Did Lloyds Deceive Shareholders?

Remember the court scene in the movie A Few Good Men where Tom Cruise (as Lt. Daniel Kaffee) tells Jack Nicholson quite blatantly: "I want the truth!"? I can imagine shareholders in the place of Cruise, demanding the truth from management when firms misled them. The bank under question now is British stalwart Lloyds (NYS: LYG) , which is being sued by U.S. shareholders who claim the bank misled them when it took over fellow lender HBOS during the financial crisis of 2008. Lloyds has had quite a forgettable 2011, and this news comes as quite a setback at the very start of the new year. Let's dig in a little deeper.

Shareholders feel hoodwinked
Former Chairman Victor Blank and former chief executive Eric Daniels, along with the bank's board, have been charged with "reckless disregard for the truth." While Lloyds was making the HBOS purchase, Daniels claimed that it was a "fantastic opportunity to create the U.K.'s leading financial services group and create great value for both sets of shareholders." But a few weeks into it, Lloyds had to seek government aid -- the bank got $26.4 billion by surrendering 43% of its stake. The extent of the financial problems the bank was grappling with was thus unknown to shareholders.

Investors claim they were kept in the dark about declining HBOS finances up until February 2009, when Lloyds posted a staggering loss of $15.4 billion. According to lawyers, HBOS was technically insolvent and had to depend on the Bank of England and the U.S. Federal Reserve Bank for funding in order to keep its head above water. This information was apparently not shared with the investors, thus the brouhaha. Bank of England Gov. Mervyn King claimed that without state aid, HBOS would not have been able to survive.

Coming back to the movie, Jack Nicholson shouts back to Cruise: "You can't handle the truth!" Well, the truth did stare shareholders right in the face and was indeed very difficult to handle. Shareholders reportedly lost nearly $21.6 billion (14 billion pounds) as Lloyds' shares crashed following the HBOS acquisition. These shareholders, who include nearly 1,400 U.S. residents as well as various institutions, may just seek amends. If investors were in the know, couldn't have this been avoided? Who knows?

The consequences
U.S. laws are quite clear on the costs of withholding information from shareholders while purchasing shares. Lloyds, which got listed on the NYSE back in 2001, is required to disclose company information. If the Securities and Exchange Commission takes it upon itself to probe further, it may impress heavy fines upon Lloyds. That isn't unheard of. Not so long ago, Goldman Sachs was made to pay a $550 million fine because it apparently misled investors while promoting subprime mortgages. So Lloyds has a lot to be wary of.

Not much is going well for the London bank. It lost $6.3 billion in the first nine months of 2011, as it had to pay a $5.1 billion fine for selling customers faulty payment protection insurance. (What has it been up to? One wonders.) To top it all, CEO Antonio Horta-Osorio, who arrived from Banco Santander to help script a turnaround, couldn't handle the pressure and went on an indefinite leave, citing stress and exhaustion. Much was expected of Osorio, who had earlier combined a number of struggling British banks under Santander's U.K. wing and helped mastermind their turnaround. His absence definitely left a big void at the top. The lawsuit couldn't really have come at a worse time and further tarnishes Lloyds' image.

But there is a bit of good news as well. Osorio returned earlier this week after a nine-week absence. Hopefully, the return of its charismatic CEO will make the new year a little better for the troubled British bank.

Fool contributor Shubh Datta doesn't own any shares in the companies listed above. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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