By Sinead Cruise and Andrew MacAskill
LONDON (Reuters) - Royal Bank of Scotland bosses avoided repricing billions of dollars of souring investments on the eve of the 2008 financial crisis for fear of endangering bonuses and a takeover bid for a rival, court documents allege.
The claimants' filings allege senior managers were warned by internal risk experts for more than six months that overvalued toxic debt, including subprime mortgage bonds, had left the bank dangerously exposed to a collapse in U.S. property prices.
But some managers resisted the warnings, allege lawyers acting for RBS shareholders now seeking billions of pounds in compensation for losses suffered when the bank was bailed out in the 2008 crisis, according to the claimants' "particulars of claim" and a witness statement seen by Reuters.
In documents filed by lawyers acting for RBS, the bank rejects those allegations, and denies that it should have repriced assets more promptly or that it misled shareholders over its finances.
The allegations, which focus on the months leading up to the 2008 crisis, are at the heart of a 4 billion pound ($5 billion)lawsuit brought by thousands of RBS's investors, which is due to start in the UK early next year. Documents seen by Reuters include the claimants' particulars of claim and the bank's defense.
In the 1990s and 2000s, RBS had gone from being a small Scottish lender to a global banking giant, largely thanks to an aggressive expansion plan led by former chief executives George Mathewson and Fred Goodwin.
In the summer of 2007, the bank stunned markets by leading a consortium of lenders in a 71 billion euro ($77.3 billion) takeover of Dutch bank ABN Amro just as worries about a massive U.S. credit bubble were gathering momentum.
Little more than a year later, RBS became one of the biggest casualties of the turmoil that engulfed the industry. In 2008, the Edinburgh-based bank made a then record 12 billion pound cash call on investors. Just six months later, RBS - Britain's largest corporate lender and home to hundreds of billions of pounds of customer deposits - required the first tranche of a UK government bailout that ended up costing 45.5 billion pounds.
As a result, some shareholders, including some of Britain's biggest institutional fund managers, lost more than 90 percent of their investments. They are now claiming they were misled about the state of the bank's finances ahead of the 2008 cash call and are seeking compensation for their losses.
A trial is scheduled to begin in London in March after the two sides failed in July to agree an out-of-court settlement. It could end up being one of the costliest cases in English legal history.
RBS, which is still 70 percent owned by the British taxpayer, declined to comment for this article. But Chief Executive Ross McEwan said last month that the bank, while still pursuing settlement talks with some of the claimants, was ready to fight if the case reaches court.
The bank has already booked billions of pounds of writedowns since 2008 and is facing a number of U.S. cases alleging mis-selling of mortgage bonds. It has provisioned $5.6 billion to settle these and other historic misconduct charges.
Some analysts estimate the total eventual claims against the bank will outstrip RBS's expectations.
The claimants' particulars of claim and a witness statement seen by Reuters detail allegations regarding the bank's behavior in the months before its near-collapse; they allege there were significant disagreements between staff with responsibility for steering the lender through the worst banking crisis since the Great Depression.
The issue of whether the bank deliberately decided against writing down the value of its troubled mortgage-backed bonds – and whether this decision caused misrepresentation of the bank's financial health - is a key area of contention.
The bank was one of the world's leading sellers of mortgage-backed securities (MBS) and other asset-backed securities (ABS) in the mid-2000s. RBS Greenwich, a U.S. unit of the bank, underwrote $99 billion of U.S. sub-prime securities in the two years to the end of 2006, a volume surpassed only by Lehman Brothers, according to a separate set of U.S. court documents filed in the Southern District of New York in connection with a July 2015 action by RBS investors against the bank.
According to the UK claimants' court filings, senior RBS managers on both sides of the Atlantic clashed with risk analysts over how to value the bank's exposure to distressed debt. Much of the risk was embedded in complex structured credit products called Collaterised Debt Obligations (CDOs).
In September 2007, Victor Hong, a former risk manager for JP Morgan and Credit Suisse, was appointed head of fixed-income Independent Price Valuation (IPV) at RBS Greenwich. As a managing director of risk management, he was one of the most senior analysts responsible for assessing the market value of the unit's fixed-income portfolio.
Hong says that soon after he was appointed he complained to his bosses that these assets were troubled and needed to be marked down in value, according to his witness statement. Hong says he refused to sign off the IPV report for September 2007, alleging in his statement that the IPV function was "effectively a sham and was not independent at all."
Claimants' lawyers told Reuters his testimony is likely to prove important in their case against the bank. The trial is expected to last six months and to hear from scores of witnesses.
Hong's witness statement alleges that analysis and research passed to senior RBS management from subordinate staff, including Hong, showed some other banks and dealers were marking down some ABS CDOs towards 25 cents in the dollar by October 29, 2007, while RBS senior management was recommending that ABS CDOs were marked at 75 cents in the dollar.
Ultimately, the September 2007 report carried a disclaimer stating the bank had been unable to independently verify the value its $3.5 billion portfolio of super-senior ABS assets since July 31, 2007, "due to a lack of market liquidity and transparency." In court documents for the defense, RBS says a lack of trading in such assets at the time made it difficult to pinpoint what the correct values were.
Hong told lawyers for the claimants that his predecessor, Lauren Rieder, told him that the writedowns he and others were calling for would not be authorized by senior RBS management, according to the particulars of claim. The documents do not specify what level of writedown Hong wanted.
In that conversation, Hong alleges in the particulars of claim, Rieder used words to the effect that he should "get comfortable" with signing off the September 2007 IPV report and the unchanged marks because to press for lower valuations would mess up "the bonuses."
In a message sent to Reuters via social media network LinkedIn, Rieder said the allegations against her were "totally false and completely made up." She declined to comment further. Rieder is not expected to testify at the trial.
According to the particulars of claim, Hong alleges that Bruce Jin, former head of Market Risk at RBS Greenwich Capital Markets, encouraged him to sign off the September 2007 valuation report, and that Jin said he would support Hong if anyone questioned the bank's inability to revalue the assets.
Jin told Reuters the conversation Hong describes never took place. Lawyers for RBS say in court documents that there is no truth in Hong's claims and that Hong was told by at least one manager, identified in the documents as Carol Mathis, that the issue of how to value super-senior (SS) CDOs had been escalated to more senior management.
Mathis was then the chief financial officer for RBS in North America. Emails sent by Reuters to Mathis via Digital Asset Holdings LLC, where she now serves as Chief Financial Officer, went unanswered.
Hong, who also alleges that managers in London wanted to avoid writedowns because of RBS's bid for ABN Amro, resigned in November 2007, less than two months after he had started at RBS. He blamed "persistent discrepancies between trader marks and analytical fair-market values" for making his job intolerable, according to his witness statement.
Hong, who went on to work for the Federal Reserve Bank of New York, alleges that Jin told him he would receive a bonus at the end of March 2008 if he reconsidered his resignation, according to his witness statement. Jin told Reuters that such a conversation never took place.
In a defense document filed at the court, RBS says that Rieder signed the September IPV report in place of Hong but denies her action was inappropriate, noting that Hong was a new recruit.
In court documents RBS also denies Hong was improperly prevented from performing his IPV job. The bank says it was already considering changes to the valuation of some of the assets in question, and that some ABS CDOs were written down within a month of Hong's departure.
The bank denies that Hong conducted any substantive analysis of the value of RBS's super-senior CDOs, alleging his research amounted predominantly to "unstructured provision of press reports, research notes and market information relating to the valuation of ABS CDOs held by other institutions."
Former staff at RBS Greenwich, which is based in Connecticut, have told Reuters that UK-based management undermined their powers to reprice billions of dollars of distressed debt.
While Jin, speaking out for the first time since leaving the bank, rejected Hong's specific allegations against him, he told Reuters that RBS's approach to valuing troubled assets at the time was too slow, given the market data then available. He said that senior UK managers influenced pricing decisions at RBS Greenwich.
"Normally, if you have a trading book position, the desk has the ability to mark those positions, it is within their rights, and no other authority can take away that ability. But that happened at RBS," he said. "You do not have another body, certainly not from another region, taking over the ability of a trader to mark their marks."
In court documents for its defense, RBS says it was appropriate for senior management to take part in discussions when it was hard to judge the value of distressed assets.
Jin, who now works at the Japanese bank Nomura as head of market risk in New York, said he had been a "vocal" opponent of the alleged failure by RBS to respond to market conditions more quickly. He said he has so far declined to help lawyers acting for shareholders, and was reluctant to get involved in the legal case because he wanted to focus on his current role.
A second source, who asked not to be named, said RBS Greenwich bosses were uncomfortable with the loss of authority over U.S marks but acquiesced to avoid clashes with more senior executives in Britain.
"It was all being run out of London. It was entirely run out of there," the source said.
The claimants' particulars of claim allege that Chris Kyle, the London-based chief financial officer of RBS's investment bank, and Deloitte, the bank's accountant, had suggested a batch of revised "fair value marks" on super-senior CDOs by April 2008. The heads of the investment bank, John Cameron and Brian Crowe, allegedly overruled them because they were unhappy with the writedowns these new marks would have triggered, according to the particulars of claim.
Crowe told Reuters he could not remember whether such a conversation took place. Cameron did not respond to requests for comment by email and LinkedIn. Kyle and Deloitte declined to comment.
In its defense document, RBS says it did discuss the valuations of these assets with Deloitte both before and after April 9, 2008. The defense document says that the values ultimately decided upon were higher than those first discussed with the accountancy firm.
The bank denies that this supports shareholders' claims that the bank knew these exposures had been "dramatically over-marked" since late 2007.
(Additional reporting by Kirstin Ridley, Edited by Richard Woods and Simon Robinson)