WHISTLEBLOWING ABOUT THE SCOTTISH WIDOWS DEMUTUALIZATION

(Note that Scottish Widows is part of Lloyds TSB, now Lloyds Banking Group)

Website updated to 31 March 2011 (including full transcripts of interviews with Group Fraud & Security here and here and letter of dismissal)

Described below is:

Here is a list of people involved in this matter, with an explanation of what each person did.

This website is available via Google Directory > Society > Work > Whistleblowing

On 22 December 2008 I served on Lloyds TSB a claim against Lloyds TSB and named directors and members of staff for breach of contract, negligence, harassment and causing mental shock. See Part 4 for further information.

INDEX

Part 1 (this page) - Uncovering a scandal (Equitable Life, Lloyds TSB, Scottish Widows and the Financial Services Authority)
   
1. Introduction
2. Background - Equitable Life or Understanding Guaranteed Annuity Rate (GAR) policies
3. What I was doing at the time of the Equitable Life court case
4. The Scottish Widows Demutualization
5. The Penny doesn't drop
6. The Penny Drops
7. Implications for Scottish Widows
8. Wider implications
   
Part 2 - The turn of the screw (Reporting to management, suspension, investigation, dismissal)
   
Part 3 - A banner with a strange device (Follow-up actions)

Part 3 explains what I have done since I was dismissed to follow up:

  • the original whistleblowing matter;
  • the victimization by my management resulting from the whistleblowing;
  • the failure of Scottish Widows' auditors (PricewaterhouseCoopers) to qualify the 1998 accounts of that company on account of the whistleblowing matter.
   
Part 4 - Legal action against Lloyds Banking Group plc, the Parliamentary Ombudsman and the ICAEW
   
 

1. Introduction (Top of page)

Legal Notice

What is the point of this paper? (Includes advice to whistleblowers)

Some quotes to set the scene!

'The use of recriminating about the past is to enforce effective action at the present.' - Winston Churchill, House of Commons, 1936

'The search for truth implies a duty. One must not conceal any part of what one has recognized to be true.' - Albert Einstein

'The truth is incontrovertible, malice may attack it, ignorance may deride it, but in the end there it is.' - Winston Churchill

'A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest.' - ICAEW 'Additional Guidance on Ethical Matters for Members in Business', section 1

'The philosophy of the organisation [Lloyds TSB] has got to be reflected around treating people fairly, treating people equitably. We've got to deal with people with the utmost responsibility; with everybody whether it's members of staff, whether it's customers, whether it’s in the community, whether it's shareholders.' - Peter Ellwood, Chief Executive of Lloyds TSB (the one who refused to protect a whistleblower).

Michael Izza - Integrity personified (Yeah right)

'The message that we need to get across is that we stand for the highest professional standards: because of us, people can do business with confidence. It's a fantastic statement in good times and it's a vitally important one in tough times.' - Michael Izza, ICAEW Chief Executive, in an article entitled 'Telling it like it is' in the January 2009 issue of 'Accountancy'. Talk about being in denial! This statement follows the effective bankruptcy of major banks across the world as a result of gambling, deceit, greed, corruption and downright criminality, but, to my knowledge, not one of these banks had its accounts qualified by its auditors, which is a failure of professional standards that beggars belief - to the point where you say 'Why do we bother to have auditors at all?' Michael Izza, as Chief Executive of the ICAEW, has refused to carry out any form of investigation into these staggering failures. Nice one, Mike!

'It is one of the glories of this country that every now and then one of its citizens is prepared to take a stand against the big battalions of government or industry.' - Lord Justice Jacob (The Daily Telegraph, 11 February 2009, Ferguson v British Gas [2009] EWCA Civ 46)

'It will give a true and representative insight into how banks behave at the executive level in a way that will stimulate investigations and reforms, I presume. You could call it the ecosystem of corruption but it’s also all the regular decision making that turns a blind eye to and supports unethical practices: the oversight that’s not done, the priorities of executives, how they think they’re fulfilling their own self-interest.' - Julian Assange, founder of Wikileaks, in November 2010 speaking in an interview about the forthcoming realease of documents exposing the conduct of an as yet unnamed bank (as at 11 December 2010).

Welcome

Welcome. My name is Graham Senior-Milne (formerly Milne). I am British, was born in 1955 and I am a Chartered Accountant. I live in Northumberland, England. You can E-Mail me at grahammilne001@btinternet.com. First of all I would like to apologize for the length of this paper (although it is actually quite short) but it is necessary to name names and to state the facts, including dates, documents and brief details of applicable laws and regulations. Also of course I have to explain why I believe that the actions or opinions of certain people are wrong and one cannot do this with a few soundbites; it requires facts and reasoned arguments. I have tried to do this as succinctly as possible. I have written this paper as a story so, hopefully, you will find it quite interesting as you get into it. Although this paper describes a financial scandal it is, in essence, very simple, as you will soon find out. Please do not be put off before you start. Courage, mes amis! Q: What is the difference between a lawyer and a flounder? A: One is a bottom-sucking scavenger, the other's a fish.

'Quis custodiet ipsos custodies?' ('Who shall guard the guardians themselves?')

This paper describes a financial scandal involving major financial institutions, regulators, civil servants, professional bodies, the police, politicians, prominent business leaders, lawyers and so on. Most of the people mentioned here were not party to the original scandal, they are those who have failed to act when they should have. Delay is their most powerful weapon and there appears to be a universal assumption that if they stonewall you long enough you will eventually go away; they are nearly always right in this. Almost without exception every person who you would have thought had a duty to do something about it has 'run a mile'. In short, when it came to the test they demonstrated what I can only call a despicable lack of moral fibre, if not, in some cases, downright dishonesty, as you will see. There is no conspiracy amongst those who have failed to act, just a mixture of moral cowardice and self-interest which manifests itself in ignoring or bullying the 'small guy'. I have been appalled at how widespread this conduct is amongst those whose duty it is to protect the public interest. 'Quis custodiet ipsos custodies?' indeed.

Key points

Please bear in mind the following key points while reading this paper:

2. Background - Equitable Life or Understanding Guaranteed Annuity Rate (GAR) policies (Top of page)

In order to understand this scandal, you need to understand a little about the Equitable Life crisis. If you have a basic understanding or awareness of what happened (i.e. that Equitable Life went bust because it had sold policies with a guaranteed rate of return) then you can probably skip this bit. Nonetheless, this is the shortest summary you will find anywhere (believe me, I have looked) and actually provides a fascinating insight ('horrifying' would be a better description) into the workings of government and officialdom, particularly the delaying tactics they use (still going strong in the case of Equitable Life after 10 years). This is an education in itself on the lines of 'Those who don't learn history are bound to repeat it'. It is worthwhile knowing about because I can guarantee that a similar scandal will affect you or people you know at some stage. So, forewarned is forearmed. Be prepared for when it happens to you; it could save you a lot of money. If Equitable Life policyholders had known about what I describe here many of them wouldn't have lost their entire savings. Think about it.

The summary is quite short.

Equitable Life is a life insurance company and was one of the biggest financial institutions in the UK. It closed its doors to new business on 8 December 2000 with liabilities of GBP*1.5 billion (then about 3 billion US dollars). The liabilities that led to the collapse were caused by the sale (from 1957 onwards) of Guaranteed Annuity Rate (GAR) policies, that is policies which gave the policyholder the right to purchase an annuity** at a fixed rate. From 1993 actual annuity rates fell below guaranteed annuity rates thus creating a financial 'black hole' of about GBP1.5 billion. Equitable Life attempted to address the problem by paying reduced discretionary terminal bonuses to GAR policyholders exercising their right to buy an annuity at the guaranteed rate. This led to the 'Equitable Life case' of 1999/2000 (actually started by Equitable Life itself as a test case) in which it was ruled by the House of Lords (the highest court in the UK) on 20 July 2000 that Equitable Life could not pay reduced discretionary terminal bonuses to GAR policyholders exercising their right to buy an annuity at the guaranteed rate. Of course, Equitable Life only had a finite pot of money (the 'With-profits Fund'), so the effect of the ruling was to force one group of policyholders (the ordinary or non-GAR policyholders, who were the majority) to pay another group of policyholders (the GAR policyholders, who were a minority).

See 'The Alternative Penrose Report' for a good summary of the Equitable Life affair (but no longer up to date of course).

*GBP = UK pounds sterling

**An annuity is simply a regular income paid, usually monthly, to an individual from a lump sum investment, usually for the purposes of providing retirement income. In the UK you have to use a proportion of your pension fund 'pot' at retirement to purchase an annuity and this provides your retirement income. The way these policies work is that the policyholder pays a regular (usually monthly) amount for a period of time (e.g. 25 years), as a deduction from their salary for instance, and, at the end of that period, the sum accumulated is used to buy an annuity. The amount of the annuity (i.e. the amount of the regular payments) depends on the 'annuity rate' at the time of the purchase of the annuity, as well as other factors such as age, health and so on. Annuity rates fluctuate in relation to long-term interest rates. If you have purchased a guaranteed annuity rate policy then the company is contractually bound to buy you an annuity at that rate regardless of the market annuity rates. In other words, if the market rates are unfavourable the company has to pay a bigger lump sum than has been accumulated in your 'pot' - and fund the difference from somewhere. Multiply this by, say, 100,000 people and you can begin to get an idea of the problem.

Who regulated Equitable Life?

These dates are significant in relation to the various enquiries described in the following section.

See also this BBC article

Equitable Life - A summary of the official and professional enquiries, excluding legal proceedings, covering enquiries by:

The enquiries:

Note how these enquiries are all limited in (one or more of) scope, period and powers of investigation. Indeed, one of these enquiries (The UK Government's Penrose Enquiry) had no formal powers at all!

So what is the truth?

Well, the truth is quite simple. Equitable Life was the author of its own misfortunes, as Lord Penrose said. It sold the GAR policies and, in addition, it had an over-generous bonus policy which meant that it had insufficient reserves to get it through a financial 'rough patch', so that when the GAR problem arose it was exposed. That's it as far as the company is concerned, and non-GAR policyholders may have had a right (presumably extinguished by the compromise agreement of 2002) to sue the company as a result. But that is not the point of course. The point is that the government established a regulator, the FSA, to protect policyholders from precisely this sort of scenario (i.e. companies failing to maintain sufficient reserves to meet their liabilities, including GAR liabilities) and, critically, policyholders were entitled to rely on that regulator to do the job it was supposed to do (the FSA has a legal duty under EU and UK law to protect consumer interests) - and they did rely. That regulator turned out to be ineffective, incompetent and actively dishonest. Worse than that, when the GAR problem began to appear, the regulator and the powers that be (up to and including the Treasury and the Chancellor of the Exchequer, Gordon Brown) made a conscious and deliberate decision to conceal it from the policyholders, leaving them in the lurch financially. Many of these policyholders are now dead, having lived through years of penury as a result of this decision - and still, 10 years after the Equitable Life crisis, the powers that be are playing a delaying game to deny the remaining policyholders the remedy they deserve, even after the Parliamentary Ombudsman's report. These people were quite happy to set up enquiries such as the Penrose Enquiry because they adopted the usual tactic of giving them a very limited remit (Remember, Lord Penrose, you're not allowed to allocate blame!) and no investigatory powers, and they were fully confident (and I mean 110% confident) that when the enquiry reported some years later they could safely brush off its conclusions and recommendations or set up some further blocking device (a panel of some sort, for instance), which is exactly what they have done. This can go on forever.

Of course Equitable Life was not alone in having a GAR problem; that problem existed right across the life industry in the UK, as has been made clear. So it was not just the Equitable Life policyholders who were deliberately misled by the very people who were supposed to protect them, it was the policyholders of practically all the other life companies as well. The question is 'Where have all these GAR liabilities (which were estimated to amount to GBP14 billion) gone?' Answer? They have been paid for by the policyholders without their knowledge or consent, as I explain below.

What this means is that all the major life companies were heading for a 'GAR disaster'. Equitable Life was merely first to go because its generous bonus policy meant that it was in a relatively weaker financial position. When this happened all the other life companies, like canoeists who see a fellow canoeist ahead of them disappear over a weir, started to paddle desperately away from the danger area; that danger area being public exposure of their GAR liabilities. This is why, with the connivance of the government, the Treasury and the regulator (the FSA), the full and horrifying extent of the problem has never been fully recognised. But bear this in mind. Had the problem been disclosed (by the auditors of the life companies in particular) then the weaknesses in the regulatory regime (i.e. the FSA) could have been rectified and had they been rectified then the UK would have been spared the worst consequences of the global banking crisis some ten years later. A warning from history.

And then we also have the theft of the 'inherited estates' - but that is another story...

The theft of the inherited estates

See this announcement by Aviva (ex-Norwich Union) on 30 July 2008, which says: 'In a process known as reattribution*, policyholders in the CGNU Life and CULAC funds will be able to choose whether to receive a cash payment now in return for giving up their right to receive any possible future payouts from the funds' inherited estates - or to stay as they are, in the knowledge that sizeable distributions are unlikely, especially in the next few years.' In other words, we have your money (the excess pot built up by all past and existing policyholders) but will never pay it to you (because payment is at the absolute discretion of the directors - hahahaha!) so you might as well 'split' it with us, so that you, the policyholders, take, say 60% of your money and we, the shareholders**, take 40%. This way, we, the shareholders, get billions of pounds of the policyholders' money for nothing. As they say - 'It's a steal!' So, for 'reattribution' read 'theft'. Seriously, they do this. The company involved here is Aviva, one of the biggest in the UK. The directors of this company think of themselves as respectable people. What do you think?

Note that the press release says: 'The offer has been negotiated with an independent Policyholder Advocate, Clare Spottiswoode, who represents the interests of policyholders. She said: "I'm delighted that we have a deal that is in the interests of the vast majority of policyholders. There is a substantial amount of cash available for them [Really? So why not just give the policyholders their own money then?] and this offer also provides a fair return to shareholders. This deal is good in all respects."' 'A fair return to shareholders'? In what way? It wasn't their money, so how can they earn a 'return' on money that isn't theirs? Answer? In the same way that a thief earns a 'return' when he burgles a house.

*'reattribution' i.e. what was 'attributed to' (owned by) you becomes 'reattributed to' (owned by) me. Thanks!

**when I say 'shareholders' I mean 'the company' and when I say 'the company' I include 'those employed by the company', including the directors, who stand to gain personally, through their pay and bonuses, from holding the policyholders to ransom.

See here, here, here and here also. (The Times says that 'Which?', the consumer magazine, says that 'reattribution' of the inherited estates is 'legalised theft'. I couldn't have put it better myself.

So what with the GAR issue and the theft of the inherited estates, the policyholders of the life companies have been taken to the cleaners, not only by the government and the regulators (who made a conscious decision to keep the policyholders in the dark about the GBP14 billion GAR problem - see below), but also by their own companies, who have quite literally stolen (legalised theft but still theft) at least the same again from the same policyholders out of the funds built up, in some cases over centuries, by the policyholders - the inherited estates.

The dog that didn't bark in the night.

Spot the difference:

Sleeping dog Ann Abraham,
Parliamentary Ombudsman

It is clear from the above that no comprehensive enquiry has ever been conducted into the GAR issue, or into the FSA's regulatory supervision of that issue, on an industry-wide basis; this is in spite of the fact that, as you will see, I have written to the Treasury Select Committee (every member), the Parliamentary Ombudsman and the European Parliament's Committee of Enquiry into the crisis of the Equitable Life Assurance Society (every member), amongst others. Read on!

But hold it a moment! Let's look at the terms of reference of the second Parliamentary Ombudsman's enquiry, the one that reported in July 2008. This states that the objective of the enquiry was 'to determine whether individuals were caused an injustice through maladministration in the period prior to December 2001 on the part of the public bodies responsible for the prudential regulation of the Equitable Life Assurance Society and/or the Government Actuary's Department; and to recommend appropriate redress for any injustice so caused' (Main Report, page 1).

Now this is quite clear. It says that the objective of the enquiry was to determine whether 'individuals' (i.e. 'any individuals', since the word is not qualified, so not just 'the policyholders of Equitable Life') were 'caused an injustice by maladministration on the part of the public bodies responsible for the prudential regulation of the Equitable Life Assurance Society and/or the Government Actuary's Department'.

This does not limit the scope of the enquiry to Equitable Life and its policyholders only; it includes ANY INDIVIDUAL CAUSED AN INJUSTICE THROUGH MALADMINISTRATION ON THE PART OF THAT BODY RESPONSIBLE FOR THE PRUDENTIAL REGULATION OF EQUITABLE LIFE (FOR WHICH READ 'FSA').

So, we can paraphrase to 'ANY INDIVIDUAL CAUSED AN INJUSTICE THROUGH MALADMINISTRATION ON THE PART OF THE FSA'. In other words, NOT restricted to Equitable Life policyholders only. This is not just hair-splitting; it is about the proper interpretation of words which could (and did) significantly affect access to justice and the right to a proper remedy of millions of people, the very reason that the Parliamentary Ombudsman set up the enquiry in the first place.

Moving on to page 2 of the report, under the heading 'The subject matter of this report' we find the statement: 'The investigation which led to this report has centred on allegations of regulatory failure on the part of those responsible for the prudential regulation of insurance companies in the period prior to 1 December 2001, as those general responsibilities were discharged in the case of The Equitable Life Assurance Society.' Well OK, the allegations which lead to the enquiry related to Equitable Life but the terms of reference of the enquiry quite rightly covered any company regulated by the FSA, since one of the main objectives of any enquiry is to identify the scope of the problem ('OK, we have a problem. How widespread is it?'). In fact, one should question the scope of any enquiry that does not address that question.

The question is therefore one of why the Parliamentary Ombudsman did not carry out her enquiry in accordance with the clear words of her own terms of reference, particularly given that she was aware that other life companies had GAR problems (Main Report, para. 74 as stated above) and that I had notified the Parliamentary Ombudsman of my concerns relating to Scottish Widows fully 21 months before she issued her report, as described in part 3 of this paper (actually her office fought like mad NOT to investigate my complaint, as you will see). Knotty one that.

Furthermore, let us assume for just a second that the Parliamentary Ombudsman made a mistake in drafting her terms of reference; that she intended to limit her enquiry to wrongs done to Equitable Life policyholders only. During her enquiry she becomes aware that the regulatory failures which affected Equitable Life also affected all other life insurance companies; in fact, that the Equitable Life crisis was just the tip of an iceberg. So what was her response? Did she say 'Well, thank heavens! I can look into these other companies because, fortunately, I drafted my terms of reference widely enough to cover them.' - a decision which no-one could have challenged. No, she made a CONSCIOUS DECISION NOT TO LOOK INTO THE WIDER AND FAR MORE SERIOUS PROBLEM, she ducked below the parapet leaving millions of people (the policyholders of those other life insurance companies) in the lurch, without access to justice or a proper remedy. In short, she failed in her duty to the public and consciously so. Shame on you, Ann Abraham.

3. What I was doing at the time of the Equitable Life court case (Top of page)

At the time of the Equitable Life court case in 2000 I was working as an IT auditor with Lloyds TSB in London, one of the big UK 'clearing banks' and one of the largest financial institutions in the world. I joined them in 1998 and was transferred to a similar job in Edinburgh with Scottish Widows in January 2002 following a heart attack in September 2001. Scottish Widows had been taken over by Lloyds TSB in March 2000. I had no involvement through my job with the Scottish Widows demutualization* but my mother did hold a Scottish Widows policy and she received, as far as I can remember, something in the region of GBP4,000 as a result of the demutualization.

*Scottish Widows was a 'mutual' organization, which simply means that it was owned by its policyholders. When the policyholders sold Scottish Widows to Lloyds TSB it ceased to be a mutual organization and became an ordinary public limited company - hence 'demutualization'.

4. The Scottish Widows Demutualization (Top of page)

The Scottish Widows demutualization of 2000 was effectively the sale of Scottish Widows by its owners (the policyholders) to Lloyds TSB. The purchase price was GBP6 billion, of which GBP4.5 billion was paid by Lloyds TSB to Scottish Widows policyholders and GBP1.5 billion (about 3 billion US dollars at that time) was retained in a so-called 'Additional Account'. I think my understanding of the matter at the time was probably the same as that of other Scottish Widows policyholders; I did not understand why this GBP1.5 billion had been held back (there was no meaningful explanation in the documentation sent to policyholders) but my understanding was that it would be distributed to policyholders after the demutualization as terminal bonuses (see page 2 and page 23 of the Demutualization and Transfer Policyholder Circular of 19 November 1999); in other words, that part of the purchase price (GBP4.5 billion) would be paid immediately and the rest (GBP1.5 billion) would be paid later (i.e. it would be deferred). I suspect most people assumed that they (Lloyds TSB and Scottish Widows) 'knew what they were doing and it had all been approved by a Court anyway'.

5. The Penny doesn't drop (Top of page)

Since I look after my mother's financial affairs, I did receive the demutualization documents sent to Scottish Widows policyholders including the key document, the Demutualization and Transfer Policyholder Circular of 19 November 1999. Perhaps surprisingly (but as an IT specialist I am not an expert in this area), it did not occur to me that most, if not all, of the other life companies in the UK had been selling GAR policies in the same way as Equitable Life and, as a result, had similar, if not larger, GAR liabilities. It certainly did not occur to me that this was the case with Scottish Widows.

6. The Penny Drops (Top of page)

On 31 January 2002, shortly after I joined Scottish Widows in Edinburgh as an IT auditor, I was summoned to a meeting with the other staff of the Internal Audit Department. This meeting took place at the Scottish Widows headquarters in Morrison Street, Edinburgh. It was explained by the Head of Internal Audit that the meeting had been called to inform us that Lloyds TSB/Scottish Widows were about to issue a press release to the effect that the GBP1.5 billion in the 'Additional Account' was not now going to be paid to ordinary policyholders but would be used instead to uplift the benefits to GAR policyholders or words to that effect. I understand that the Internal Audit Department were informed of this because some of them had been involved in the demutualization.

7. Implications for Scottish Widows (Top of page)

It may sound dramatic but the implications of what had been said hit me like the proverbial brick as I came out of that meeting:

  • that Scottish Widows had sold GAR policies in the same way as Equitable Life (I believe that they had actually sold more than twice as many - 200,000 against 90,000);
  • that the directors of Lloyds TSB and Scottish Widows* must have known from the start of the demutualization process about the existence of a contingent liability (contingent on the outcome of the Equitable Life case) of GBP1.5 billion in respect of GAR policies;
  • that the sale of Scottish Widows to Lloyds TSB had been engineered as a way of dealing with this liability (You can picture the Board Meeting of Scottish Widows (June 1999? See this article by Ian Fraser in the Sunday Herald on 20 June 1999) - 'Do you realize that if the Equitable Life court case goes the wrong way, we will go down the tube? What are we going to do about it?');
  • that the GBP1.5 billion had been set aside specifically to meet this liability;
  • that the directors of Lloyds TSB and Scottish Widows had misled both the policyholders of Scottish Widows and the Court of Session (who approved the demutualization scheme under the Insurance Companies Act 1982) as to why this GBP1.5 billion was set aside - in rugby parlance they had sold the policyholders a dummy**;
  • that in misleading the policyholders and Court of Session the directors had committed a criminal offence under s.71 Insurance Companies Act 1982;***
  • that in not properly disclosing the matter in the accounts of Scottish Widows for the years ended 31 Dec 1998 and 31 Dec 1999 the directors of Scottish Widows had committed a criminal offence under s. 19 Theft Act 1968;****
  • that in not properly disclosing the matter in the accounts of Lloyds TSB for the years ended 31 Dec 1999, 31 Dec 2000 and 31 Dec 2001 the directors of Lloyds TSB had committed a criminal offence under s. 19 Theft Act 1968;*****
  • that because the Scottish Widows policyholders had not been properly informed of this matter they had a reasonable expectation that the GBP1.5 billion would be paid to them and had approved the demutualization on this basis;
  • that the Scottish Widows policyholders had therefore been effectively (i.e. actually) defrauded of GBP1.5 billion;
  • that Lloyds TSB, Scottish Widows and the directors of Lloyds TSB and Scottish Widows were liable to a civil action in damages.
Put simply, what actually happened was that the policyholders of Scottish Widows were led to believe that they would receive GBP6 billion from the sale of Scottish Widows and they actually received GBP4.5 billion, so they lost GBP1.5 billion. It is that simple. Essentially, and as a result of a sleight of hand, Lloyds TSB/Scottish Widows made the policyholders pay for the GAR liabilities when they gave the misleading impression that there were no significant liabilities not included in the purchase price, that is they gave the impression that Lloyds TSB was paying GBP6 billion for the net assets (net of liabilities that is) of Scottish Widows. So any argument that the policyholders lost nothing because 'they would have had to pay for the GAR liabilities anyway' falls to the ground. On the basis of the information provided to them (i.e. the policyholder circular) it was reasonable for the policyholders to believe (and they were led to believe and did believe) that Lloyds TSB was buying Scottish Widows for GBP6 billion including all significant liabilities, so that Lloyds TSB, and not the policyholders, would assume the burden of such liabilities, as is normal when a business is sold. On top of that the policyholders had no reason to believe that there were any significant GAR liabilities, contingent or otherwise, because no such liabilities were disclosed to them either in the accounts of Scottish Widows for 1998 (or 1999) or the policyholder circular of November 1999 or, of course, by the Financial Services Authority at any time.
 
Notes on section 7:

*The directors of Scottish Widows were:

Lawrence M Urquhart LLB, CA (Chairman)
Gavin J N Gemmell CBE CA (Deputy Chairman)
Richard H Davey BA
Orie L Dudley Jr BA
G Ronald G Graham CBE, LLB
Angela A Knight BSc
Alistair J Low FFA
William H Main CA
Dr Chris Masters BSc, PhD, AKC
Michael D Ross, FFA, CIMgt
Newton Scott
Charles G Thomson BSc, FFA
Rosalyn S Wilton BSc, FFA

The directors of Lloyds TSB listed in the 1999 accounts were:

Sir Brian Pitman (Chairman)
Sir Nicholas Goodison (Deputy Chairman until 11 April 2000)
Alan Moore CBE (Deputy Chairman from 11 April 2000)
Peter B Ellwood (Group Chief Executive)
Michael E Fairey (Deputy Group Chief Executive)
Michael D Ross (Deputy Group Chief Executive from 3 March 2000)
M Kent Atkinson
Dennis Holt
Archie G Kane
David P Pritchard
Ewan Brown CBE (Non-executive)
A Clive Butler (Non-executive)
Sheila M Forbes (Non-executive)
Christopher S Gibson-Smith (Non-executive)
L E (Paddy) Linaker (Non-executive)
Thomas F W McKillop (Non-executive) (from 1 May 2000)
Peter C Nicholson (Non-executive) (until 11 April 2000)
Dame Bridget Ogilvie DBE (Non-executive) (until 11 April 2000)
The Earl of Selborne KBE (Non-executive)
Lawrence M Urquhart LLB, CA (from 3 March 2000)

The directors of Lloyds TSB listed in the 2000 accounts were:

Sir Brian Pitman (Chairman until 18 April 2001)
Maarten van den Bergh (Chairman from 18 April 2001)
Alan Moore CBE (Deputy Chairman from 11 April 2000)
Peter B Ellwood (Group Chief Executive)
Michael E Fairey (Deputy Group Chief Executive)
Michael D Ross (Deputy Group Chief Executive from 3 March 2000)
M Kent Atkinson
Dennis Holt
Archie G Kane
David P Pritchard
Ewan Brown CBE (Non-executive)
A Clive Butler (Non-executive)
Sheila M Forbes (Non-executive)
Christopher S Gibson-Smith (Non-executive)
L E (Paddy) Linaker (Non-executive) (until 18 April 2001)
Thomas F W McKillop (Non-executive) (from 1 May 2000)
The Earl of Selborne KBE (Non-executive)
Lawrence M Urquhart LLB, CA (from 3 March 2000)

The directors of Lloyds TSB listed in the 2001 accounts were:

Maarten van den Bergh (Chairman from 18 April 2001)
Alan Moore CBE (Deputy Chairman)
Peter B Ellwood (Group Chief Executive)
Michael E Fairey (Deputy Group Chief Executive)
Michael D Ross (Deputy Group Chief Executive)
M Kent Atkinson
J Eric Daniels (joined 2001)
Archie G Kane
David P Pritchard
Ewan Brown CBE (Non-executive)
A Clive Butler (Non-executive)
Sheila M Forbes (Non-executive)
Christopher S Gibson-Smith (Non-executive)
DeAnne S Julius CBE (Non-executive) (joined 2001)
Thomas F W McKillop (Non-executive)
The Earl of Selborne KBE (Non-executive)
Lawrence M Urquhart LLB, CA (until 17 April 2002)

**The Demutualization and Transfer Policyholder Circular was dated 19 November 1999. The Special General Meeting to approve the demutualization was held on 22 December 1999, one month later. Court approval was obtained on 28 February 2000 and the demutualization (sale of Scottish Widows to Lloyds TSB) took effect on 3 March 2000. There does seem to have been an unseemly haste to complete this process. There is of course no suggestion that this process was driven by the Equitable Life case then before the Court of Appeal, which ruled on 22 January 2000 that Equitable Life had to meet its GAR liabilities in full, which decision was upheld on appeal to the House of Lords on 20 July 2000 (the originating summons in the Equitable Case was issued on 15 January 1999; the High Court found in favour of Equitable Life on 9 September 1999 and appeal was then made to the Court of Appeal, who reversed the High Court decision). In any event, the directors of Lloyds TSB and Scottish Widows knew full well, before 19 November 1999, of the potentially critical consequence of such a ruling in the Equitable case (i.e. that the ordinary policyholders would be GBP1.5 billion worse off) but did not mention this in the circular.

Note that England and Scotland have different judicial systems. Scottish Widows is a Scottish company and the highest court in Scotland is the Court of Session. Appeals from the Court of Session are to the House of Lords (in England). In England, civil proceedings are normally started in the County Court or the High Court. Appeals from the High Court are to the Court of Appeal and from the Court of Appeal to the House of Lords. The Equitable Life case followed this latter route.

Note also that the decision of the Court of Appeal in the Equitable Life case was made on 22 January 2000 yet the Scottish Widows demutualisation scheme approved by the Court of Session ('The Scheme') on 28 February 2000 makes no mention of the impact of this decision (i.e. that the ordinary policyholders would be GBP1.5 billion worse off). This is absolutely critical because it means that the contingent liability had crystallised (become an actual liability), according to the ruling of the Court of Appeal in the Equitable Life case, and subject only to an appeal to the House of Lords in that case, BEFORE THE COURT OF SESSION APPROVED THE SCOTTISH WIDOWS DEMUTUALISATION SCHEME. (If you read section 19 of the demutualisation scheme concerning the operation of the 'Additional Account' you will understand why the judges of the Court of Session were probably completely out of their depth, not that this was intentional on the part of Scottish Widows of course.)

***THE INSURANCE COMPANIES ACT 1982

The 'Scheme' document dated 11 November 1999 was put before the Court of Session in Edinburgh under section 49 of the Insurance Companies Act 1982. Section 49(2) of the Act states that the Court will not approve an application under section 49 unless, inter alia, the requirements of section 49(3) are met. The requirements of section 49(3) include a requirement that a statement setting out the terms of the scheme should be sent to all policyholders (this was done via the policyholders circular dated 19 November 1999 referred to above). Section 71 provides that any person who causes or permits to be included in any statement sent out under section 49(3) a statement which he knows to be false in a material particular or recklessly causes or permits to be so included any statement which is false in a material particular shall be guilty of an offence and liable to imprisonment for a term not exceeding two years or a fine or both (section 49 - image 1, image 2, image 3; section 71 - image 1, image 2, image 3).

'Material false statement'

The pertinent question here is what constitutes a 'material false statement'. In the first place no-one I think would question that GBP1.5 billion is 'material', so that just leaves the question of whether what was or was not said in the policyholder circular of 19 November 1999 was 'false'. A statement is clearly false if it says something that is untrue but a statement is also false where it omits to say something and that omission leads the reader to a false understanding, particularly where this involves an understanding of the consequences of an important proposal. Truth is more than the absence of lies. Note, in this context, that clause 17(1) of the Law Commission's Draft Criminal Code states that 'a person causes a result... when... (b) he omits to do an act which might prevent its occurrence and which he is under a duty to do according to the law relating to the offence'*. It is my view that this was the situation in relation to the statement or statements made in the policyholder circular dated 19 November 1999. This document says (page 23) that the GBP1.5 billion balance on the Additional Account will be paid out as terminal bonus on with-profits policies to the extent not needed to meet contingencies allocated to the with-profits fund. These contingencies include 'any additional cost of meeting guaranteed benefits'. What is not mentioned is the fact that Scottish Widows had at that time a contingent liability of GBP1.5 billion in respect of GAR policies, that there was a court case (the Equitable Life case) then before the Court of Appeal and that if the decision in that court case went against Equitable Life (as actually happened 2 months later in January 2000) then the balance on the Additional Account would NOT be available to ordinary policyholders as terminal bonus but would be required to meet the GAR liabilities.

*See also a US case Morrison v. Coddington, 662 P. 2d. 155, 135 Ariz. 480 (1983): 'Fraud and deceit may arise from silence where there is a duty to speak the truth, as well as from speaking an untruth.' See also Brown & Ors v Innovatorone Plc & Ors [2012] EWHC 1321 (Comm) http://www.bailii.org/ew/cases/EWHC/Comm/2012/1321.html at 880, quoting CRSM v Barclays Bank [2011] EWHC 484 at 219: 'Silence by itself cannot found a claim in misrepresentation. But an express statement may impliedly represent something. For example, a statement which is literally true may nevertheless involve a misrepresentation because of matters which the representor omits to mention. The old cases about statements made in a company prospectus contain illustrations of this principle – for example, Oakes v Turquand (1867) LR 2 HL 325, where Lord Chelmsford said (at 342-3):

"... it is said that everything that is stated in the prospectus is literally true, and so it is; but the objection to it is, not that it does not state the truth as far as it goes, but that it conceals most material facts with which the public ought to have been made acquainted, the very concealment of which gives to the truth which is told the character of falsehood."'

Financial Reporting Standard 12

The question is, of course, whether the statement on page 23 does actually make clear, in accordance with relevant accounting standards (FRS 12), the nature and extent of the contingent liability and the director's assessment as to the likelihood that the contingency would crystallize; in other words, having read the statement would a policyholder understand:

  • that Scottish Widows had a contingent liability of GBP1.5 billion in respect of GAR policies at that time?
  • that if the Equitable Life case, then before the Court of Appeal, went against Equitable Life then the GBP1.5 billion put aside by Scottish Widows in the 'Additional Account' would not be paid to ordinary policyholders as stated on page 23 of the Demutualization and Transfer Policyholder Circular of 19 November 1999 but would be paid to GAR policyholders instead?
  • what the assessment of the directors of Scottish Widows was as to the likelihood of the liability crystallizing?

The answer to these questions is, of course, a resounding 'No'. The wording on page 23 ('any additional cost of meeting guaranteed benefits') falls so far short of adequate disclosure that it amounts to positive concealment - in other words a material false statement.

Note that FRS 12 applies to financial statements, that is sets of accounts. Nonetheless, financial statements are designed to present a true and fair view and it therefore follows that any financial-type document which is supposed to present a true and fair view should comply with Financial Reporting Standards (FRS). It is for those who seek not to comply with FRS who need to justify their position. FRS 12 is therefore the 'yardstick' by which the adequacy of the disclosure of the contingent liability in respect of GAR policies should be judged.

The point here is that we all know that hardly any policyholders will have read the full policyholder circular and that it would be unreasonable to have expected them do so. Many were elderly people with no understanding of the life industry. Are they really going to read actuarial reports and all that muck? They will have read the first couple of pages at most, perhaps the summary and, more importantly, the section titled 'How much will I receive?' (which just happens to be immediately below, in large letters, the bit about the Additional Account - drawing the attention away). Of course, the directors of Scottish Widows were perfectly well aware of this fact and it was therefore incumbent on them (a sort of enhanced duty of care) to make sure that important matters were put in an obvious place and were not buried in the middle of the document. One way to ensure that things are as confusing as possible is to keep referring to other parts of the document, so that the reader loses their way i.e. on page 2 it says 'See page 23', then on page 23 it says 'see below', then when you look below it says 'see above' (referring to a different above which, given the columnar layout of the page, is actually left and below). Helpful is it not? But all technically legal of course. The simple fact of the matter is that had the directors wished to make sure that the policyholders read about and understood the GAR issue, they could have done so very easily by including a few sentences in the summary (we are, after all, talking about GBP1.5 billion). Would that really have been too much in a 100 page document? I don't think so.

Permitting the inclusion of a material false statement - a criminal act by the FSA.

A specific consideration here is that section 71 of the Insurance Companies Act 1982 provides that any person who causes or permits to be included in any statement sent out under section 49(3) a statement which he knows to be false in a material particular or recklessly causes or permits to be so included any statement which is false in a material respect shall be guilty of an offence and liable to imprisonment for a term not exceeding two years or a fine or both. Now, if the FSA were aware that Scottish Widows had a contingent liability of GBP1.5 billion at the time of the demutualization and they allowed (permitted) Scottish Widows to issue a policyholder circular (the one dated 19 November 1999) which failed to properly disclose this fact then, it seems to me, that they (the FSA and possibly the individuals concerned) committed a criminal offence. Now the FSA most certainly were aware of the existence of the contingent liability in respect of GAR policies (since the Government Actuary's Department had carried out a review of GAR liabilities across the industry in June 1998) and would have had sight of the policyholder circular of 19 November 1999 before it was issued. Since the FSA had the power to prevent the demutualisation going ahead*, their decision not to prevent it going ahead amounts to 'permitting' it to go ahead - in the full knowledge that Scottish Widows were breaking the law. The FSA have therefore committed a criminal offence under section 71 of the Insurance Companies Act 1982.

*See also s.104-114 Financial Services and Markets Act 2000 concerning business transfers and, in particular, s. 109 concerning scheme reports and approval thereof by the FSA, as well as Sch. 12 concerning FSA certificates.

****THE THEFT ACT 1968

(Note also s.17 Theft Act 1968 relating to false accounting)

Section 19 Theft Act 1968 states that: 'Where an officer of a body corporate or unincorporated association (or person purporting to act as such), with intent to deceive members or creditors of the body corporate or association about its affairs, publishes or concurs in publishing a written statement or account which to his knowledge is or may be misleading, false or deceptive in a material particular, he shall on conviction on indictment be liable to imprisonment for a term not exceeding seven years.'

Note that s. 19 covers those who 'concur' in publishing such written statements or accounts and so it could apply to officers who do not directly 'approve' documents.

Scottish Widows - 1998 Accounts (for the year ended 31 Dec 1998)

As at 31 Dec 1998 Scottish Widows had a potential liability of GBP1.5 billion in respect of GAR liabilities. The Equitable Life case started with an originating summons in the High Court on 15 January 1999, before the Scottish Widows accounts were signed off on 2 Mar 1999. The commencement of that case gave rise to a contingent liability for Scottish Widows (contingent on the outcome of the Equitable Life case) which was a material post balance sheet event. The only circumstance where disclosure of such a matter is not required is where the likelihood of the contingency crystallising is considered to be remote (that is something significantly beyond unlikely). If the directors of Equitable Life had considered the likelihood of the GAR liability crystallising to be remote, then it is logical that they would not have taken the matter to court; so the fact that they did take the matter to court is firm proof that they considered it to be more than a remote likelihood that the liability would crystallise - and if the directors of Equitable Life believed that, what reason would the directors of Scottish Widows have for coming to a different conclusion?

Significantly, the UK government's Penrose Report noted that annuity guarantees were an industry-wide issue by November 1997 (Penrose Report, Part 4, Ch. 12, para. 8, p. 380), meaning that Scottish Widows, PricewaterhouseCoopers, the FSA, the Treasury and so on were fully aware of the GAR problem well before the Equitable Life crisis or the Scottish Widows demutualisation. Also, of course, the Joint Disciplinary Scheme's June 2010 report on Ernst & Young's conduct as auditors of Equitable Life concluded that Ernst & Young should have qualified Equitable Life's 1998 accounts in the absence of legal advice to the contrary.

Scottish Widows - 1999 Accounts (for the year ended 31 Dec 1999)

The 1999 accounts were signed off on 16 Feb 2000, after the ruling of the Court of Appeal in the Equitable Life case on 22 Jan 2000. While that ruling was subject to appeal to the House of Lords, the fundamental accounting principle of prudence would require that the GBP1.5 billion GAR liability should have been provided for in the accounts (i.e. where the second highest court in the land has stated that a liability exists, it is prudent to provide for that liability), failing which, and as an absolute minimum, the GAR liability should have been disclosed as a contingent liability (contingent on the House of Lords ruling). Neither of these things were done and the omission must have been a conscious one on the part of the directors.

Lloyds TSB - 1999 Accounts (for the year ended 31 Dec 1999)

The acquisition of Scottish Widows by Lloyds TSB took place on 3 Mar 2000, after the ruling of the Court of Appeal in the Equitable Life case on 22 Jan 2000. The accounts were signed off on 10 Feb 2000. The acquisition of Scottish Widows was a material post balance sheet event for Lloyds TSB and the ruling of the Court of Appeal was also a material post balance sheet event, not only in the context of the Scottish Widows accounts but also in the context of the accounts of the Lloyds TSB group. On this basis the GAR liability should have been disclosed in the 1999 accounts of Lloyds TSB, either as a provision or as a contingent liability (see preceding section). Pro-forma consolidated results for the combined group (Lloyds TSB and Scottish Widows) for 1998 and 1999 were presented as part of the financial review but the GAR liability was not disclosed either there or in the accounts proper.

Lloyds TSB - 2000 Accounts (for the year ended 31 Dec 2000) and 2001 Accounts (for the year ended 31 Dec 2001)

By 31 Dec 2000 Scottish Widows was part of the Lloyds TSB group. Also, the House of Lords had ruled in the Equitable Life case on 20 July 2000, so the GBP1.5 billion GAR liability was undeniably an actual liability from that date and should therefore have been provided for and disclosed as a provision for the GAR liability in the 2000 accounts. As it was, the GBP1.5 billion was sitting in the 'Additional Account', which the Scottish Widows policyholders had reasonable grounds for believing would be paid to them over time as terminal bonuses, because this was what they had been told in the policyholder circular of 19 November 1999 and because the existence of the GBP 1.5 billion GAR liability had not been disclosed to them in ANY set of accounts of either Lloyds TSB or Scottish Widows as detailed above. The truth of the matter was not 'slipped out' (as a 'change in practice' - which the media fell for, by the way) until the press release of 31 Jan 2002. This press release was clearly issued because of the imminent signing of the 2001 accounts (which happened on 14 Feb 2002) where this 'change in practice' was revealed. Note that the 2001 accounts refer to 'an extensive review of current practices' but it was, of course, nothing of the sort because Lloyds TSB were obliged to meet their GAR liabilities in full as a result of a ruling by the House of Lords; it has nothing to do with 'practices' because they had no choice in the matter. To this extent the 2001 accounts were also misleading and the reference to an 'extensive review' was simply designed to provide some sort of excuse/explanation as to why the matter had not been dealt with sooner.

Excuses, excuses

According to a BBC news report of 31 Jan 2002 in response to the press release: 'It has taken 18 months for Scottish Widows to make the changes - and the company defended the delay. It said the Equitable ruling was "complex" and only parts were relevant to Scottish Widows' policyholders. Mr Naismith said: "We have got a lot of policies going back 30 years and had to look back and see how it applied. We then had to consult the FSA, and Inland Revenue and make computer system changes." "We wanted to get it all sorted before making any announcements," he said.'

Note:

  • The GAR problem was coming to a head well before 1998. Scottish Widows had public notice of the problem in Jan 1999. It took them 3 years (so they claim) to work out the monetary impact of the GAR problem. Sure! All they had to do was to calculate the liability on the basis that they would need to pay their GAR liabilities in full, which was the outcome, thus giving them the worst case scenario. In any event, they would be required to know this sort of information for regulatory monitoring purposes and, in fact, the FSA had been chasing all the life companies on a regular basis in order to monitor their potential exposure to GAR liabilities.
  • The House of Lords ruling was not complex. In essence it was quite simple i.e. 'Pay up in full'.
  • The reporting requirements for company accounts quite simply do not allow companies to delay revealing information in their accounts on the basis that 'we had to make computer changes' or similar excuses. Where a liability or a contingent liability cannot be quantified precisely (and remember Scottish Widows 'happened' to put just the right amount into the 'Additional Account' in 2000), the directors are required to make the best estimate they can and explain the basis of estimation in the accounts. It is for the auditors to decide whether they accept the estimate and the basis on which it has been made. If they don't agree with the estimate and the amount is material then they should qualify their audit report. Simple.

Looking at the above, you can see that 5 sets of accounts covering a period of 4 years had to be fiddled in order to conceal the GBP1.5 billion GAR problem. This must be the largest sustained 'cooking of the books' in the history of financial reporting in the UK. What were the auditors (PricewaterhouseCoopers), who audited both companies, doing during this period? Keeping their fingers crossed perhaps?

8. Wider implications (Top of page)

In addition, there was an implication, though I did not raise this with my management (see section 9):

I am not aware that the accounts of any life company have been qualified as a result of GAR liabilities. Well done, the auditing profession!

This article in the Scotsman may be of interest. You may find here the name of the 'executioner', the man who actually devised the scheme to defraud policyholders.

*The only actual estimate of the total GAR liabilities of the life companies that I have seen was mentioned in The Daily Telegraph on 21 July 2000 (the day after the House of Lords ruling in the Equitable Case) which put the figure at GBP14 BILLION (about USD28 BILLION at that time). Note that although there was speculation in the press about the possible extent of the GAR problem, this is a very different thing from the FSA, as the regulator whose duty it is to protect consumer interests, taking steps to ensure that the policyholders of individual companies were informed of the true situation of those companies with respect to GAR liabilities. In short, if the regulator (the FSA) will not reveal the true situation and the life insurance companies themselves will not reveal the true situation (and the policyholders have no legal right to obtain the necessary information from the companies or the regulator), how is the ordinary policyholder supposed to find out the facts?

Other relevant articles in The Daily Telegraph are here and here.

FTSE 100 between January 2001 and March 2006

Next - Part 2 - Reporting to management, suspension, investigation, dismissal