The Financial Conduct Authority (FCA) has been criticised for allowing Lloyds Banking Group to set up a “flawed” compensation scheme for victims of a massive fraud.
The SME Alliance, which represents small firms ruined in the fraud, has filed an official complaint with FCA.
It accuses Lloyds of covering up its awareness of criminality and excluding some victims from compensation.
Lloyds said it believes its voluntary scheme is fair.
The bank also said it is reviewing whether the fraud was properly disclosed with the help of a High Court judge.
The compensation scheme was announced after the January 2017 convictions for fraud, corruption and money laundering of six people including two former bankers of HBOS, a subsidiary of Lloyds.
The £245m scandal targeted small business customers, who were typically forced out of their firms and ruined.
Lloyds’ chief executive Antonio Horta-Osorio said he was “absolutely determined” that victims were compensated “fairly” and “swiftly”.
The bank set up a review with the agreement of Andrew Bailey, chief executive of the FCA.
However, the financial watchdog left it up to Lloyds to judge which victims were eligible and how much compensation to pay.
Lloyds says it has made an offer to all 71 victims included in its review.
However, the SME Alliance said some victims have been excluded from the review altogether, with no realistic means of challenging the decision.
It says other victims have died awaiting compensation while some have been given an offer of zero and many feel short-changed.
The SME Alliance has obtained legal advice from Jonathan Laidlaw QC that the review, which the bank claims is independent, is inadequate because the bank selects which victims to include and exclude is therefore judging matters in which it has been culpable.
It said: “The review currently operating to redress the wrongs is procedurally defective.
“The methodology and guiding principles are flawed and appear partial to the bank’s interests. The scope of the review and Lloyds Banking Group’s selection of participants remains unclear, and there is no right of external appeal or oversight from the FCA.”
While the FCA does not regulate commercial lending, it does have power to regulate the conduct of Lloyds Banking Group as a listed firm.
It also oversees the Senior Managers Certification Regime which governs the conduct of top bank executives.
Representatives of the victims of the fraud accuse Lloyds of seeking to limit its exposure to compensation claims by claiming the bank had no knowledge of criminality until 2017.
But there is documentary proof that both Mr Horta-Osorio and chief operating officer, Juan Colombus, were aware of criminal allegations in 2012 and were warned in a 2014 report by one of their own employees that Lloyds was knowingly covering up serious criminal conduct.
The 2014 report, titled Project Lord Turnbull, was written by forensic accountant Sally Masterton, a senior manager in Lloyds’ risk division who was helping Thames Valley police with inquiries into the fraud.
Ms Masterton, who had worked at HBOS before its takeover by Lloyds during the financial crisis, had access to the banking group’s internal records.
Her report found the fraud was “deliberately concealed” and went far beyond the matters investigated and tried in 2017.
A spokesman for Lloyds Banking Group said: “We firmly believe the review was the right approach to secure compensation for victims of the HBOS Reading fraud.
“The review is a voluntary process put in place by the group with the clear objective of providing fair and reasonable compensation for customers in a way which was quicker and less expensive than through a court process. We believe this objective has been fulfilled.”
While the FCA does have oversight of Lloyds Banking Group as a listed entity, the watchdog says it has no formal involvement in the voluntary review.
A spokesman said: “We continue to engage with Lloyds Banking Group and customers affected. In 2017 the FCA announced it had resumed its investigation into events surrounding the HBOS . That investigation remains ongoing.”