Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 140 - 159)



Mr Laws

  140. Your evidence has been very interesting, Mr Godfrey, because it contrasts with that which we heard this morning from the Aberdeen managers who were saying it was reasonable to market these products as low risk, and then unfortunately a big fall in the stock market came along and that is where the problems arose, but you are saying that the portfolio characteristics deteriorated over the last few years to make them higher risks. When do you think it was no longer reasonable to market these products as low risk?
  (Mr Godfrey) Again, we are getting into slightly technical grounds here.

  141. Not that technical.
  (Mr Godfrey) Well, the income shares and the capital shares were always marketed as being higher risk. Now, I believe that even in the income shares and capital shares the quality was to a certain extent deteriorating and the risks were increasing.

  142. What about the zeros?
  (Mr Godfrey) Well, this is where we are not the rocket scientists. It is clear now to me that the introduction of bank debt has caused the destabilisation of the zeros in that, when they become uncovered, what previously was a degeared asset exhibiting low risk qualities suddenly became geared and started falling off the cliff pretty rapidly.

  143. When do you think that changeover came and these instruments should no longer have been marketed as being low risk?
  (Mr Godfrey) The changeover came when bank debt started being introduced in a big way, which is probably 1999/2000. It became clear to us the impact this was having, as people who were not the designers of the product, really only as things deteriorated very severely towards the back end of this year.

  144. So after 1999/2000 it would have been wrong for people like Aberdeen to be marketing zeros as being of low risk characteristics?
  (Mr Godfrey) I am not sure I would go that far. What I would say is that probably they should have been marketed with a clear explanation if they understood at the time that the existence of the bank debt gave new characteristics to the zeros that investors should be aware of.

  145. And they were not?
  (Mr Godfrey) They were not.

Mr Ruffley

  146. Could I say that I think your evidence has been refreshing because you use some stark language in relation to the split capital sector. You say its good name has been blackened; you say the stain has started to spread, and we welcome that. That is not true of the whole sector but it is true of certain players in that sector. You talked about a magic circle; you said there was no evidence. Are you still looking for evidence of a magic circle?
  (Mr Godfrey) We are not the regulator—

  147. I did not ask you that; I know you are not the regulator. Are you looking, as a trade body, keeping your eyes open, for evidence of any description of a magic circle?
  (Mr Godfrey) Well, I will tell you what we are doing because it may not fit exactly into that—

  148. Why not just answer the question I have asked?
  (Mr Godfrey) Well, we are not going looking but we are keeping our eyes and ears open.

  149. How are you doing that? What are you finding?
  (Mr Godfrey) I think you can put what we find into a number of different categories. Firstly, you have rumour and speculation, which comes to you as hearsay evidence: secondly, you have circumstantial evidence that we can see for ourselves by looking at facts and figures as to what has happened in the past; and, thirdly, we have what I would describe as being soft evidence in that it comes to us from people who claim to have been in meetings and heard what was said but which has not been given to us in the form of written deposition or corroborated by a second person at that meeting. Now, all of these we have passed on to the Financial Services Authority, who clearly are the appropriate agency to deal with that information.

  150. That is helpful: I just wanted to get to the body of it. Your organisation obviously hears a lot and you have been passing over allegations, because that is all they can be presumably at this stage, to the Financial Services Authority. Is that the position?
  (Mr Godfrey) Yes.

  151. Have you been picking up evidence of this activity to date? Are the pieces of evidence relating to a time period in the last twelve months or the last five years? Tell me over what period these allegations are being picked up in relation to the magic circle.
  (Mr Godfrey) I would say three and a half years.

  152. Could I ask whether you would care to tell us which funds and organisations have been the subject of these rumours?
  (Mr Godfrey) I think it would be inappropriate for me to do that in the context of the Financial Services Authority having an investigation about to start or already being in the midst of an investigation into the facts that we passed to them. I think it would probably be prejudicial to people who may be innocent in this, so if the Committee would allow me I would rather not answer that.

  153. I absolutely accept that but can I confirm this: you are very concerned by the sound of your language, and I think you are right to be—you use the words "blackened" and "stained". What sort of sanctions will be available from your point of view, not the Financial Services Authority's, if any charges against various fund managers and their employers are proved?
  (Mr Godfrey) The Association of Investment Trust Companies is a trade association and we represent companies that are eligible by our rules to be members, and those rules are that the companies should be eligible for listing as closed-end investment companies and so forth. Under the Competition Act you can be deemed to be acting anti-competitively if you try to keep people out so we do not have a formal structure of sanction against members.

  154. In the case of the losses of some individuals who have written to this Committee, some of them are being wiped out through alleged mis-selling. Who do you think is to blame? Is there a structural problem in the way that some of these products were devised or do you think individuals are to blame? In a sense who do you think is to blame for this?
  (Mr Godfrey) Firstly, on behalf of the industry as a whole I want to apologise to shareholders who have lost so very much money. It is something that the industry collectively deeply regrets. I would have to say again that, clearly, it is individuals who do things and they do not just happen by a process of osmosis, but we have passed all the information that we have to the Financial Services Authority. There has been a combination of development and circumstances which has brought us to this position, which is a combination of development in the product in terms of introduction of bank debt, in terms of investing in technology companies or high yielding bonds or in shares of other splits, combined with what was to them the unexpected behaviour of stock markets globally that has made this happen, as I am sure anyone will tell you. If markets have gone up about 20 per cent in each of the last two years we would be congratulating them all on having won the awards again.

  155. Lastly, what are you doing about the cross-holding problem which, despite the previous witnesses, is clearly a problem: it is not the sole reason for some of the disasters that have occurred but it is a large component in this fiasco. What are you going to do about it and what can you do?
  (Mr Godfrey) Some things are self-regulating and others need a push. What we are doing proactively is trying to improve transparency and understanding so that people who perhaps have a very significant appetite for risk know what they are getting into and may still want to buy shares, and people can take a more informed judgment about what they are getting when they buy a share. So we have encouraged both members and non members—we think it is so important for the industry as a whole that we have made this facility open to members as well as non members—to supply details of their holdings in other splits that we will then put up on our website so that people can take an educated view about not just the extent of the holdings in other splits but the quality of those holdings as well. Secondly, we have a very significant and costly data project going on at the moment where we have asked every split trust to supply us with their entire portfolio, albeit in confidence, so we can run some very detailed analytical work to understand just exactly what non split assets are underpinning the value of the whole sector, and we think that will provide boards with information that they currently cannot get. One of the difficulties about holding splits that hold splits that hold splits is that, once you go beyond a second layer, it becomes impossible for the director or the manager at the top to know exactly what their effective holdings are, what their effective level of gearing is, and what their effective expense ratios are.

Mr Plaskitt

  156. Will you publish the conclusions of that?
  (Mr Godfrey) Yes. We will publish the broad conclusions but not details about individual trusts.

Dr Palmer

  157. A lot of the discussion this morning has focused on the issue of deliberate collusion. Now, if I am the leader of a local council and every year a property developer gives me £5,000 and from time to time decisions are made which are favourable to that property director, it is not necessary to show that we have sat down and agreed the link. If I have not declared the interest and I have taken part in the decision, I will be assumed to have colluded effectively. Do you not think that the fact, as you say in your very helpful report, that we have a situation where as much as 70 per cent of the income shares issued last year were bought by split funds and other funds whose managers also manage splits comes down to a de facto collusion? That it became industry practice to support each other, even if they were not all in a room agreeing to it?
  (Mr Godfrey) I think that in itself is not beyond reasonable doubt evidence. When combined with other circumstantial evidence and the soft evidence that I referred to earlier, I do not believe that the whole sector of split capital managers and every player in it were all colluding with each other but I think there is no doubt that there have been some instances of bad practice by some individuals.

  158. Would you agree that it is fundamentally unhealthy for management charges to be levied in this situation not on the real value of the assets but on the paper value, including debt?
  (Mr Godfrey) No, not wholly. It is always a question of the quantum, is it not? If it looks as though there is a lower charge because you are saying it is only, say, 1 per cent on the gross assets but the shareholders only amount to 50 per cent of that and the income shareholders only 33 per cent of the total, then the effective cost against the income shareholders is no longer 1 per cent but 3 per cent, and I think that needs to be made clear.

  159. You say in your report at paragraph 4.8, ". . . the true value of the assets underpinning the share price [in this situation] can be impossible to calculate. If fund A buys shares in fund B that are at a premium, it is fund B's share price, not its net asset value that becomes a component of fund A's net asset value. As the group expands, one gets premiums on premiums on premiums and an increasing premium at the top level that may prove unsustainable". Should the Association therefore not be issuing binding guidelines on its members to make sure this does not happen?
  (Mr Godfrey) We are not investment managers or investment experts, so I do not think we are the best people necessarily to make that sort of judgment. What we have tried to do is increase transparency so that people who know more about it than us can analyse it and take a view and communicate that view.

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