Does Co-op Group deserve to keep control of Co-op Bank?
Holders of Co-op Bank's preference shares and subordinated bonds are revolting over Co-op Group's plan to convert part of their investment into ordinary shares and force big losses on them.
It is all getting a bit messy, for the Co-op Group, and for the regulator, the Prudential Regulation Authority (PRA).
Today a group of retail investors in these preference shares and bonds, co-ordinated by Mark Taber, has written to Andrew Bailey, head of the PRA.
They raise a couple of potentially embarrassing questions for Mr Bailey and the Co-op.
First is whether there was a false market in Co-op preference shares and bonds for the best part of a couple of years.
You may recall that I wrote back in May that the PRA's predecessor, the Financial Services Authority, had at the end of 2011 told Co-op Bank that its ambition to buy more than 600 branches from Lloyds in the so-called Verde deal was dependent on it improving its capital ratios, management and governance, inter alia.
Now Mr Bailey confirmed to MPs only a few days ago that this is indeed what the FSA had done.
Here is the thing.
If Co-op had been told of these deficiencies by the regulator and instructed to rectify them, shouldn't the Co-op have passed on this information to holders of its bonds and preference shares?
A ruling by the regulator that a bank does not have enough capital, for example, plainly has implications for the value of bonds and preference shares.
It is, to use the jargon, price-sensitive information.
So shouldn't the Co-op Bank have told its investors that it was a weaker bank than they may have believed?
Now as it happens, Verde was being offered to Co-op with a surplus of capital.
If the deal had gone through, the capital hole would have been filled.
But there was no certainty the deal would go through. And, indeed, it collapsed.
So one question for Co-op Bank and the regulator is why relevant price-sensitive information was not passed on to holders of preference shares and subordinated debt.
Question number two is about the distribution of losses in the reconstruction of Co-op Bank.
All image to the contrary, Co-op Bank is not a mutual. It is a PLC owned by a mutual - Co-op Group.
In other words, all the shares or equity in Co-op Bank are owned by the Co-op Group and its members.
To tell you what you presumably already know (as is my wont), the convention when a business gets into difficulties is to wipe out the existing common equity before foisting losses on preference shareholders and bondholders.
But under Co-op Group's rescue plan for Co-op Bank, Co-op Group and its members will continue to own a majority of the shares in Co-op Bank.
Co-op Group will take some losses, but perhaps rather smaller losses than convention would suggest it ought to be taking - and it is instead forcing larger losses on bondholders and preference shareholders.
It is quite difficult to be categorical about whether the distribution of losses is fair, because Co-op Group has not published the details - which are subject to negotiation.
And if you are a supporter of mutuals, you may say hooray that Co-op Group wants to remain in control.
But there are important points of public policy at stake here, about how shareholders can be forced to take their responsibilities seriously as owners of banks.
As of the end of 2012, the equity in the Co-op Bank was valued at £1.6bn. And given that the regulator says it needs to find £1.5bn of new equity for the bank, in theory if all the new equity came from bondholders and holders of preference shares, Co-op Group would still be the majority shareholder.
But this is based on the assumption that the bondholders and preference shareholders actually want to own equity or shares in Co-op Bank.
They don't. They are being told they have to convert their bonds and preference shares into shares and new bonds, to save Co-op Bank.
So it is legitimate for them to ask why Co-op Group's existing equity in Co-op Bank should be valued at a bean, if it is not prepared to find the full £1.5bn that the regulator says is needed by Co-op Bank.
Or to put it another way, since the regulator believes that Co-op Bank was not managed prudently, and Co-op Group's stewardship was inadequate, shouldn't Co-op Group's investment in Co-op Bank be more or less wiped out, before losses are forced on anyone else?
And if that principle is not applied, doesn't it give hope to shareholders in other banks that they too would not feel the full financial consequence of their foolishness, if they fail to keep a beady eye on the activities of the management of banks - and isn't the sustenance of that hope precisely the opposite of the stewardship reforms that regulators and government seek?
There is no serious argument against the idea that one of the great flaws of the boom years that preceded the great crash of 2007-8 is that shareholders in banks behaved like absentee landlords.
If the manner of the reconstruction of Co-op Bank protects its owner from the full effects of its management failure, what hope is there that investors in other banks will take their ownership responsibilities seriously?
Update 1000, 9 July
Co-op Group has explained to me why it believes it deserves to continue to control Co-op Bank.
At the time of the formal rescue of the bank, scheduled for November, Co-op Group will indeed see its stake in the bank devalued to nothing, or wiped out.
It will then inject £1bn into the bank, half-raised by selling two insurance businesses and half-raised by borrowing (via a bond which Co-op Group will issue).
The remaining £500m would come from the forced conversion of the subordinated debt and preference shares into ordinary shares listed on the stock market and new bonds.
And Co-op Group makes one further point. If the preference shareholders and bondholders don't like it, there is an alternative.
It is called resolution, in which the bank would be seized and rescued by the Bank of England, and the pref holders and bondholders would see the value of their investments reduced to a big fat zero.
In other words Co-op Group says the choice for bondholders and pref holders is between big losses and total losses.