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Apr 30, 2009

M&A focus: NEDs role under question

An examination of the role NEDs played in financial mergers in the UK

Legendary investor Warren Buffet once remarked that it’s only when the tide goes out that you get to see who’s been swimming without trunks on. This neat analogy loses some of its appeal, however, when you consider that many of those stranded in the buff by recent global economic events are the aging inhabitants of the UK’s boardrooms.

Those under particular scrutiny at the moment work – or worked – in the UK’s financial services industry. They put their shaky seal of approval on deals that went badly wrong, first at Royal Bank of Scotland (RBS), when it took over ABN Amro at the top of the market, and then at Lloyds, which has struggled to remain afloat after absorbing the UK’s biggest lender, HBOS, earlier this year.

Boards are supposed to put a check on reckless deal making, especially the non-executive directors (NEDs) who are there to ask questions on behalf of shareholders. But they didn’t, or couldn’t. (Some feel the City grandees who man these roles were intimidated by bullying CEOs.) Either way, the role played by NEDs in Britain’s banking fiasco is now a matter of public debate.

Some attack NEDS for failing in their basic duty to protect shareholder value, as the deals they waved through have caused so much damage. RBS’ purchase of ABN made up a big proportion of its record loss of £25 bn ($37.3 bn), the biggest in UK corporate history, while Lloyds’ rushed merger with HBOS saw the bank take a hit of £10 bn. Both RBS and Lloyds are now majority-owned by the UK government.

It’s an easy argument to make with the benefit of hindsight. But what of the 95 percent of RBS shareholders who also backed the ABN bid? Or the UK prime minister, who personally encouraged Lloyds’ chairman, Sir Victor Blank, to pursue the acquisition of HBOS when the two met over drinks at what has since been described as ‘the most expensive cocktail party in history’? Surely the blame must be spread more widely. You can’t pin it all on the NEDs.

Even NEDs, however, admit things are not working quite as they should. In a recent survey of board members by remuneration consultants MM&K and boardroom recruitment firm Hanson Green, two thirds of NEDs admit they are  not sure they have the power to control chairmen and CEOs.

One suggestion that would boost NEDs’ ability to challenge the executive team is for banking directors to get special training for the role. Ex-HBOS chairman Lord Stevenson made this point rather well at the UK Treasury Select Committee’s hearing into the banking crisis earlier this year.

Given the complexity of modern finance, he said, non-executives at banks should be prepared to put in extra time to get to grips with how things work. Only then could they hold management to account.

If taken up, this would mark a turning point for UK corporate governance. Previously directors were valued more for their independence than their competence. Now the Financial Services Authority (FSA), the UK’s financial watchdog, appears to be leaning the other way, according to Ken Rushton, a fellow of the Institute of Chartered Secretaries and Administrators. ‘The FSA might also move toward more enforcement action against incompetent non-executives, putting the onus on individuals rather than companies,’ he says.

NEDs cowering in the shallows should take note.