Lloyds Banking Group headquarters. Credit: Bloomberg Mercury

When a group of U.K. politicians submitted a complaint against Herbert Smith Freehills in early July it marked an unprecedented step.

The MPs and Lords, who form the All-Party Parliamentary Group On Fair Business Banking, alleged the firm had acted either unethically or incompetently in its advice to U.K. financial institution Lloyds Bank and submitted a complaint to the Solicitors Regulation Authority.

Such a public complaint about a top-tier law firm is rare and people familiar with HSF's thinking say the firm is less than impressed.

But what exactly are the claims, and how has HSF found itself in the firing line?

Law.com International gained sight of the 21-page complaint and spoke with various people involved in the long-running saga to find out what is being alleged and what is known so far.

Case Zero: The Reading Fraud

The matter starts with fraud over a decade ago by individuals in the impaired assets division at the Reading branch of Halifax Bank of Scotland , which was later acquired by Lloyds. 

In 2017, a court found the division head worked in collusion with a group of turnaround consultants to fleece small businesses and directors out of thousands of pounds, often leading to the bankruptcy of their businesses. 

Collectively, the group were convicted of a £245 million fraud which took place over a period of half a decade. In total, six people were jailed for a combined 47 years. 

The judge's verdict was damning, summarising it as: "an utterly corrupt senior bank manager letting rapacious, greedy people get their hands on a vast amount of HBOS's money and their tentacles into the businesses of ordinary decent people … and letting them rip apart those businesses, without a thought for the lives and livelihoods of those whom their actions affected"

But the ordeal does not stop with them.

Making Inquiries 

The question has remained: how much did Lloyds know about the fraud, and what actions did the bank take to mitigate it?

Until the conclusion of the criminal trial, Lloyds had maintained a position of ignorance, while a number of victims claim that the bank was aware of the fraud at an early stage, and did not investigate the failings taking place at HBOS. 

That issue itself is the subject of a private inquiry, instigated in 2017 by Lloyds Banking Group, and led by a former High Court judge, Dame Linda Dobbs. The inquiry findings are yet to be published, following a number of delays, with the current deadline expected at the end of this year. 

However, the APPG claims that it is concerned about the absence of investigation into HSF in the law firm's role as trusted legal adviser to Lloyds. The group of MPs allege in the 21-page report that HSF, in its advisory role to Lloyds, "appears to be unethical". 

They want the SRA to fill in the gaps which the Dobbs Inquiry might miss.  

Accusations Abound

Given the fraud took place in the mid-noughties, HSF's involvement in the HBOS fraud saga comes fairly late on, after HBOS' merger with Lloyds. 

The firm has a long-standing relationship with Lloyds, going back over a decade, according to the Law.com International news archive. 

But where and when the firm became involved in the fraud case itself is unclear. The earliest correspondence involving HSF on the matter seen by Law.com International is dated to 2014.

This was the same year the firm began acting for the bank in a dispute with its shareholders over the HBOS takeover in the same year – a legal battle which concluded in 2019 in the bank's favour.

The APPG levels three broad thematic claims against HSF regarding its advice for Lloyds; that it lacked professional independence; it prioritised short-term commercial objectives over "higher duties it owed as officers of the court"; and that it acted either unethically, or incompetently in its advice. 

The nature of investigations by the SRA mean it is very difficult for HSF to respond to its critics on these contentions, though a spokesperson for the firm said that it is "aware of the complaint and, while we are unable to comment on the detail of it, we are very confident in our position."

One person with knowledge of the process cast doubt on the APPG claims, saying they are based on "assumptions that are incorrect".

Compensating Losses

The APPG's primary complaint against HSF focuses on its alleged role in the fraud compensation review.

This scheme was established by Lloyds in 2017 after the conclusion of the criminal trial. The bank appointed an independent reviewer, Professor Russel Griggs, to assess the claims and pay out sums to those impacted. 

The scheme made awards worth over £102m to 187 companies' directors, but attracted criticism from victims who claimed the methodology was flawed and the bank was treating them unfairly. 

A review undertaken by Sir Ross Cranston, announced in parliament in December 2018, concluded the following year that the scheme constituted an "unacceptable denial of responsibility". 

The compensation scheme was re-opened after Cranston's report found the scheme's structure and implementation was neither fair nor reasonable, though it did not find it was unlawful.

The APPG alleges that HSF was likely "heavily engaged" in structuring the Griggs' review and implementing it, which resulted in these shortcomings. 

In the SRA complaint, the group states that the "structure of the review is very likely to have been agreed by LBG in consultation with HSF – if not in fact actually devised by HSF".

Criticism of the scheme also centred on the fact that the bank only paid out to victims for distress and inconvenience, rather than direct or consequential losses for fraud losses – a move that Cranston concluded made it seem like the bank was the only financial victim of the fraud.

HSF, the APPG alleges, was likely responsible for the design, which they claim was either an intentional creation, or resulted from a failure to foresee the problems due to incompetence.

The extent of HSF's involvement in the scheme is still not entirely clear. One person familiar with the matter said that the process was run by the bank, not HSF, and that the firm did not design or run the scheme. They said customers were independently advised and that every outcome was approved by an independent reviewer.

They added that Lloyds took advice on particular issues from a number of different professional advisers and these advisers included, but were not limited to, HSF. 

Correspondence sent by HSF to one person on the compensation scheme in 2018, and seen by Law.com International, suggests that HSF acted for the bank in some capacity on the scheme.

The firm stated in the letter: "We can confirm we were instructed by the LBG review" in relation to participation in the scheme.

In another case, one victim of the fraud, Paul Pascoe, says that he has been in dialogue with Lloyds Banking Group since January regarding an approach to a settlement, and that the bank has not denied HSF's involvement in the scheme. 

Pascoe added that the bank proposed entering a mediation with him, but refused to use any other legal advisers for that process other than HSF. 

Lloyds Bank did not respond to requests for comment.

Access Denied

The second allegation raised by the APPG against HSF focuses on what it describes as a "culture of denial". The group questions whether HSF helped mislead authorities regarding whether the bank had knowledge of the fraud. 

At the heart of this matter is a report written in 2014 by Sally Masterton, a Lloyds senior manager in the bank's credit risk oversight division on behalf of Lloyds. 

Her report put forward allegations of wide-spread fraud in the HBOS Reading division that she said needed to be investigated. 

Masterton herself left Lloyds soon after the report was finalised, settling with the bank shortly afterwards. 

In two letters seen by Law.com International, the bank dismissed Masterton's report and said no further investigation would take place. 

In a further letter from HSF to the Financial Conduct Authority, re-printed in the SRA complaint, the law firm claims that the Masterton report claims that "the draft report was not commissioned by LBG. Rather, it was undertaken by Ms Masterton of her own volition."

In 2018, Lloyds retracted this position, admitting in a settlement agreement with Masterton that the report was commissioned by the group. 

The APPG questions the extent to which HSF knew that the report had been commissioned by Lloyds when the statements were made, whether it knowingly made falsehoods to the regulator and whether it took any steps to correct the record.

Another person with knowledge of the matter said the issue is complicated and claimed that HSF's understanding is likely to have been that Masterton had told the bank of concerns which it asked her to put down in writing.

What next? 

Summing up its grievances, the parliamentary group sought assurances from the legal regulator regarding HSF's activity throughout the Lloyds/HBOS saga, particularly relating to the compensation scheme and its handling of Sally Masterton's report.

The regulator is still investigating a previous claim against the firm in January 2019, a copy of which has been seen by Law.com International.

That complaint also focuses on both Lloyds and HSF's treatment of Sally Masterton, which the APPG claimed to have "serious concerns" over. The letter concludes by asking the SRA what it can do to hold law firms accountable for their advisory actions.

The 2019 complaint also focuses more broadly on the use of non-disclosure agreements between the bank and those on the compensation scheme, with the parliamentary group asking the SRA to set out its position on the use of "gagging clauses" under British law. The SRA launched a consultation on this matter four months after the complaint was filed.

An SRA spokesperson said: "We continue to investigate before deciding on any next steps."

According to HSF, the SRA is in the initial stages of its inquiries, which the firm itself is assisting with.