The articles published on the Deminor Investor Protection Blog (hereafter the “Blog”) constitute the views and opinions of the author solely and do not engage in any way Deminor International or any of its controlled or affiliated entities. The texts published on the Blog do not constitute and should not be considered or relied upon as investment or legal advice. They are merely intended to inform readers about recent developments, trends, events, special topics and opinions in the field of investor protection. Deminor International or any of its controlled or affiliated entities do not accept any responsibility for the accuracy or completeness of the information, views and opinions published on the Blog, nor for the use that readers may make thereof. The texts published on the Blog are protected by copyright.
Thibault Van Eeckhaut
The disclosure by the BT leadership at the end of January of a £ 530 million write-down due to “inappropriate behavior’’ at the company’s Italian business did not only shake up the headlines and BT’s share price - which dropped some 20 per cent - it also puts a renewed focus on the well-known issue of auditor rotation.
PwC has been the auditor of BT since the company listed on the London Stock Exchange in 1984 (see BT Annual Report 2016, p. 120). Likewise, PwC had been Tesco’s auditor for more than 30 years when Tesco announced serious accounting irregularities in September 2014.
Back in 2008, when BT’s Global Services division took a £1.6 billion write-down, top management and internal controls were changed but PwC’s position remained unchanged. BT’s 2016 annual report expresses the desire to tender its audit contract by 2019, although the recent scandal may force the company to speed up this process.
What is Europe’s take on auditor rotation? Let’s take a quick look at the amended Directive on statutory audits of annual accounts and consolidated accounts (recently transposed on 17 June 2016) and a Regulation on specific requirements regarding statutory audit of public interest entities.
The main purpose of these new and amended E.U. rules is exactly to address the problems regarding auditor independence. The rules aim to decrease the number of possible combined services an audit firm may offer its clients (Regulation, article 5). Further aims would be to tackle a lack of choice of audit firms emanating from high concentration levels in the top-end of the audit market and therefore a continuing risk of audit market domination by the “Big Four” (Deloitte, Ernst & Young, KPMG and PwC) by an increased monitoring of market quality and competition (Regulation, article 27). The introduction of a mandatory rotation of audit firms after a maximum engagement period of 10 years is also set out (Regulation, article 17) although the rotation periods are subject to specific transitional periods. The rules furthermore provide for a more quality oriented and transparent supervision of auditors (Regulation, article 26) as well as the creation in 2016 of a Committee of European Auditing Oversight Bodies (“CEAOB”) in order to improve cooperation between national audit authorities in the EU. (Regulation, article 30).
Regarding auditors’ liability, useful guidelines may be found in Commission Recommendation of 5 June 2008 concerning the limitation of statutory auditors and audit firms. As such it states that “Member States should accordingly be able to determine under national law a cap in respect to auditors’ liability. Alternatively, Member States should be able to establish under national law a system of proportionate liability according to which statutory auditors and audit firms are liable only to the extent of their contribution to the damage caused, without being jointly or severally liable with other parties.” It recommends that “the civil liability of statutory auditors and audit firms arising from a breach of their professional duties should be limited except in cases of intentional breach of duties.” There is still some work to be done if we want auditors to be exposed to external pressure
Directors’ and auditors’ independence is one of the cornerstones of a sound corporate governance system. If companies do not change their practices, it is not surprising that legislators will step in, as the EU did with regard to auditor independence. Perhaps it’s also time to revise the existing auditors’ liability regime if we want to avoid further accounting scandals from shaking up the headlines.
Founded in 1472 as a charity to lend to the poor of Tuscany, Banca Monte dei Paschi di Siena (“MPS”), the Italian third largest commercial and retail bank by total assets, is considered the oldest operating bank in the world.
After its listing on the Italian Stock Exchange in June 1999, the Tuscan bank began an intense phase of commercial and operational expansion, which culminated on 8 November 2007 with the announcement of the acquisition of rival regional lender Antonveneta for EUR 9 billion (EUR 6 billion of which was for goodwill) in cash from Banco Santander, which had paid for it plus Interbanca EUR 6.6 billion only a few months earlier. This disastrous deal, already at that time harshly criticized by many market participants (MPS shares plunged more than 11% the day after the announcement, giving it a market capitalization of EUR 10 billion), marked the beginning of the financial crisis that has engulfed the bank.
To finance the purchase of Antonveneta, in January 2008 MPS launched a capital increase of EUR 6 billion, borrowed a further EUR 1 billion and secured the remaining EUR 2 billion through the issuance of subordinated bonds. Since then, in order to boost its capital base, the Italian State had to underwrite bonds issued by the bank twice (in 2009 the so-called “Tremonti bonds” and in 2013 the so-called “Monti bonds”) for a total of EUR 4.1 billion. Additionally, it raised its capital a second time in 2011 for EUR 2.15 billion, a third time in June 2014 for EUR 5 billion (from EUR 3 billion previously planned) and a fourth time in 2015 for EUR 3 billion (from EUR 2.5 billion previously planned).
After accounting EUR 2 billion writedowns on bad loans (i.e. its eight consecutive year of writedowns on bad loans for a total of EUR 20.3 billion), in January 2016 MPS announced a net profit of EUR 390 million for 2015. Nevertheless, without a gain of around EUR 500 million from the restatement – requested by market watchdog Consob – of a controversial derivative trade and taking into account one-off items, the bank would have posted a net loss of EUR 110 million (i.e. its fifth consecutive year of losses for a total of EUR 14.7 billion).
Notwithstanding the catastrophic situation described above, it is time for a next EU health check (results are to be disclosed on 29 July 2016) and what is the news for MPS? In anticipation of its results, the ECB has recently requested to the Tuscan bank to sell by 2018 EUR 9.6 billion of its net (of provisions) non-performing loans (“NPLs”). Banking analysts estimate that the ECB’s demand could require additional writedowns of around EUR 4 billion, forcing MPS to tap the market for up to EUR 7 billion.
One simple question here: who is to blame? Firstly, the bank’s largest and controlling shareholder until the 2013 bailout, namely the charitable foundation based in Siena (Tuscany) “Fondazione Monte dei Paschi di Siena”. The foundation, dominated by local politicians, used to appoint half of the bank's board of directors, including the chairman. Managers have sacrificed the efficiency of the bank to serve the interests of their political patrons.
Secondly, MPS’s former and new management (i.e. the management appointed in 2012). The bank’s current crisis is in large part undoubtedly to be ascribed to reckless choices made by the previous management and in particular by Giuseppe Mussari (chairman from 2006 till 2012), Antonio Vigni (general manager from 2006 till 2012), and Gianluca Baldassarri (chief of finance from 2001 till 2012). In October 2014 a court in Siena sentenced Giuseppe Mussari, Antonio Vigni and Gianluca Baldassarri to 3.5 years in prison after being found guilty of giving false statements to the market and regulatory obstruction in relation to the purchase of Antonveneta and risky derivatives trades designed to conceal mounting losses. As for the new management, with Fabrizio Viola (surprisingly still the current CEO) and Alessandro Profumo (chairman until July 2015), it started cleaning up the bank’s balance sheet with the approval of the 2011 financial statement. However, despite the sale of assets, the closing of branches and the layoffs of thousands of workers, MPS continues to report losses, amid restatements of financial accounts to comply with Consob’s requests (the last of which dates back to December 2015), and to have dire need of money.
Thirdly, the Bank of Italy and the Consob. If yet needed, MPS is a further proof that in case something goes wrong there is no one in the Italian market that can prevent investors from suffering losses. In particular, the Bank of Italy, under former governor Mario Draghi (current president of the European Central Bank), authorized the acquisition of Antonveneta without conducting any due diligence before agreeing the deal. No surprise then if the final cost exploded from the EUR 9 billion announced to the astronomical figure of EUR 17 billion. Furthermore, it is reported that it spotted accounting irregularities that allowed MPS to mask losses more than two years before the bank was forced to restate profit. Yet, where was the Bank of Italy when MPS’s portfolio of NPLs reached warning size? As for the Consob’s responsibilities here it is sufficient to mention the several false statements (and consequently prospectuses) approved by both the former and the new management.
An advertising campaign launched in early 2007 dubbed MPS “An Italian story since 1472”. With a current market capitalization of less than EUR 900 million, the recklessness of a few people, combined with poor management and “sleeping” authorities, has earned the bank an infamous nickname: “An Italian story of incredible value destruction”.
Does a recent judgement of a Dutch court usher in the end of commercially driven litigation initiated by claim foundations in the Netherlands? End of June a landmark decision was rendered by dismissing a claim of a Dutch claim foundation because of the commercial motives behind the foundation and the non-compliance of that foundation with the Dutch Claim Code. Since numerous other claim foundations in the Netherlands are more or less similarly organized as the foundation that initiated the litigation that resulted in this landmark decision, this judgement can have far stretching consequences for these other Dutch claim foundations and the litigation initiated by them.
Only if certain requirements are met, Dutch claim foundations can initiate litigation on behalf of a class of interested parties to try to obtain a declaratory judgment on liability of the defendant. Dutch legislation prescribes that the claims pursued by the claim foundation shall however be dismissed if the interests of the class members are not sufficiently safeguarded. This open legal standard of “sufficiently safeguarded interests” provides judges a certain discretionary power to assess the motives of claim foundations.
In an action of the Dutch claim foundation “Stichting Renteswapschadeclaim” litigation for alleged misselling of interest rate swaps the defendants argued that the requirement of “sufficiently safeguarded interests” was not met in this case and that the foundation was not compliant with the Dutch Claim Code (a code created in 2011 with “best practices” related to the governance of claim foundations).
Although Dutch legislation does not prescribe that claim foundations must be compliant with the Claim Code, the legislative history regarding collective actions mentions that, besides numerous other aspects, the (non-)compliance of a claim foundation with the Claim Code can be taken into account by a court when assessing the fulfillment of the requirement of “sufficiently safeguarded interests”. So far the role that the Claim Code has played in Dutch case law when it comes to this assessment has been almost nonexistent. With the present judgement this situation may change dramatically.
Judgement of the Dutch lower court
In its judgement the Dutch court specified to deem the compliance of claim foundations with the Dutch Claim Code highly relevant when assessing the requirement of “sufficiently safeguarded interests”. The court concluded that the foundation “Stichting Renteswapschadeclaim” was not compliant at all with the Claim Code. This conclusion was based on the following arguments.
First of all, the court considered that the foundation “Stichting Renteswapschadeclaim” was founded by just one single person (the chairman of the foundation), with no other purpose than litigation and lacked a proven track record. The court also took into account that the chairman of the foundation is also the founder of other foundations such as the “Volkswagenaudiclaim” foundation. This illustrates, according to the court, that the decision to create the foundation “Stichting Renteswapschadeclaim” was at least (also) commercially motivated.
The court also concluded that, regardless the fact that during litigation an additional board member was added and a supervisory board was installed, the foundation still was not compliant with the principles of the Claim Code and especially not with the principle that a claim foundation must have a “balanced” governance structure. According to the court, the role and power of the second board member seems to be limited when compared with the chairman who created the foundation. Also the two members of the supervisory board were not present at the court hearing and one of them only has limited knowledge of the Dutch language. Finally, the articles of association of the foundation do not stipulate anything regarding the remuneration of the chairman of the foundation nor does the supervisory board play any role in determining this remuneration, which are also clear violations of the Claim Code.
The court drew as a final conclusion that an adequate system of “checks and balances” is absent within the foundation “Stichting Renteswapschadeclaim” and too much power is concentrated within just one single person: the chairman and founding father of the foundation. The court therefore ordered that the interests of the class members are not sufficiently safeguarded with regard to the claim asserted by the foundation and declared that just on this basis the foundation is inadmissible and the claim is dismissed.
Implications of this judgement
Dutch (claim) foundations are barred by law to aim to make profits. However, the initiating parties behind the claim foundations (law firms, funders, advisors) sometimes nevertheless attempt to use Dutch claim foundations for commercial purposes. As long as the interests of the members of the class are safeguarded sufficiently, the Dutch courts do not see a problem in such a construction. However, in this case it seems the court has taken a stricter approach than other courts in other more or less similar cases.
This decision shows a heightened attention for the interests of class members and especially those class members who contracted with the foundation that represents them. It also shows that the principles of the Claim Code in the future perhaps will play a significantly more important role than before this judgement.
Since numerous claim foundations in the Netherlands are more or less organized and set up in a similar way as “Stichting Renteswapschadeclaim” this judgement can have far stretching consequences. All these claim foundations, and those investors that contracted with these foundations or consider themselves part of the class represented by these claim foundations, should take heed of this judgement and its possible effects on the pending litigation initiated by these claim foundations. If other Dutch courts follow the stricter approach applied in the case of the foundation “Stichting Renteswapschadeclaim”, the claims of these foundations will also be dismissed.
In a press release of 26 October 2014, commenting the results of the Comprehensive Assessment conducted by the European Central Bank (ECB) on the 130 largest banks in the Eurozone (including 15 Italian banks), the Bank of Italy pointed out that when account was taken of the capital increases undertaken in the period January-September 2014 the potential EUR 9.7 billion capital shortfalls detected on 9 Italian banks (including Banca Monte dei Paschi di Siena – MPS –, Banca Carige, Banca Popolare di Milano – BPM –, Banco Popolare, Banca Popolare di Vicenza and Veneto Banca) concerned only 4 banks (i.e. MPS, Banca Carige, BPM and Banca Popolare di Vicenza) for the lower amount of EUR 3.3 billion. Furthermore, it added, integrating the results with the additional capital strengthening measures decided in 2014 (i.e. extraordinary asset divestments, completion of the authorization procedures to use internal models under way for some time, and the elimination of specific capital requirements) the potential capital shortfalls were further reduced from EUR 3.3 billion to EUR 2.9 billion and concerned two banks: MPS and Banca Carige.
Interestingly enough, in the same press release, the Bank of Italy commented that the Comprehensive Assessment results confirmed “the overall resilience of the Italian banking system, notwithstanding the repeated shocks to the Italian economy in the past six years: the global financial crisis, the sovereign debt crisis, and a double-dip recession.”
A year and a half later, the Italian banking system is in serious trouble and the bailout of four small regional banks (i.e. Banca Etruria, Banca Marche, Cassa di Risparmio di Chieti, Cassa di Risparmio di Ferrara) in November 2015 at the expenses of creditors (for a good part retail investors) is simply the tip of the iceberg.
More precisely, since the ECB’s Comprehensive Assessment, the Italian stock market has seen tremendous sell-offs of troubled institutions shares such as MPS (-83% on the closing price as of 24 October 2014) and Banca Carige (-74%), despite the EUR 3 billion and EUR 850 million capital increases respectively carried out last year. After more than two months of difficult negotiations with the ECB over governance and capital requirements, on 23 March 2016 the boards of BPM and Banco Popolare agreed a deal under which Banco Popolare will tap investors for EUR 1 billion. Banca Popolare di Vicenza is asking for a EUR 1.5 billion capital increase to survive. Veneto Banca will raise EUR 1 billion in the cash call expected in mid-June. Last but not least, on 11 April 2016 Quaestio Capital Management SGR (an asset management company) announced the launch of the so-called Atlante, a 5 billion-euro fund backed by a number of institutional investors, aimed at supporting the banks’ recapitalizations requested by the supervisory authorities and easing the deconsolidation of non-performing loans (NPLs) from banks’ balance sheets.
But what went wrong? Why all these multibillion capital increases? The Italian banking system was not resilient? Despite the continuous reassurances by the Italian market authorities, the accuracy of the carrying value of the Italian banks’ assets has turned out to be not so “accurate”. What is shocking for investors is the fact that especially those banks that today appear to be the most troubled (such as MPS, Banca Carige, Banca Popolare di Vicenza and Veneto Banca) have long been under scrutiny by the Bank of Italy. The four small banks rescued last year have even been in special administration before. Not to mention the multimillion sanctions issued by the Bank of Italy against several directors, managers and internal auditors following its several inspections.
Why then this mess? The explanation can be found in one simple proverb: “To close the stable door after the horse has bolted”.
Maria Cecilia Faget Brünner
As you may remember, long, long time ago, back in 2001, Argentina faced its worst economic crisis, leading to a default on its bonds. Following the default, Argentina made it through – with the unforgettable succession of four presidents in less than 3 months - and was able to re-negotiate part of this defaulted debt in two separate blocks (one in 2005 and the other in 2010). But a significant group of investors refused all proposed re-negotiations of the defaulted debt. They wanted all the money owed by virtue of these bonds and they issued proceedings before the courts of New York, which had jurisdiction over the original bonds. The lesson was learned and the re-negotiated bonds were issued under Argentinian law and subject to Argentina’s jurisdiction.
Long story short, the holdouts won their case before the courts of New York. They obtained an injunction preventing Argentina from making payments to those bondholders that did accept the restructured bonds, unless equal treatment was granted to the holdouts. Since then, Argentina has been in a technical default: unable to pay neither the holdouts nor the restructured bondholders.
In December 2015, Argentina welcomed a new president (Mauricio Macri) who promised throughout his presidential campaign that the holdouts issue would be one of the top priorities of his new government, along with foreign exchange and currency control regulations.
On February 5th 2016, Argentina’s new Ministry of Finance and Public Credit publicly announced the terms of a proposal to eligible holders of any series of bonds of Argentina. The governmental proposal to the holdouts involved the payment of 100% of the principal and a 40% discount on the interest (a 25% haircut on the total amount due pursuant to the courts of New York’s decision). This proposal was originally accepted by a group of Italian holdout bondholders and later by some of the largest remaining holdout institutions. Mr. Prat Gay, Argentina’s Minister of Finance, said during his presentation of the proposal: “There are no countries in the modern world that can grow without access to credit”.
The settlement agreement was subject to the following conditions precedent: i) the approval of the terms and conditions of the offer by the Argentine Congress; ii) the repeal or abridgement of “Lock Law” (prohibiting Argentina to offer holdouts a better deal than the one accepted by holders of the restructured bonds) and iii) the U.S. District Court for the Southern District of New York permanently lifting all pari passu injunctions granted to certain holders of defaulted Argentine bonds.
On March 16, 2016, Macri received his first (overwhelming) victory in Congress: 165 votes over 86 approved the holdout proposal. At the Argentine Senate 15 days later, his strength was confirmed. On March 31, 2016, Senators voted 54 against 16 in favor of the payment to the holdouts. The discussion was closed, and Argentina is now ready to issue new bonds and to return being a trustworthy debtor. The Government has confirmed that the payment to the holdouts shall be made in cash (derived from a new issuance of debt of up to USD 12.5 billion) and not from the Central Bank USD reserves.
It seems that winds of change are blowing in Argentina. The end of an era, some may say. What can be argued without a shadow of doubt is that Argentina is willing to return to what it used to be, and it has what it takes to regain a leading place.
- Auditor rotation and liability back in focus
- Banca Monte dei Paschi di Siena (MPS): an Italian story of incredible value destruction
- The end of commercial claim foundations in the Netherlands?
- What went wrong with the Italian banks?
- The end of an era: Argentina's deal with the holdouts
- Collective damage actions in the Netherlands: four years later, still no result
- Why cleaning up the banking system should remain a priority for European policymakers
- BNP Paribas - Violation of Ethical Principles: How Institutional Investors Can Contribute to the Effectiveness of Good Governance in Europe
- A severe medicinal operation in the MDAX: The case of Celesio AG
- If only all sovereign states were like the Lannisters...