Select Committee on Treasury Minutes of Evidence

Examination of Witnesses(Questions 700-719)



Mr Mudie

  700. They got greedy. The cost of bank borrowing had come down and assets were going up at a greater rate so they borrowed more and more. They were literally thinking they could print money but then asset prices went down and they were stuck because they had borrowed to buy and they were finished because the banks called them in. It is the extent—even their Association accept it—and you missed it?

  (Mr Thomas) I will give you an example, sir, of something which other people did quite easily. One of the failed ones had only bank borrowings and yes, if they had had zeros underneath those bank borrowings they would not have been in such trouble, that is a good example of it.

Mr Tyrie

  701. I want to clarify what I think we have discovered here. We have discovered two crucial things, and Brewin Dolphin are at the heart of both. The first is that you did not understand the product that you had created and were marketing. You thought you did but you did not. Your only defence on that, as far as I can tell, is you are saying other people did not understand it either.

  (Mr Thomas) Our stress testing was very, very extensive; I did understand it.

  702. The second point I think we have uncovered, and I do not seem to be getting any correction or even qualification on this point, is that there was no communication going on in this firm at all and that you created a fundamentally new product which was being sold as if it were a traditional product to several thousands of private investors, many of whom have now lost their money. Correct?

  (Mr Hall) It is absolutely correct that Mr Thomas did not—

  703. It is an appalling state of affairs, is it not?

  (Mr Hall) He did not feel that he had created anything that was any riskier than earlier. Is that correct?
  (Mr Thomas) That is right.


  704. Your answers have been direct, more so than the obfuscation from previous witnesses on that, so that is very helpful. But in the article on yourself, Mr Thomas, on Sunday it said that senior industry figures said ". . . greed is the bottom line of this. The brokers have made huge amounts of money." This is the merry-go-round. This is what it is all about and people who were sold zeros were not told about the effect that gearing would have. They were not told, unlike in the promotion when they thought they were first in the queue, that as soon as you get a bank they were second in the queue and the bank was safe but the ordinary investor was not, he was washed up, and that is the issue we are looking at and we want honest answers to that.

  (Mr Thomas) I can throw some more light on it, if you like, sir. I can remember only one case of one potential placee saying, "You have created a zero with a gearing of its own and we do not want to take the placing." That was another large stockbroker who specialised in private clients who bought zeros. He differentiated between that kind of geared zero and the earlier kinds.

  Mr Tyrie: When was that, Mr Thomas?

Mr Mudie

  705. Who was he and when?

  (Mr Thomas) In about 1998-99.

Mr Tyrie

  706. So in 1999 somebody came to you and said,"Hey, you may not understand your product but I do"; it is a lethal product, it is a nasty cocktail with double gearing on the zero.

  (Mr Thomas) Only one man of all the others I was talking to.

  Mr Tyrie: But somebody was coming to you and saying, "You may not fully understand your product but I do"?

  Chairman: Who was this honest man?

Mr Tyrie

  707. Who was against this gearing? "This gearing is doubled geared" is what he was saying to you.

  (Mr Thomas) It was one case, one opinion, one telephone call.

Mr Mudie

  708. This man drew to your attention what could happen within the structure. He showed you what could happen and what was happening and you dismissed it because it was only one person.

  (Mr Thomas) We did not talk in great detail. Nobody had reconstructed what might happen. All he said was, "I do not like geared zeros", and I did not place anything with him.

Mr Tyrie

  709. He said he did not like it for a specific reason, a correct reason, which was that it was gearing on gearing and you took no notice of it. It did not cross your mind that your product that you thought was okay might have some flaw, that the guy might have a point?

  (Mr Thomas) No, I did not.

Mr Palmer

  710. Who was the gentleman?

  (Mr Thomas) I do not think I am giving away any information which would hurt him in any way, sir. There was a father and son relationship I had known in Henderson Crossthwaite for years and years and years. The father is called Pickford and so is the son. That is the only criticism I have ever had of any of my designs.

Mr Ruffley

  711. Could I ask Mr Hall when exactly were the first signs evident to you of a zero being unlikely to pay its full value on maturity?

  (Mr Hall) September 2001.

  712. September 2001. Not before then? Bells were not ringing before then at all?

  (Mr Hall) No.

  713. Is that a straight no or "to the best of your knowledge and belief" that nothing before September 2001 at all occurred to you or any of those who worked for you? We are talking about the private client side.

  (Mr Hall) Absolutely. To the best of my knowledge and belief, 2001, September thereof.

  714. Right. So far as you are aware, were other brokers' financial advisers in relation to their private clients changing their advice in relation to zeros before September 2001?

  (Mr Hall) So far as I am aware, there was one.

  715. There was one?

  (Mr Hall) I may have got it in retrospect.

  716. So it was out there in the market that this was a bit dodgy?

  (Mr Hall) No, I do not think it was that far and I am not sure of what period I personally would have been aware of the fact that there was one who had thought that there might be a problem earlier.

  717. When you discovered there was a problem—in relation to private clients I am talking about here—how did your advice change?

  (Mr Hall) Our advice changed particularly insofar as the risk assessment was concerned. Very sadly, one of the things that became apparent at once was the fact that the marketability of the stocks in this sector dried up, as did confidence. With no confidence it went out like a light, so one became unable to sell any quantity of stock and the prices fell rather rapidly and the best advice I was getting was that although the sector was under pressure, there were problems, certainly if one had bought a zero and advised a client to buy a zero for a particular purpose, it was highly likely that they were looking over the whole of the period when it was likely to be repaid and around September 2001 it became apparent that there were pressures and that it was possible that they were going not to be repaid in amounts that had been expected. It was not suggested to me at that stage that what has happened would happen, in other words, they went bust.

  718. Could I turn to Collins Stewart. In the memorandum they sent—in good time unlike Aberdeen—you specifically refer to the difficulties caused for splits in the recession of the early 1990s. What I do not quite get here is given that that history was very much on the record and should have been at the forefront of your minds, why the levels of gearing were allowed to get to the levels they got to, ending quite disastrously for investors. Why, with all that history, was it ignored?

  (Mr Crawford) I do not think it was ignored. I think just to go back—

  719. Sorry, we are talking and we have been talking for about half an hour or longer about the critical importance of very, very high gearing which has ended in disaster for investors, many of them people who cannot afford to lose any money. You followed the arguments, it is not a new point. This very high level of gearing should have been very much to the fore of the minds of Collins Stewart and others. You admit to that in your memorandum. These were high levels of gearing; why did they get so high?

  (Mr Crawford) As I was about to say, I think the lessons of the 1990s were not ignored. If you look back at the 1990s, some of the split structures which came out of there were very simple structures inasmuch as they had maybe half of their capital in ordinary shares and half of them in zeros, so with regard to the ordinary shares, the cost of the ordinary shares was quite high because the zeros were compounding at quite a large number and they represented a large proportion of the structure. It is also fair to say at that time the first zero which nearly did not work was the zero in Olim Convertible, and that was in the early 1990s, so the experience of zeros almost not working had been realised in the early 1990s as well. However, when bank debt did come to the fore, as we said in the late 1990s, bank debt was considerably cheaper and people saw the benefits that would accrue to the ordinary shareholders as well. What you ended up with were structures where typically the gearing was not necessarily the same level as the zeros were in the previous years, so the bank debt was seldom as high as 50 per cent and normally ranged between 25 and 40 per cent, so the gearing was lower in terms of the bank debt but clearly it was a different structure altogether from the early 1990s.

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