The unanswered questions around the emergency HBOS cash call

Lord Stevenson of Coddenham, the chairman of HBOS, strode excitedly on to the stage at the Edinburgh International Conference Centre, his arms whirling energetically. It was Thursday 26 June 2008 and hundreds of shareholders had gathered to hear the board's reasons for supporting the proposed £4bn rights issue, which had been first mooted the previous April, a few weeks after the bank had been attacked by short sellers.

The bank's board, led by Stevenson, had told them the money was needed to provide a solid platform for HBOS's future growth and to strengthen its capital position.

Today, HBOS has been rescued from collapse by Lloyd's Banking Group and those investors are demanding to know whether the board gave them a full account of how parlous the bank's state really was when it asked them to put up new money. They may at last be about to get some answers.

In a circular published on 3 June that year, Stevenson reassured investors that he was "optimistic about the fundamental prospects of the company's core business", and that the bank was "well placed to deliver long-term sustainable growth". In an accompanying trading statement unveiled at the Edinburgh investors' meeting, HBOS added that performance was "satisfactory" and that "we look forward to a stronger second half year. For the year as a whole, we expect a resilient performance."

Stevenson, despite some visual nervousness, admitted the bank's share price was "horrible" but was putting a brave face on things and was adamant the proposed rights issue was going to be sufficient to see the bank through.

HBOS's shares had plummeted from more than £11 each in May 2007 to 276p, one pence above the rate at which they were being offered in the capital raising, which was being underwritten by investment banks Kleinwort Benson and Morgan Stanley.

Speaking to shareholders at the crunch meeting, Stevenson said: "The rights issue is absolutely right and will put us in a competitive position. We are saying performance will be satisfactory and resilient. Armageddon may happen, and we should be prepared for it, and we are. We are telling the truth; we are truthful people. But if we weren't, there's an army of regulators, auditors etcetera to make sure we are."

HBOS's chief executive, Andy Hornby, who has since become chief executive of Alliance Boots, added that the rights issue was "about making sure we've got real capital strength for whatever macroeconomic environment comes our way".

Hornby added that the fundraising would make HBOS "really strong versus all peer groups on a UK and European scale and therefore be in a position to take appropriate market share". Speaking to journalists after the meeting Hornby said the HBOS board was not concerned about the bank's exposure to commercial property lending.

"The important thing with any form of property lending is to make sure your collateral is right, and our average LTVs are considerably lower than average in residential property, and we try to do the same in commercial property." He suggested the average loan to value across its commercial property loan book was 65 per cent.

Hornby insisted that the capital raising was not a short term palliative but was being "done for the long term; this is our decision for the long term". He didn't answer a question on whether further rights issues might be necessary further down the line.

Neither the peer, who was HBOS's chairman from its formation as a result of Halifax's merger with Bank of Scotland in 2001 until the bank's rescue by Lloyds TSB last year, nor the retail whizzkid Hornby can have imagined the extent of the disaster that would destroy their bank a few months later.

However, this does not absolve them from blame. Many investors felt totally cheated and misled by Stevenson and the HBOS board given what happened to the bank a few months after that fateful Edinburgh meeting. Despite pressure from shareholders demanding to know whether the Financial Services Authority was investigating the events, the City's policeman has refused to give anything away. Now Lloyds Banking Group has done their job for them. On page 114 of its own rights issue prospectus published last Tuesday, Lloyds confirmed that the FSA is conducting a "supervisory review" into disclosures made by HBOS's former board at the time of its 2008 capital raisings.

Lloyds said the FSA's investigation is into the "accuracy and completeness of financial disclosures made by HBOS in connection with its capital raisings in 2008, including information as to corporate impairments disclosed in the circulars and/or prospectuses issued by HBOS in connection with such capital raisings. The group is co-operating fully with this review."

In the rights issue prospectus document published on 19 June 2008 HBOS said: "the company is of the opinion that, taking into account the net proceeds of the rights issue, the working capital available to the group is sufficient for the group's present requirements, that is, for at least the 12 months from the date of this prospectus."

But the bank was effectively bust by 18 September, a mere four months after the document was printed. The bank needed a rescue by Lloyds, which in turn needed an £11.5bn capital injection from the Government the following month.

The review by the FSA is focusing on whether Stevenson and the HBOS board omitted material information about the amount of bad and doubtful debt in HBOS's £116bn corporate loan book, which had been recklessly assembled by its former head of corporate, Peter Cummings, in the preceding few years. Cummings, who retired from the bank in a January with a £330,000 pension had exacerbated the position by taking equity stakes in many customer companies often based on pre-credit crunch prices.

The FSA investigators are also likely to want to establish whether the HBOS board did enough to warn investors of the risks associated with the bank's dependence on wholesale funding for 49 per cent of its £600bn balance sheet. The bank's former finance director, Mike Ellis, is understood to have been to Canary Wharf for an interview already.

John Hunter, a former company secretary at HBOS who is also a shareholder in the bank, said: "A year ago I asked both the Treasury and the FSA whether an investigation was under way. I welcome this confirmation that the sought-for investigation is now taking place and hope it will not just be limited to the documentation but also extend to the statements made from the platform by Lord Stevenson."

Lloyds has warned its investors that the FSA's review "may result in enforcement actions and public sanction, which could expose the group to an increased risk of litigation in addition to financial penalties and/or the deployment of such regulatory tools as the relevant regulator deems appropriate in the circumstances.

"The outcome of any regulatory review, proceeding or complaint against the group or the heritage HBOS group is inherently uncertain and difficult to predict particularly at the early stages and could have a material adverse effect on the group's operations and/or financial condition, especially to the extent the scope of any such proceedings expands beyond its original focus."

Under securities law, directors of companies who persuade investors to buy shares in their company through "untrue or misleading statements" could be liable to pay compensation to investors who lose out at a result, as could the companies concerned. That could arise in cases where a board conducted inadequate due diligence or omitted material information when putting a prospectus together.

"If the board is found to have misled the market, it could open the floodgates to hundreds of civil actions against Lloyds Banking Group," said one senior corporate lawyer.

Another expert warned that directors who engage in any behaviour likely to give a user of the market a false or misleading impression as to the price or value of an investment could face unlimited financial penalty and could be barred from being directors for life. If criminal proceedings were to follow, on the assumption that members of the HBOS board fraudulently misrepresented their bank's financial health, they could be jailed.

Paradoxically, at the Edinburgh International Conference Centre meeting in June 2008, Lord Stevenson lashed out at UK regulators for not doing enough to tackle white-collar crime, including stock market manipulation followed by short-selling, which is believed was one of the reasons that HBOS's shares had shed so much of their value.