Rato and the preferred shares: The story of a legal (and perfect?) fraud

Trading companies (banks and companies) need funding to work. To obtain funding, they offer investors two types of papers.

The first type of paper allows investors to take decisions about the company. For public limited companies, this is known as a “stock share”. The more money you give to the company, the more stock shares you receive and the more weight your opinion has. Therefore, the success of the trading company depends on the decisions taken by the shareholders.

(Articles of the Legislative Royal Decree 1/2010, Spain’s Official Bulletin of July 3rd 2012: Article 90. Shares and stock shares. Shares in limited liability companies and stock shares in public limited companies are aliquot, indivisible and accumulative parts of the share capital. Article 91. Gaining shareholder status. Each share or stock share provides its legitimate holder with the status of shareholder and grants the rights specified in this law and the articles of association, such as the right to vote.)

The second type of paper (called “bond” or “non-voting share”) is a simpler option. Investors do not take decisions about the company; instead they receive interest on their money. If the company fails to pay interest, investors gain decision-making power and can, for example, dismiss the managers who did not pay them. Therefore, managers are forced to be profitable in order to avoid being dismissed by investors.

Article 98. Creating and issuing.

  • Limited liability companies can create bonds for a nominal value not higher than half their capital, and public limited companies can issue non-voting shares for a nominal value not higher than half the paid-up share capital.

Article 99. Preferred dividend.

  • Holders of shares and non-voting shares have the right to receive the minimum yearly dividend (fixed or variable) established by the articles of association. Once the minimum dividend is established, the holders have the right to obtain the same dividend that corresponds to shares or ordinary stock shares.
  • If there is distributable profit, the company must distribute the minimum dividend, as explained in the previous paragraph.
  • If there is no distributable profit, or if it is not enough, the unpaid portion of the minimum dividend must be paid within the five following years. As long as the minimum dividend is not paid in full, shares and non-voting shares have this right with the same conditions as ordinary stock shares, and they always keep the economic benefits.

Article 401. Issuing company.

  • The public limited company and the partnership limited by shares can issue numbered series of bonds or other securities that acknowledge or create a debt.

In the early 90s, trading companies known as “banks” or “credit institutions”, which engage in buying and selling funds (money), wondered how to invent a new type of paper that would allow them to stop paying back investors without these being able to dismiss them or recover their money. Free money without conditions, the dream of every fraudster.

The strategy was very original. The bank would create subsidiary (bogus) companies, and these would issue the new papers. Investors would buy the papers and the money would be siphoned off to the parent company, the bank. However, the investor would not receive any rights from the parent company. To close the loop and dodge the (few) guarantees of the Spanish legal system; these subsidiary companies would be registered in tax havens. In case of non-payment, the poor investors would be facing a wall: a bogus company in a country with an unknown legal system and no chance to claim or take action against the bank which now has their savings.

No legislator in their right mind would have allowed this chaos, and by no means would have legalized it.
None?  No.  Here comes into action our friend Mr. Rato.
In 2003, Rodrigo Rato was the Vice-President of the Spanish Government and the Minister of Economy. He knew that banks needed funds to continue feeding the housing bubble, which was full steam ahead at the time, so he decided to legalize the invention.
To this aim, his Ministry prepared a reform of the Law 13/1985, dated May 25, on investment ratios, equity and information obligation of financial intermediaries. This reform mentions, for the first time, the cheating papers, called “preferred shares”, but it does NOT define them, it does not state what they are in Commercial Law. It just says that these exist, and that banks can consider the funds obtained selling them as their own capital.
Basically, this is what Mr. Rato’s law says:

    • Preferred shares must be issued by trading companies created by banks for this purpose only. It explicitly forbids doing this from tax havens, but it does not specify what happens with preferred shares already issued from tax havens.
    • The funds that the subsidiary companies receive become right away a part of the bank’s own capital and, therefore, are affected by the business results of the bank. The Administrative Board of the bank rules the subsidiary company, but the investor does not gain any decision-making power over the parent bank.
    • In spite of the interest and conditions agreed upon between the investors and the bank, the bank can unilaterally stop paying the investor, for an unlimited period of time and without building up debt.
    • Preferred shares can be quoted, bought and sold on the stock exchange market.
  • Law 13/1985, dated May 25th, on investment ratios, equity and information obligation of financial intermediaries. Article 7 and second additional provision, consolidated text, Spain’s Official Bulletin of May 28th 1985*

In short, Rodrigo Rato legalised this fraud instead of stopping it. This was excellent news for banks, since it gave preferred shares a government guarantee, which made more naive people invest in them without worrying, although they did not understand what they were buying.

Everybody was happy until the bubble burst and the crisis arrived, and preferred shares’ investors tried to recover their money. Then they understood that it was a trap: they had bought nothing; they had just given away their money to the bank.

Of course, they took legal action against the banks, claiming their savings back, arguing that nobody had explained the fact that what they were really doing was donating their money, virtually forever.
Since this is really what happened, and they were massively tricked, many claims were admitted and judges started handing down judgements in favour of the people, forcing the banks to return the funds, which made the powerful (banks, ECB, EU, etc.) very nervous.

All of a sudden, the magic paper that provided exceptional funding could become a flaw in their plans to exploit the State.
Cash injections to banks, financial rescue packages and the austerity measures that they entail: all this would be jeopardised with a flood of legal sentences forcing banks to return the money to the tricked investors.

So when our fearless Mr. Rato became a “banker” with problems, Rajoy’s Government decided to defend him. Proving their submission to the merchants and leaving citizens defenceless, they took advantage of the summer holidays to definitively armour the legal scam of the preferred shares.

By means of Spain’s Official Bulletin (Royal Decrees dated July 14th and August 31st – note the “stealthiness” of these dates – and the following reforms), the Government authorized banks to cancel the payment of interests to preferred shareholders in a even more flagrant way.

Stock shareholders and preferred shareholders are now on the same level to bear the bank’s losses. Access to court is now harder for those affected by the scam, and to top it all, if a favourable sentence is handed down, the Fund for Orderly Bank Restructuring (FROB by its Spanish initials) is able to prevent the sentence from being executed.

To sum up, one can say that, from Rato’s 2003 reform to the recent decrees of the current government, a whole legal structure was created tailored at allowing commercial and savings banks to collect funds from people, for free, not return them and not have ANYTHING happen to them.

However, they did not take into account that people are not that gullible, and that we, all together, can detect the flaws in their legal structure and thwart it. We will not stop until they are all behind bars and pay back what they stole from us…

… €uro by €uro, step by step, Rato by Rato.

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