“ONLY WHEN THE tide goes out do you discover who’s been swimming naked,” goes the now-hackneyed quote by Warren Buffett.
But the tide was high and rising in the latter months of 2019 when the Central Bank of Ireland interviewed Davy Stockbrokers executives as part of its long-running investigation into a controversial bond sale. Although the company isn’t required to file annual accounts, Davy enjoyed retained earnings of €123 million at the end of 2019 with total assets on its books of over half a billion euros, according to the Business Post.
Davy was a well-respected and profitable outfit in an Irish economy that had regained much of its pre-crash lustre. Normal service had resumed after the upheaval of the early part of the decade.
Just two years later, chief executive Brian McKiernan, deputy chairman Kyran McLaughlin and others have resigned.
Its bonds desk has been disbanded; its authorisation as a primary dealer of Irish government bonds has been removed by the National Treasury Management Agency; and the firm’s board has decided, amid a spiralling scandal, that the only way to save Ireland’s largest brokerage is to put it up for sale.
All of this a little over a week after the Central Bank revealed the findings of its probe, which began in 2016, and slapped Davy with a €4.1 million fine for four breaches of European Union market regulations.
Bond deal
The Davy scandal could have been engineered in a lab specifically to trigger our national post-traumatic stress disorder about the bad behaviour of financial services firms.
It involved a major Irish brokerage, a secret deal, a Maple 10 developer and, for good measure, the sale of Anglo Irish Bank bonds.
What the regulator uncovered was a plan, concocted by a group of 16 Davy employees including senior executives, to profit from the sale of the bonds on behalf of a client, developer Patrick Kearney.
Kearney had approached the firm to handle the sale, the cash from which he would use to settle a debt owed to a vulture fund and any profit split between him, the firm and his advisor, LeBruin Private.
What Kearney didn’t know is that the group of 16 were also on the other side of the transaction as buyers. An internal executive committee gave the go-ahead for the deal, allowing it to slip by the firm’s internal compliance framework, which likely would have raised red flags about the obvious conflicts of interest at the heart of the arrangement.
The transaction “highlighted a weak internal control framework within Davy in relation to conflicts of interest,” which “served to create an elevated risk of investor detriment”, the Central Bank said in its enforcement notice last week.
Worse still, Davy initially failed to disclose the full extent of the wrongdoing.
It was only after the commencement of the investigation that the Central Bank realised the extent of the inaccurate information provided. In particular, the information provided by Davy was presented in such a way as to make the involvement of certain individuals appear more central to the transaction than in fact was the case.
“This lack of candour was treated as an aggravating factor in this case,” the Central Bank said.
Despite this, the fine was ultimately reduced from €5.9 million down to €4.1 million because Davy agreed to an early settlement.
A decade of reflection
Immediately, the story raised ghosts from the ‘bad old days’.
“Of course, I’m particularly concerned,” said Minister for Finance Paschal Donohoe shortly after the Central Bank’s announcement, “that this incident occurred in the period after the financial crisis, which was a period during which we reflected much and commented much on the standards of behaviour that we expect within our financial services sector.”
If anything, though, the Davy scandal has shown that the State’s ability to hold individuals to account is lacking, despite a decade of “reflection”.
Undoubtedly, from a regulatory perspective, the environment has improved substantially since the crash, says Professor Blanaid Clarke, McCann Fitzgerald Chair of Corporate Law at Trinity College Dublin.
“There have been changes in terms of enforcement since the banking crisis both nationally and internationally. A lot of this has been led by the EU,” she explains.
“They have introduced new regulations, new requirements in terms of fitness and probity and accountability, new requirements in terms of risk management’s new requirements in terms of capital.”
But this week, Central Bank officials made it clear that regulators need an expanded toolkit to be more effective.
Speaking to the Oireachtas finance committee, Derville Rowland, director general of financial conduct at the Central Bank, said the legal framework “requires further strengthening with regard to individual accountability”.
In 2018, in the wake of the tracker mortgage scandal, the Central Bank produced a report that “indicated a renewed focus on culture”, explains Professor Clarke.
Contained within it was a recommendation for a new Senior Executive Accountability Regime (SEAR) that would allow the Central Bank to pursue individuals working in regulated companies and hold them accountable for wrongdoing.
“At the moment, under the current administrative sanctions regime, the Central Bank can investigate individuals and sanction them but only if they have participated in the wrongdoing, belonging to the firm,” she says.
How it works then means you have to prove the wrongdoing of the firm before you can look to the individuals. What [The Central Bank] has proposed is breaking that link and the effective way of breaking it would be SEAR.
It also means that regulated companies would have to provide a statement of responsibility for each individual working there. For the regulator, the advantage of that “map of responsibilities” Professor Clarke says, is “they can see immediately, if there is an issue, who to go to”.
Three years after the Central Bank first recommended the changes, the Government said this week that it plans to prepare legislation on the implementation of SEAR before the summer.
Criminal reports
In the meantime, Davy’s board confirmed on Thursday evening that it plans to sell the business. “The Board of J&E Davy has decided to pursue a sale of the Group. Rothschild & Co has been appointed as financial adviser to manage the process,” read the terse press release.
It’s widely expected that Bank of Ireland is in pole position to swoop in and buy the firm, which the bank actually sold in 2006 for a reported €350 million.
Huge question marks remain about the board’s handling of the scandal, however. Key board members like chairman John Corrigan, a former chief executive of the National Treasury Management Agency, remain in situ despite the resignations of senior executives and directors.
Corrigan, who has chaired Davy since 2015, has been tasked with cleaning up the mess and repairing the firm’s reputation in the wake of the scandal.
As for the group of 16 behind the bond sale, the Central Bank made clear this week that the story isn’t over.
During the week, Derville Rowland was clear that further investigations by other State agencies remain a distinct possibility. Although she said the Central Bank did not refer any information about Davy to the gardaí, she said it had “tentative engagement” with unnamed agencies about further probes into the matter.
“Now that the details are out, we are prepared to engage with other authorities,” Rowland told the committee although she was clear that Central Bank investigators did not form the view that there were “criminal reports” to be made.
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