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LONDON (Reuters) - One morning in May, the chief executive of Royal Bank of Scotland, one of Britain's biggest banks, called together his senior executives for an urgent briefing. Ross McEwan had just attended a meeting with officials at the financial regulator and had important news.
"I think they've found something," he said, according to three sources with direct knowledge of the meeting.
McEwan was referring to the regulator's investigation into claims by customers that RBS, once a colossus with a balance sheet nearly twice the size of the British economy, had deliberately pushed small businesses to bankruptcy so it could pick up their assets cheaply.
For three years, the bank has vigorously denied the allegations about its Global Restructuring Group (GRG).
But the meeting at the Financial Conduct Authority (FCA) convinced McEwan outright denial was no longer an option, according to insiders. Now, they say, the 300-year-old lender is considering a compensation scheme for small firms – from tyre makers to nursing home operators – which say GRG abused them or forced them out of business.
The cost to the bank, rescued during the financial crisis by British taxpayers, could run to billions of pounds. But bank executives hope the step might help draw a line under the mounting tally of blunders and alleged wrongdoing which has dogged RBS since 2007, crippling its reputation, impeding its recovery and delaying government plans to re-privatize it.
Of the many scandals that have entangled RBS in recent years, executives say McEwan feels the GRG allegations have been most damaging. McEwan, who became chief executive at RBS in 2013, is trying to refocus the bank. He has closed or sold its investment banking operations and wants to place small-business customers at its heart, recasting it as a predominantly domestic lender that supports Britain's economy.
Asked to comment on the bank's plans, Jon Pain, RBS's Chief Conduct and Regulatory Affairs Officer, said the bank is cooperating with the regulatory investigation. "We have no plans for any redress scheme in relation to this matter," he added.
The sources within RBS agreed there are no specific plans for a redress scheme yet. But they said there has been a change of thinking in recent months. The bank's board will make a decision on possible compensation after the regulator's report is published, they say, and it has hired external advisers to make sure it is fully prepared.
The FCA declined to comment on the scope of its investigation, but reiterated an earlier statement that it expected to complete its review of RBS by the end of the year.
RBS could offer compensation without admitting liability, lawyers said. Even this would be "a real seismic change," according to Dean Nicholls, a partner at law firm Gordon Dadds. He has acted for several clients in cases against GRG and says he learned of the bank's thinking through legal circles.
"They seem to be taking a completely different approach, perhaps driven by a combination of what's been happening at a political level and the FCA's position," he said.
Paying customers off could avoid costly litigation, which includes a possible class action from hundreds of businesses.
Dean D'Eye, a bankrupt property developer, is one potential claimant. He says he wants to pursue a claim against RBS for "millions of pounds." He alleges the bank's NatWest division pushed his business into GRG without his knowledge and unfairly called in all his debts at no notice.
"It's not just the money," he said. "For what they put me and my family through I want an apology and an annulment to my bankruptcy. I would rather expose them for the diabolical liberty they have taken."
RBS declined to comment on his case.
A compensation scheme would make the bank's risks clear, which could also help Britain's Finance Minister George Osborne sell more of the state's shares in RBS. The bailout in 2008 and 2009 cost a total 46 billion pounds ($70 billion). The ministry sold off a first batch of stock in August, taking a loss of more than 1 billion pounds as it cut its holding to 73 percent.
The shares are now trading at 313 pence, leaving taxpayers with a current loss of around 16 billion pounds on their remaining stake.
The finance ministry declined to comment.
The RBS division that became GRG was set up in the early 1990s to take troubled businesses and help turn them around.
After the financial crisis – which Britain's government blamed in part on the failings of RBS's past management – GRG was seen as part of the solution to the bank's problems.
The fees it collected helped offset RBS's bad debts and improve the bank's capital strength. At its peak in 2010, GRG handled tens of thousands of British businesses with a combined value of around 90 billion pounds. That's twice as much as the state spent to bail out the bank.
Starting in 2008, complaints trickled out from small businesses which said RBS had forced them into dealing with GRG. They claimed that GRG had undervalued their assets and imposed punitive fees.
The complaints were often posted on social media and at first made no impact. They were eclipsed by other allegations and accidents, including RBS's part in attempts to rig foreign exchange and interest rate markets, and a U.S. investigation into its sales of bonds backed by home loans. The bank also drew flak over its reluctance to cut executive pay and a software glitch which disrupted customer payments.
By 2013, Osborne was pressuring the bank to clean up the messes and focus on domestic lending. McEwan, a New Zealander with a decade's experience in retail banking, was seen as best-placed to do the job.
Though softly spoken, McEwan, a 6-foot-2 supporter of New Zealand's All Blacks rugby team, has brought a new down-to-earth dynamic to the bank, insiders say. On his appointment he told one newspaper his goal was to make RBS number one for customer service by 2020.
He was barely a month into the job when a report surfaced which made that goal look tough. Compiled by Lawrence Tomlinson, a businessman from the north of England employed by the government as an "entrepreneur-in-residence," it zeroed in on the complaints about GRG and alleged that RBS had systematically set out to break its small business customers to generate profits for the bank.
Tomlinson said RBS "artificially" distressed otherwise viable businesses and put them on a journey toward administration, receivership and liquidation. Once in GRG, they were tipped toward insolvency and the bank bought up their assets "at cut prices." He later told members of parliament that more than 1,000 companies had come forward alleging "morally wrong" treatment by GRG.
The report "came as a major shock” to the RBS board, said a senior RBS source. The bank denies the allegation that it systematically abused small businesses.
RBS asked law firm Clifford Chance to undertake a "thorough and independent review." After five months, Clifford Chance found no evidence for the allegations. RBS welcomed the report, for which it had paid 1.5 million pounds.
Britain's regulators also acted. Bank of England Governor Mark Carney told parliament the FCA should conduct an investigation into what he called the "deeply troubling" claims. The FCA said it would publish its investigation in late 2014. Britain's Serious Fraud Office said it may launch its own investigation after the FCA.
Pressure was mounting. Scottish businessman Neil Mitchell brought together more than 370 firms which believe they have a claim against GRG. The group is planning an "unlawful means conspiracy action" case against the bank and four individuals, alleging they conspired to perform illegal acts.
"There's a growing groundswell of potential claimants. More and more people are coming forward," Mitchell said.
RBS executives were called to appear at a parliamentary inquiry into Tomlinson's allegations in June 2014. They said GRG had not become a "profit centre" for RBS. But five months later, RBS chairman Philip Hampton wrote to the committee to retract that statement and apologize for what he called "misleading" evidence. He said GRG was a profit centre; the RBS executives had made "an honest mistake."
In August 2014, RBS said it was closing GRG. Hampton and two executives who appeared before the committee have left RBS.
More than a year later, the FCA's review has yet to be published.
On the morning of May 8, McEwan ordered a driver to take him from RBS's office at Bishopsgate in the City of London to the FCA's concrete and glass headquarters in Canary Wharf.
Britain was waking up to a surprise election outcome. The Conservative Party had increased its majority and could govern the country on its own. For McEwan, that meant Chancellor Osborne, the man who had backed him to reinvent RBS as a trusted stalwart of the entrepreneurial economy, would remain in office and keep pushing to sell RBS.
As well, The Times of London had just published a report which appeared to back Tomlinson's claims and went even further, suggesting RBS had forced companies into default to help it keep its own capital ratios healthy. The bank had denied the allegation, but McEwan urgently needed clarity from the regulator about when it was going to publish its report.
At the meeting, McEwan pushed the FCA officials to publish their review as soon as possible, three sources with direct knowledge of the meeting said.
What he heard in reply left him "spooked" and convinced that the regulator would take punitive action against the bank, one of them told Reuters.
The FCA, which had already reviewed evidence submitted by Tomlinson, had asked to see thousands more documents, one of the sources said. Its investigation had been extended and would be "broader and deeper" than the bank had expected.
The review would not be published until the end of 2015 at the earliest, meaning speculation about its findings would persist.
That, the sources said, would make it harder for the government to sell RBS stock, because a sale prospectus would have to detail all of the bank's outstanding risk relating to past misconduct and litigation.
"In any sale, if something bad happens after, you risk criticism," said a source directly involved in the sale of the government's stake. "If you wanted to wait (until) there were no grey clouds on the horizon, I think you'd be holding this stake for much, much longer than you would want to," the person added.
It was at a board meeting at the end of May that RBS directors decided to change strategy, insiders said. The directors agreed to hire external advisers, officially to assist with the bank's response to the FCA's investigation, but also to prepare a scheme to compensate GRG customers.
The advisers - accountancy firm PwC and legal firms Denton Wilde Sapte and CMS Cameron McKenna – declined to comment on their remit.
The inside sources said the bank is preparing for a multi-billion pound bill at most. Some lawyers doubt it will ever cost that much. Many of the firms GRG dealt with no longer exist, so their former owners won't be able to claim compensation.
And firms that have survived would have to claim what are known as consequential losses. These take into account missed opportunities, to try to take businesses back to where they were before an alleged wrongdoing.
Claimants have to demonstrate missed opportunities, slower growth, soured business relationships or even ill health brought on by financial difficulties. None of these are easy to prove.
And even if RBS goes ahead with a compensation scheme, not all its former customers would sign up. D'Eye said he, for one, would not: "I will never trust a bank again in my life."
Edited by Sara Ledwith and Simon Robinson