M&A drama is on the rise, with battles underway over the troubled acquisition of ABN AMRO by Royal Bank of Scotland (RBS). Reaching near-Shakespearean levels, this plot is filled with stories of hostility, arrogance and greed, along with colorful characters like “Fred the Shred” (so dubbed by Fleet Street). Its legal themes include hostile acquisition, board business judgment, disclosure sufficiency, litigation, and government bailout. Like any good theatre, this one teaches profound lessons to its audience – and in our era of financial service consolidation and acquisition, one audience that should be paying close attention is that of acquisitive financial service executives. 

As background, a consortium of banks, including Fortis, Banco Santander and RBS commenced an unsolicited tender offer in April 2007 to purchase ABN AMRO for nearly $96 billion dollars, comprised of cash and stock.  For its part of the transaction, RBS offered £10 billion in return for ABN AMRO’s Global Wholesale and International Retail businesses. In addition, RBS also acquired the cash proceeds from ABN AMRO’s sale of LaSalle Bank. Former RBS Chief Executive Sir Fred Goodwin’s desire to prevent Barclays from acquiring ABN AMRO led him to make a sweeter bid, even though shareholders had expressed unease about further M&A deals. After a long bidding war with Barclays, ABN AMRO finally accepted the consortium’s bid because it was mostly in cash compared to the offer by Barclays, which was mostly in stock. 

RBS's M&A strategy raised financial concerns from the start, and these issues grew and continued to dog them.  Even before the closing, questions were raised around over-paying and business synergy.  These questions have now risen to the level of active litigation, with the acquisition a key element of shareholder litigation filed against RBS in the Southern District of New York including Lindsay et al. v. Royal Bank of Scotland Group PLC et al. and Raynor et al. v. The Royal Bank of Scotland Group PLC et al.  Both complaints relate to RBS’s offering of two categories of ADS shares and focus, among other things, on the role of the acquisition of ABN AMRO in the collapse in value of the company’s shares.  Plaintiffs allege violations of the securities laws, stemming from reassuring statements made by RBS officers and directions between June 26, 2007 and January 19, 2009.  According to plaintiffs, these statements were materially false and misleading, made to convince investors that RBS was well capitalized.

These lawsuits raised various M&A issues.  Disguised as securities litigation, the morals of these stories involve board-level business judgment, internal controls and disclosure duties.  A careful examination shows that, though not explicitly stated, undercurrents of failed fiduciary duty weave through the litigation complaints as well.  Specifically, plaintiffs point to the mis-begotten strategic M&A decisions which led RBS to allegedly overpay for ABN AMRO (thus creating excessive “goodwill”) and then mismanage the associated goodwill, adding insult to financial injury.  Plaintiffs further allege a lack of internal controls to catch the failures of the acquisition. While this partial acquisition of ABN AMRO was presented as growth opportunity for RBS, plaintiffs assert it was done to cover up the failure of RBS’s own business, itself practically insolvent due to impaired assets, bad loans and the “hubris” of CEO Sir Fred Goodwin.

According to the complaints, RBS’s failures were not limited to its acquisition strategies.  Its core business is assaulted in the litigation filings. The complaints point out the failures of RBS to fully disclose its exposure to the subprime mortgage markets, claim the bank didn’t record it losses properly, allege internal controls were insufficient to catch the improper recording and contend that its capital base was not enough to withstand the deteriorating aspects of the business. At its core, RBS’s business was flawed because of its own subprime exposure. ABN AMRO’s weaknesses further compounded those of RBS.

Disclosure problems persisted throughout.  Sir Fred Goodwin insisted on, and pushed for, the deal at the very top of the market.  Concurrently, RBS initiated an offering in June of 2007, exactly when the ABN AMRO acquisition was transpiring.  In its disclosures, RBS claimed that the merger would make great strategic sense and stated that the acquisition of ABN AMRO businesses would open up growth opportunities that would help drive strategic development.  In other offering documents, RBS stated that the ABN AMRO acquisition would allow it to leverage the combined businesses and even achieve cost savings.  Similarly supportive statements were made by Goodwin, among others, for months following the closing – despite analysts’ critique of the deal and its price.

RBS’s disclosures continued to be flawed after the deal was completed. RBS was persistent in its attempt to downplay the need to raise any more capital, but the company slowly began to leak information about its leaky financial position. In April 2008, RBS announced a £12 billion rights issue, but then it was revealed in May of 2008 that the SEC was investigating the bank over its exposure to subprime mortgages. Once the financial crisis was in full swing, news emerged that the British government was taking a combined 70% ownership interest of RBS through a bailout scheme to keep the company afloat. Additionally, RBS revealed $500 million in losses due to the Madoff scandal. Finally, in January of 2009, RBS delivered the final nail in its coffin when it reported that it expected to loose close to £28 billion, which plaintiffs assert are due in large part to the write off of goodwill associated with ABN AMRO. The upshot?  The company’s investors have been able to turn to the courts for legal redress.

The tragic story of RBS and the self-indulgence exhibited by its chief executive should serve as cautionary tale for future acquisitions, particularly in the financial services industry – where RBS’s irresponsible behavior led to one of the biggest losses in banking history. The financial services industry as a whole has a long way to go in restoring its credibility. As it attempts to do so, it can’t continue to go after the sweetest deals, but instead should focus on those which put shareholder interests first.  For the foreseeable future, we are likely to see continued consolidation within the financial services industry. Parties to these deals should be focused on performing detailed due diligence, cautious pricing and valuation, and very careful disclosure to investors and regulators.

Published: March 26, 2009