Examination of Witness(Question Number
TUESDAY 22 OCTOBER 2002
260. So are you inclined to think that there
might have been some kind of conspiracy by default, as opposed
to just a cock-up, in relation to the disaster that has occurred
in this sector?
(Mr Alexander) There is one set of mistakes, that
I will come on to in a minute, which relates to advisers generally,
but, in terms of the way these funds were run, I do not think
there was a mistake, I think that the people knew what they were
doing from the beginning. If you go back into some of the records,
Mr Currie, of Aberdeen, is quoted in the Financial Times, in 1997,
as stating, when they start these new types of split capital trusts,
he stated that they are really only suitable for, effectively,
the professional investor, or somebody with an adviser; which
begs the question, if he said that in '97, why were Aberdeen marketing
these directly to the public and to people who had absolutely
no access to the markets. So I think that everybody inside Aberdeen,
BFS, etc, knew what they were doing.
261. And can I just ask you whether you have
uncovered any evidence of higher cross investment between those
trusts where there were common directors, in comparison with those
where there were not?
(Mr Alexander) Yes; we have lots of evidence of investments.
We are at the moment plotting another chart showing the actual
cross investments, but, clearly, where there were common directors
there was significant cross investment.
262. And where there was not?
(Mr Alexander) Yes, higher than where there was not.
263. By a very significant amount?
(Mr Alexander) By a very, very significant amount,
and involving the same people time and time again. It is sort
of fairly clear that an awful lot of people did not touch this
with a barge-pole, particularly from the investment community.
264. There have been investment trusts around
for a long time; why does this particular type of investment trust,
the split capital trust, induce this cross holding and cross appointment
of directors? Is there something inherent in the concept of a
split capital trust that induces that sort of behaviour?
(Mr Alexander) No. I think that what happened was
that up until 1997 the split capital market was a fairly settled,
well-ordered market; interest rates started to drop and these
new schemes were put together, I think, actually to try to get
a hold of the market, to offer people a higher rate of return
than they might otherwise have got. There were significant structural
differences between, if I may call them, the old-style split capital
trusts and these new-style ones, they had very high levels of
borrowings in them, and they invested in each other, and they
had, on top of that, a high level of management charges. One of
the factors that was not apparent to people was that the management
charges, which was usually between 3 and 4 per cent of set-up,
was charged on the total amount of the fund; now that means, if
you had a fund of, say, £30 of equity, £70 of borrowing,
the management charge would be £3, which was charged to the
equity, which means, on day one, 10 per cent of the equity of
that fund went away in management charges. So, from the beginning,
it was up against
265. But what induced that sort of behaviour
in these new trusts?
(Mr Alexander) If you have to look, why did they do
it, I think the fund managers thought it was a fantastic opportunity
to make a great deal of money; because they were building up huge
(Mr Alexander) Corporately and individually, because,
by putting in huge levels of gearing, it meant that the fees were
significantly greater; by investing in each other it ensured a
ready supply of purchasers for the shares in each other. So, therefore,
you had an animal that was significantly different. Now the failure
by the industry, by the IFAs, by the brokers, in my view, and
it is borne out by all the correspondence I have seen, is that
they got a leaflet through and it said, "This is a zero;"
they then said, "Zeros are good; this is a zero, therefore
it is good." They did not look into the documentation, because
had they looked into the documentation in the prospectus themselves
the risks were generally spelled out; and IFA after IFA, when
he writes his mea culpa letter to the client after September
11, talks continuously about "zeros being a good thing,"
and they never focus on the fact that these particular zeros were
not the same as those that they had previously looked at. And
so, if you like, the failure by the industry was to continue to
classify these instruments as the same thing as things that had
gone before, and failed to read the documents.
267. So really what you are saying to us is
that, if a manager went to the bank and got £100 million
of bank debt for these funds, and they charged 3 per cent, then
they would get £3 million?
(Mr Alexander) Yes.
Chairman: Not bad for a day's work.
268. In essence, are you saying that you are
finding a difference, perhaps even a contradiction, between promotional
material used to promote these funds and the prospectuses that
lie behind them?
(Mr Alexander) Yes; unequivocally, yes. This is largely
the case for those that bought directly from the funds, that the
marketing material simply did not match the reality of the prospectuses.
Had they put on the marketing the warnings that were contained
in some of the prospectuses they would not have sold them.
269. Because when we had our inquiry into this
in July we saw some promotional material, and we had phrases such
as "safe as houses," "more safety features than
a Volvo," and, in the case of BFS, an interesting statement
that these are products that, I quote, "tend to come into
their own when stock markets are flat or falling." Are you
finding out that the companies promoting these financial products
were persisting with this kind of promotional description at the
same time as they were building into their prospectuses the warnings
that we have seen in the case of Guernsey?
(Mr Alexander) Yes.
270. And for how long were they continuing to
promote with one language, at the front, and warn with a different
language, at the back?
(Mr Alexander) The promotion went on right up until
the summer of 2001, when the thing started to unwind; clear, unequivocal,
low risk, very little risk, when, if you may call it, the professional
documentation was pointing to a higher risk level. And it was
this mismatch of prospectuses as against marketing material that
is the cause of concern, because, after all, the public, particularly
the smaller investor, is only ever going to receive the marketing
material, the application form to put their money into an ISA,
they are not going to go and read any underlying documentation;
most people in the City did not understand it, why should they.
271. Do you think that companies will not have
a defence, when they say, "Ah, but it was in the small print,
and, caveat emptor, you should all read it before you buy
(Mr Alexander) We are extremely confident there are
good cases against all those involved. We are ready to go now,
we intend to be issuing proceedings very shortly, and it is our
intention then to seek pre-action discovery. What we have found
today has been based on a trawl of hundreds and hundreds of files,
I have actually read every single file, because I felt only by
doing it you can get a proper impression of what people were told;
people were told a great deal of things on the telephone, people
were sent an awful lot of marketing material. Yes, we have seen
all of it; we have seen some horrendous stuff, talking about the
same as building society accounts, the same as National Savings
Certificates. People were interested in one thing, and one thing
only, and that was selling; and I think people sometimes forget
that people who are selling these products are salesmen, and people
somehow think it is in the financial sector it is any different.
These are salesmen, the public are not being protected and there
needs to be a serious look at the whole question of the way these
things are marketed. Because had anybody bothered to actually
look at the differences, as we have now done, between the prospectuses,
on the one hand, and the marketing material, on the other hand,
perhaps a lot of people would not have invested.
272. Are you satisfied that the FSA was aware
of the difference between the prospectuses and the marketing material?
(Mr Alexander) I have got no idea. I have got no idea.
Following this, it is our intention, actually, specifically, to
ask some searching questions of the FSA, as no doubt you will,
actually to find out what went on, because, clearly, there are
these issues now, which had not emerged earlier, as to their state
of knowledge, what they did or what they did not do.
273. During the course of the things you have
said to us this morning already, you have pointed the finger of
blame at the FSA, at directors and auditors; who do you think
is primarily responsible?
(Mr Alexander) I think they all are. In terms of the
ultimate, ultimate responsibility, it must be the directors; in
terms of responsibility in law, I think, clearly, the auditors
and the advisers to the people who used IFAs are liable. As far
as the FSA are concerned, clearly, there needs to be urgent investigation
into their role. I think there is culpability everywhere, I do
not think anybody has come out of this, involved in this, at all
well, and I think the sooner that this is cleared up . . . Because
I think the other point I would like to make is, what we are finding
is, the public's confidence in the financial sector has been severely
damaged again by another case, and at a time when the markets
are looking for reassurance; so this has not helped confidence
in the market.
274. I understand that split capital trusts
in this particular form would not be possible in other financial
markets, that it is only in Britain that it is possible. We are
sometimes a bit smug about the City, and say, "Well, the
world is trying to catch up with us." Do you think this is
one case where we have got it wrong and we need to look again
at what types of trusts are allowed to operate?
(Mr Alexander) I think that this is a case where people
were put off their guard by the fact that it was another product
that came out of the City. I saw a letter yesterday from an IFA
to a client, and his recommendation to invest was based on two
things, zeros are low risk, and, "simply," he said,
"Aberdeen know what they are doing." That was his advice,
based on that. And it seems to me that what has happened is that,
once people have built up a reputation in the City, they are able
to sell these products on the back of their reputation of what
they have done. People clearly have not looked into things as
carefully as they should, and, I think, in terms of selling to
the public, there needs to be a much clearer and a much tighter
form of regulation so that this thing does not happen again. Unfortunately,
it always seems to; but I think this case is really a good chance
for the industry and yourselves to look at the whole way this
thing is sold, to really try to tighten up so that it does not
275. Yes; but what you are saying then, if I
understand you correctly there, I do not want to put words into
your mouth, is that you do not feel that it is wrong that this
type of split capital trust is marketed in Britain, even though
it could not be marketed in other countries, you merely feel that
a better standard of advice is needed?
(Mr Alexander) Yes. If somebody wanted to market a
product that was a high risk derivative, which is probably what
this is, and the label on the bottle said, "Warning: this
is a high risk derivative, only suitable for private investors,"
it is a free market, you invest at your peril. What we have got
here is a situation where you had a high risk derivative being
marketed to people as a low risk place for their pensions. So
I think it is not so much the fact that you should not be able
to market them, I think the important thing is that the message
on the bottle has to be clear, not with any small print, but clear,
unequivocal, so that this thing does not happen again.
276. Do you consider that there is a justification
for fees being levied on both stocks and debt, even in the case
of cross holdings, if it is properly explained to the clients?
(Mr Alexander) Yes; if it is properly explained. I
think I am merely pointing out the fact that these people were
earning a great deal of money, and, certainly, when I explain
this to some of my clients, they had not an appreciation that
the management fees, which were, again, a small line at the bottom,
had such an effect on the equity of the fund early on. So I think
it is a case of proper explanation, but, I think, more importantly,
making sure that products that are only really aimed at the professional
investor should stay there, and should not be marketed to the
public, who simply could not, do not and could not ever understand
277. Do you actually think that any sane independent
financial adviser would advise investing in a trust where, effectively,
the management fee is 10 per cent?
(Mr Alexander) No; and, in fact, there are some IFAs
who have instructed us because they did not recommend, they actually
said, "We looked at it and we don't think this is any good."
Their clients then went to another IFA, who did very little work,
and sort of went ahead. So I think some people looked at it, some
people said that this was high risk, not everybody but some people
did it. And so I think it was a question, to a large degree, of
the Emperor's new clothes; everybody said, "This is a wonderful
thing, isn't it a wonderful thing," without looking beyond
merely this veneer, and once it was stripped away everybody then
said "Oh, dear."
278. Mr Alexander, you have just said that there
is a free market, and values go up as well as down, and money
gets lost. Now this is not America; this is not America, where,
if somebody loses money, the FBI bundles somebody in handcuffs
into a car in front of the television cameras, this is Britain
we are talking about, we do things differently. Now I want to
know what your real target is here, because you have attacked
the advisers, you have implied regulatory failure and you have
raised issues of corporate governance which can only be dealt
with in company law; now I want to know what your real target
(Mr Alexander) The real target is to recover people's
279. Who from?
(Mr Alexander) I will go through the list. First of
all, if you had an independent financial adviser or stockbroker
who was negligent in his advice to you, because everybody has
to fill out a form that says what sort of risk profile you want
to take, if you said "low risk" and you were put into
these split capital trusts that were not low risk, you have a
perfectly good case in negligence against the adviser, and the
insurers of the adviser are already dealing with the matter in
some cases. So if it is a case against the adviser then there
is a case in negligence; if there is a case that you bought directly
and there was false, misleading marketing material then you have
a case against those responsible for putting out the marketing
material. There has to be a duty of care; someone has to have
broken it. If there was a failure by the regulator towards the
end of this period where he failed to act upon information then
the law is clearly laid down by the House of Lords that there
is a possibility of looking at it. We do not know whether there
is sufficient insurance in the market to cover this, we do not
know whether the fund managers have sufficient assets; so at the
present moment we are looking at ways to see who may be responsible.
I agree with you, just because somebody has lost money in the
market does not mean there is a court case, absolutely right,
there has to be a clear breach of some settled principle of law
and negligence, and we feel that this is done, leading counsel
is finalising the proceedings and they will be issued in the High
Court very shortly.