the charade going. Most of the fraud was committed between 1998 and 2001 resulting in the stock price trading as high as $90.56. During this period CEO Ken Lay gave Skilling more and more authority, which Skilling used to manipulate the company’s accounts. The company was able to exaggerate asset values and revenue by changing an accounting policy to use market-to-market prices. These prices were then manipulated. Billions of dollars in debt were also moved from the balance sheet and hidden in shell companies in the Cayman Islands. The fraud accelerated when Skilling took over the CEO position from Lay. In 2001 the fraud became unsustainable, and the company collapsed. Ken Lay, Jeff Skilling, Andrew Fastow, and others were arrested. Fastow and Skilling served six and 12 years in prison, respectively. Ken Lay died before he was sentenced. The scandal didn’t only lead to the collapse of Enron, but to the demise of the Arthur Andersen, Enron’s auditor. The auditor overlooked the financial fraud and helped with the cover up. Arthur Andersen’s role in the fraud remains one of the biggest accounting scandals in the United States to date. Question: What are the main lessons learnt from Enrol case? Tricker: Corporate Governance 4e Additional case studies The collapse of the Andersen partnership Arthur Andersen was one of the ‘big five’ global accounting practices. Operating in many countries in the world, the firm provided audit, accountancy, and consultancy services to their client companies. The firm had developed many pioneering accounting practices and systems. Their reputation, and certainly the partnership's self-image, was as the international leader of the profession. Then in the early years of the 21st century things went badly wrong. Some of their major US clients—Waste Management, WorldCom, and Enron—became spectacularly insolvent and the auditor was claimed to be less than blameless. The claims for damages from disgruntled creditors and shareholders of the failed companies threatened the financial viability of the Andersen firm. The American firm was also found guilty of destroying evidence, although that verdict was quashed on appeal. The question was whether the Andersen partnership was based in America, or were the partners in the Andersen practices around the world also exposed? Some claimed that the partnerships were legally distinct but, in the event, the rapid loss of clients in countries around the world and partners leaving for other firms resulted in the failure of the global practice and the end of the Arthur Andersen partnership. © Bob Tricker, 2019. All rights reserved. Tricker: Corporate Governance, 4th edition Waste management In 1992, Arthur Andersen, the auditors of Waste Management, a refuse collection company in the United States, identified some improper accounting practices, which had resulted in an overstatement of reported profits. These misstatements totalled US$93.5 million, which was less than 10% of reported profit. Also, one-off gains of over US$100 million, which should have been shown separately in the accounts, had been netted against other expenses. A ‘clean’ audit certificate was signed. In 1993, the auditors identified further misstatements of US$128 million, which represented 12% of reported profit. Andersen again decided that these misstatements were not sufficiently material for the audit report to be qualified. But the auditors did decide to allow the company to write off prior misstatements over a number of years, instead of making immediate disclosure, as required by generally accepted accounting principles. In 1994, the company continued its practice of netting expenses against one-off gains. In fact, the SEC claimed that, between 1992 and 1996, Waste Management restated over US$1 billion. Waste Management was an important and lucrative client for Andersen. Between 1991 and 1997, audit fees totalled US$7.5 million, while other fees, such as consulting services, contributed US$11.8 million. In the firm’s own words, Waste Management was a ‘crown jewel’ among its clients. Moreover, Waste Management’s top finance executives had all previously been Andersen auditors. In June 2001, the SEC brought settled enforcement actions against Arthur Andersen LLP and four of its partners in connection with Andersen’s audits of the annual financial statements of Waste Management Inc. for the years 1992 through 1996. Those financial statements on which Andersen issued unqualified or ‘clean’ opinions overstated Waste Management’s pre-tax income by more than US$1 billion. The SEC found that Andersen ‘knowingly or recklessly issued false and misleading audit reports . . . [which] falsely stated that the financial statements were presented fairly, in all material respects, in conformity with generally accepted accounting principles’. Without admitting or denying the allegations or findings, Andersen agreed to pay a civil penalty of US$7 million, the largest ever © Bob Tricker, 2019. All rights reserved Tricker: Corporate Governance, 4th edition SEC enforcement action against a big five accounting firm. This case raised the vexed issue of auditor independence (now resolved by the Sarbanes-Oxley (SOX) Act). Andersen had a close relationship with a valuable client, which led to creeping year-on-year acceptance of less-than-acceptable auditing standards. The SEC’s director of enforcement commented that ‘Arthur Andersen and its partners failed to stand up to company management and thereby betrayed their ultimate allegiance to Waste Management’s shareholders and the investing public’. The Arthur Andersen firm collapsed following the Enron saga, reducing the ‘big five’ international accounting firms to four. © Bob Tricker, 2019. All rights reserved