Members present:

Mr John McFall, in the Chair
Mr Jim Cousins
Mr Michael Fallon
Mr David Laws
Dr Nick Palmer
Mr James Plaskitt
Mr David Ruffley


Memorandum submitted by Aberdeen Asset Management

Examination of Witnesses

MR MARTIN GILBERT, Chief Executive, MR GARY MARSHALL, Managing Director of Aberdeen Unit Trust Managers, and MR PIERS CURRIE, Marketing Director, Investment Trusts (Aberdeen Asset Managers), Aberdeen Asset Management, examined.


  1. Good morning, Mr Gilbert. For the sake of the shorthand writer could you identify yourselves, please?
  2. (Mr Gilbert) I am Martin Gilbert, Chief Executive of Aberdeen Asset Management.

    (Mr Marshall) I am Gary Marshall, Managing Director of Aberdeen Unit Trust Managers, which is the Group's retail division.

    (Mr Currie) I am Piers Currie, Marketing Director of Investment Trusts at Aberdeen.

  3. Good morning. Could you tell me who is the Executive Director responsible for each of your funds?
  4. (Mr Gilbert) The structure of the company is I am the Chief Executive and Chris Fishwick is the Executive Director responsible globally for our closed end funds as we call them, or investment trusts as they call them in this country. He has overall responsibility for them. Then what happens is each individual fund or each individual company has its own investment remit, so the investment management of that part of the portfolio would be delegated to a particular fund manager within the fund management division.

  5. If he is in overall control can I ask why he is not here this morning?
  6. (Mr Gilbert) Two reasons. One, I was asked to come and, two ----

    Mr Fallon: By whom?


  7. Our clerk wrote to yourselves asking for witnesses to come but there was no specific request. We would have liked to have seen Mr Fishwick. Can you tell me why he is not here?
  8. (Mr Gilbert) He is attending a number of meetings today with some of our funds because, as you are probably aware, the markets are in a very, very bad condition at the moment and we have a number of funds that are in difficulty and he is dealing with those today. I apologise. If you had wanted him here specifically we would have rearranged things and brought him here but I thought it would be adequate to bring the two gentlemen I have brought.

  9. I must say that my colleagues are a bit disappointed that he is not here. Could you tell me on how many boards Chris Fishwick sits?
  10. (Mr Gilbert) He sits on ten boards. I think we should elaborate that he does not sit on a board as an independent non-executive director, he sits on the board as a non-independent director. All our boards tend to have a management representative on each board.

  11. Okay. Could I ask did he earn salary and benefits of 1.8 million in the year to September 2001?
  12. (Mr Gilbert) Yes, that is correct.

  13. And salary and benefits of 1.734 million in the previous year to September 2000?
  14. (Mr Gilbert) That is correct.

  15. Did he officially exercise stock options worth approximately 2.3 million in the year to September 2001?
  16. (Mr Gilbert) I think he exercised the stock options but he held on to the stock so I suspect of that 2.3 million he would have probably lost about 2 million of it.

  17. Has he been promised an additional 1.4 million deferred benefit if he remains in Aberdeen's employment to 30 September 2002?
  18. (Mr Gilbert) I think that is correct.

  19. Is he the highest paid employee of Aberdeen Asset Management plc?
  20. (Mr Gilbert) Yes, he is.

  21. Therefore, can you understand, Mr Gilbert, why thousands of Aberdeen investors around the country who have lost much of their life savings feel angry when they see the director responsible receiving or being promised over 7 million in a two year period during which the trusts he was managing have collapsed almost totally in value?
  22. (Mr Gilbert) I do see your point.

  23. Thank you.
  24. (Mr Gilbert) But there are a number of other points, if you would not mind me making them. He is in charge of, as we call it, the closed end fund division of Aberdeen which ranges from Sydney right through to the US. It is one of our most successful divisions. It has contributed over the last ten years substantial profits to the group and he has been a very, very good profit generator for the group. Those particular trusts that you were speaking about for the three years before the last two were the best performing investment trusts in the UK.

  25. John Tiner of the Financial Services Authority is quoted as recently saying "If you have a director of the board of a series of trusts", and you mentioned Mr Fishwick is on ten, "it must be difficult to manage the conflict of interest that would emerge". Would you agree with that statement?
  26. (Mr Gilbert) I do not agree with that statement. He is not holding himself out to be independent on those boards, he is non-independent. He is the senior representative from Aberdeen management on those boards.

  27. Lastly, a quote from Mr Tiner again in May of this year when he said "Some splits borrowed heavily to invest and buy securities in each other in a contagious cocktail". Would you call it a contagious cocktail or a Molotov cocktail?
  28. (Mr Gilbert) Much as I hate to disagree with the regulator, which is a very dangerous thing to do, I do disagree with his comments.

    Chairman: We have the regulator later in the morning so we will certainly be asking those specific points.

    Mr Plaskitt

  29. Can I ask what position Ms Shelley O'Donnell has with Aberdeen Asset Management now or recently?
  30. (Mr Currie) Shelley O'Donnell works with me on investment trust sales and investor relations.

  31. Is she the head of investment trust sales?
  32. (Mr Currie) Yes.

  33. Do you recall an article that she wrote in July 2001 in Investment Adviser where she was commenting on the likely performance of zero dividend preference shares?
  34. (Mr Currie) There are a lot of articles on zero dividend preference shares.

  35. Do you recall hers?
  36. (Mr Currie) Not specifically, but if you remind me I will try to clarify it.

  37. In it she describes the zero dividend preference shares as low risk.
  38. (Mr Currie) I think that is very true.

  39. Do you think she was correct?
  40. (Mr Currie) I think she was correct.

  41. If we look at your 2000 ----
  42. (Mr Gilbert) I think at the time they were commonly perceived to be low risk, not just by us but by the market as a whole.

  43. That is helpful. She went on to say, seeing as we are quoting her, "they share the same risk characteristics as gilt edged government securities". Was that an accurate statement?
  44. (Mr Currie) I would have to hear the source of the article. They share similar analytical characteristics to gilt edged securities. Typically zeros are compared to gilts in terms of redemption yields and so the characteristic of zeros as an asset class has been one which has been low risk over the last 15 years.

  45. Let us take the 2003 zero dividend preference shares that you offer in Aberdeen Preferred Income. At around the time she wrote that they were priced at 275 pence. What are they now?
  46. (Mr Currie) I think they are between ten and 20 pence. I would have to check the exact figures.

  47. And they were a low risk investment?
  48. (Mr Currie) I think if we are looking at the redemption yield criteria written at the time and the analytical process that was saying Aberdeen preferred, I think you are saying, 2003 zeros, which is one zero out of 138, and expressed the properties at the time of offering a redemption yield of somewhere between 71/2 and 81/2 per cent. What that is telling you is at the time the market priced those zeros as a lower risk entity, otherwise it would have been priced at a 50 per cent gross redemption yield.

  49. I am coming to you as an investor and thinking of going into the zero dividend preference shares and I read in the quite creditable magazine Investment Adviser that your head of investment trust sales is saying that these products are low risk and share the same risk characteristics as gilt edged government securities, so I invest my 275 pence and today it is worth ten pence.
  50. (Mr Currie) Thirty-nine.

  51. It has not done very well, has it?
  52. (Mr Currie) No.

    (Mr Gilbert) Can I just elaborate on one point. To correct a point you made, we did not offer those particular zero dividend preference shares for sale. What we have offered for sale, to use your terminology, is a unit trust which invests in zero dividend preference shares. I think, like any investment, we always advocate that people take a spread of investments rather than a particular single investment. I am prepared to concede that we sold the unit trust to the general public but that particular share you are talking about is one of many that the trusts that we manage and which are listed on the Stock Exchange.

  53. Indeed, but if you take the full range and spread the risk, as you put it, it is a similar story, is it not? I believe that since 31 March 1999 the FTSE has gone down about 16 per cent but splits taken as a whole, if they are non cross-holdings they have gone down 39 per cent, if they are cross-holdings they have gone down about 80 or 90 per cent and that is across all of them, not just taking one product. That is on FSA figures.
  54. (Mr Currie) We are looking at those figures. Some of those figures we are keen to go back to the FSA to have a look at. I think the other thing I would point out is that if there is more than one share class in a split capital share, the riskiest share classes are those typically called capital shares or income and residual capital shares. These shares are the highly geared shares which means if there is a movement in the market down, say, 20 per cent, they may be down 80 per cent or more. I think one of the elements of confusion here which Martin has been trying to clarify is that the zero share class, which is a preference share, is the lowest risk share class of the ones in the split capital trusts, the other share classes are higher risk, they are securities, they are not products. What we are trying to clarify is that zeros are the lowest risk share class and in particular the product offered in the main to the retail market is through a retail unit trust investing in zeros.

  55. Shelley O'Donnell said that they shared the same characteristics as gilt edged government securities, so if I had put my 275 pence into them in February 2001, what would I have now?
  56. (Mr Currie) I think she tried to talk about zeros as a generic type in the same way as bonds. Many people think that government bonds are low risk, the safest securities, but in fact they dropped 20 per cent at one stage in 1993-94. Some people think Argentinian bonds might have been a safe bet. Because bonds are going to be backed by governments people believe them to be low risk but not all bonds are the same and not all zeros are the same in terms of their characteristics.

    (Mr Gilbert) Mr Plaskitt, could I pick up your point on the zeros in the fund we offered to the public because it is the one fund that we actually retailed to the general public and, you are quite right, did market as a low risk product.

  57. But it was not low risk, was it? Was it not completely misleading to suggest to your customers that it was low risk?
  58. (Mr Gilbert) It was perceived at the time to be low risk, not just by us but by the whole industry.

  59. I am sorry to interrupt but when as a prospective customer I read one of your senior people saying this is low risk I do not read that as saying "this is low risk today but it might be terribly high risk tomorrow". Low risk is a broad statement about the general prospectus of this investment and that was misleading, was it not?
  60. (Mr Gilbert) Mr Plaskitt, I am going to ask my colleague, Gary Marshall, to tell you what we have done about it in a second. I do have to point out that we are suffering the longest bear market since the 1930s, not the deepest since the 1930s but the longest since the 1930s. Whatever happened, these bear markets are very, very tough and zeros as a whole have tended to lose on average 30/40 per cent of their value. Perhaps Mr Marshall could tell you what we are doing about it.

  61. I think my colleagues may wish to take that up. I just want to round off on this and let my colleagues pick that up, so I am sure you will have the opportunity to do it. Do you think in hindsight that Shelley O'Donnell should not have described these products as low risk?
  62. (Mr Gilbert) I do not think hindsight is a true measure or a true description of how we should judge it. At the time we believed they were low risk.

  63. I think your investors looked at it that way.
  64. (Mr Gilbert) Unfortunately, everyone looks at it that way. Everyone judges things with hindsight. If we only had the benefit of hindsight I am sure we would all do things differently.


  65. I have got the Cazenove investment company's annual review before us here and last July they stated that "A systematic collapse could result from the high degree of investment by these trusts in other geared funds". Were you aware of that quote? If you were aware of that quote, did that affect your management practice?
  66. (Mr Gilbert) We were aware of that quote and, yes, it did affect our management practice. We did not agree with everything that was in the document, in fact we disagreed with a lot of it, as did a number of other analysts disagree. There were two opinions on that particular paper.

  67. Things kept getting worse for you despite that.
  68. (Mr Gilbert) They did get worse because sentiment got worse. I think we have got to separate share prices into two aspects: market movement and sentiment. What we have got at the moment is poor markets driven by general market falls plus falls on sentiment specific to the sector. For instance, a zero which is worth 150 pence today and might have 200 pence of assets backing it would be priced at 75 pence today and that is the sentiment factor.

  69. Just before the meeting, immediately before, we were provided with this document which you describe as "refreshed information". How "refreshed" is it?
  70. (Mr Currie) I am sorry, there is a typo on the last page.

    Mr Ruffley

  71. That is the least of your problems. Could I ask you, Mr Gilbert, how many of your splits have cross-holdings in other splits under 20 per cent?
  72. (Mr Gilbert) My colleague is looking for the figure ----

  73. Perhaps while he is fingering through there, if he could tell me how many of your splits have cross-holdings in other splits of firstly under 20 per cent, between 21 per cent and 40 per cent and 41 per cent to 70 per cent.
  74. (Mr Currie) From memory we ----

  75. No, not memory, give me the figures.
  76. (Mr Currie) This (document) compiles it as a sector rather than by split----.

  77. You should know these figures, let us get them.
  78. (Mr Currie) We have 19 split capital investment trusts, three of which are a fund of funds, which means their specific mandate is to invest in other split capital income shares. Three of them have no investment in other income shares at all and others have varying amounts between nought to ten and nought to 30. The reason why it is not off the top of my head is that they are all managed separately with different mandates, with different boards and with different instructions. There is also the fact that the ownership profile changes dramatically over time as managers invest into different areas. To answer your question, there are three fund of funds and there are four that would be described as barbell trusts that may typically have between ten and 30 per cent in income shares. The figures do change.

  79. What about the percentage, off the top of your head if you cannot give a specific number, between 41 per cent and 70 per cent? What would you say? Give us an estimate to save time.
  80. (Mr Gilbert) Three to four.

  81. Under 20 per cent?
  82. (Mr Currie) Three.

  83. Twenty-one to 40 per cent?
  84. (Mr Currie) I will check my previous file if I have it with me.

  85. Whilst you are checking that, how many of your splits are in what you would term or outsiders would term or the FSA would term "financial distress"?
  86. (Mr Gilbert) Eight at present.

  87. Eight out of?
  88. (Mr Gilbert) Nineteen.

  89. In Professional Investor in April 2001 experts at the University of Edinburgh talked about the importance of the inter-related structure of cross-holdings and what could happen in a falling market and they said "The risks created by geared trusts investing in other geared trusts are very real. Substantial price declines in the ordinary shares of some individual trusts might all too easily become a self-feeding downward spiral as the net asset values of the ordinary shares of other trusts that held them fell in turn." What do you do to manage that clear and present risk to protect investors?
  90. (Mr Gilbert) When was that report?

  91. The April 2001 edition of Professional Investor. Do not just take that as evidence, the quote that my Chairman read out, the Cazenove briefing note, makes a similar point. What do you do about that clear risk?
  92. (Mr Gilbert) I would like to correct the point that it is the cross-holdings that have caused the difficulties for capital investment trusts. It is not the cross-holdings, it is the gearing that has caused the problem. If there had been no gearing in funds at all they would not be in difficulty, to take the extreme case.

  93. But you had both, did you not?
  94. (Mr Gilbert) Gearing has added huge positive returns over the last, Piers?

    (Mr Currie) Over the last 15 years.

    (Mr Gilbert) The gearing has added about 11 per cent of the value.

    (Mr Currie) I think what you are trying to get to, Mr Ruffley, is the supposed systemic ----

  95. I know what I am trying to get to, just give us some straight answers.
  96. (Mr Currie) You can cut and slice the data with 400 different shares and class it a number of different ways. If I do not have immediate answers I will certainly come back and let you know the specifics. The issue that the FSA was raising in their report and what the Chairman appeared to be mentioning before was the question of the systemic risk affecting the sector. We now see about ten per cent of the split capital market is weak but as against that, identifying purely cross-holdings as the clear and present danger is one which is possibly over-expressed. Only about 15 per cent of the sector is invested in income shares. Investing in income shares per se is not necessarily a bad thing, income shares are priced according to how much income they can produce in the future. The problem that we see here with some of these structures that were being invented in the late 1990s was that bank debt proved to be a more inflexible form of gearing than zero dividend preference shares. Once assets fall sufficiently and fund managers effectively lose control to the bank because assets have fallen, you have an issue with income shares, This is because income shares that are unable to pay out their income fall in value quite dramatically. The sensitivity modelling is generally done by each trust and each board and each manager specific to that trust because they are all designed differently, some invest in different areas, different asset classes, some have bank debts, some do not have bank debt, some have a focus on the UK.

  97. I understand all that. You have explained the problem but why did they screw up?
  98. (Mr Currie) I think the reason with hindsight ----

  99. So you think they screwed up?
  100. (Mr Gilbert) No, he did not say that.

    (Mr Currie) Who screwed up?

  101. The managers.
  102. (Mr Currie) No, I do not think the managers did screw up.

  103. Ah. I think a lot of people listening to what you have said, Mr Gilbert, will be quite staggered by that but do continue, Mr Currie.
  104. (Mr Currie) I think one of the issues is that when these instruments are designed, and they have been designed by some of the best investment bankers and brokers in the UK, they actually build the product to try and withstand stress testing in certain market environments. As it is they stress tested it as if it was a car driving down a pretty bad rainy road and what ended up happening was that they hit a hurricane. We have seen fairly massive falls, let us not forget. A number of these trusts are exposed to the technology market which has been down about 80 per cent and a number of conventional investment trusts exposed to certain asset classes have also fallen dramatically. Geared instruments on falling asset classes do worse. That was the purpose of a number of these instruments and it is obvious what the instrument said it was going to do.

  105. Can I ask you finally, Mr Gilbert, which authorities are investigating you for collusive behaviour?
  106. (Mr Gilbert) As far as I am aware no authorities are investigating us for collusive behaviour at the moment. The industry, including Aberdeen is working with the FSA in their overall review of the split sector.

  107. At the moment. So you might expect it in the future?
  108. (Mr Gilbert) I think that is a question you should ask Mr Tiner.

  109. Are you expecting it, Mr Gilbert?
  110. (Mr Gilbert) I am not expecting it but that is a question you have got to ask Mr Tiner. I would not dare speak on behalf of the FSA.


  111. On the point you said about cross-holdings not being the problem, just to finish my colleague's comments, I have got a quote from David Franklin, who is a Director of stockbrokers Christo's, and he said "I think the directors of some of these investment trust companies should be held accountable. There is no doubt in my mind that they would have been aware of the level of cross-holdings and should have understood the consequences." Can I ask for a simple yes or no, do you agree with that?
  112. (Mr Gilbert) No, I do not agree because it is all written with hindsight, Chairman. Every comment there is with the benefit of hindsight.

    Chairman: Fair enough.

    Dr Palmer

  113. I just want to explore these cross-holdings a little more. Are you aware of the extent to which the holdings in, let us say, Aberdeen Progressive Growth is actually invested in other similar trusts?
  114. (Mr Gilbert) I think it is very important to understand that some of the funds are set up as fund of funds so their specific investment remit is to hold shares of other investment trusts. That is what it was set up to do, that is what it has been described as doing and that is what it does.

  115. So the answer is 100 per cent?
  116. (Mr Marshall) Was that Progressive Growth you mentioned or Aberdeen Preferred Income Trust?

  117. No, Progressive Growth.
  118. (Mr Gilbert) Sorry, I thought you meant Aberdeen Preferred income Trust.

    (Mr Marshall) If I could take that question. Progressive Growth is a unit trust which invests in split capital, the zero dividend preference shares which are shares of split capital trusts. It is, as Martin said, in this case designed to invest in zeros. It is very clear that it invests in zeros. That is its entire purpose and it is laid out that way.

  119. In a newspaper advertisement last year marketed to the broad public you depicted a baby and described the Aberdeen Progressive Growth trust as the "one year old that lets you sleep at night". How much of its value has it lost since then?
  120. (Mr Marshall) Since that point I think it is down at just over a 40 per cent fall.

  121. Do you regret the advertisement in retrospect?
  122. (Mr Marshall) I think with the benefit of hindsight you can come back and say clearly that fund has not performed as we laid it out to do but you have to look back at the time the advertisement was run. The information out in the marketplace about zeros was very clearly pointing towards it being a low risk asset class. They had been around for a very long period of time, had performed exactly in line with the type of statement we were setting out. We were confident that was the correct position for the fund. We understand and recognise - and it is the only product that we as a group have marketed very explicitly as low risk - that statement has not been borne out in practice and therefore we have proposed an uplift package for investors which is designed to ensure they get their money back at a date in future.

  123. As your colleagues have said, the significant factor in all this is the gearing and I understand that most splits have 70 per cent or more of their assets represented by debt, is that correct?
  124. (Mr Marshall) It varies depending on the fund. If you take any split capital fund, it is by definition geared by the existence of a zero because that is obviously a set liability against the fund. It would depend entirely upon the individual fund as to exactly how much gearing was involved. You also find clearly when the equity content has fallen and the shares have fallen that the gearing levels have increased significantly. If you look back at the levels of gearing that were around, say, in June last year, the gearing percentages were considerably lower because the markets have subsequently fallen.

    (Mr Gilbert) When we launch a fund, or a trust I should say, you can compare it to a house and a mortgage. If you are buying a house and you have a mortgage of, say, about 70 or 80 per cent down against the value of the house, that gives you a geared exposure to the property market. When we launched the funds, the maximum they were ever geared was really about 50 per cent. As assets have fallen obviously the gearing rate has gone up. We have, of course, in the falls in the market sold down parts of the portfolio because, as Piers said, the banks and the banking covenants have forced us to reduce assets. Often with the gearing now you will get a fund where there might have been originally, say, 100 million of bank debt against it but there might be 40 million of cash sitting against it.

  125. I understand but management charges are usually based on the percentage of the overall asset value, including the debt. Is that correct?
  126. (Mr Gilbert) That is correct, yes.

  127. So, leading on from the questions which the Chairman asked at the beginning of the session, what we have here is a trust which was marketed to the general public on the basis of being a trust that lets you sleep at night ----
  128. (Mr Gilbert) No.

  129. Yes.
  130. (Mr Gilbert) No. The unit trust has no gearing in it so.

  131. Okay. Your portfolio has been marketed on the basis of a safe bet.
  132. (Mr Gilbert) Yes.

  133. Many of its components are highly geared and management fees, which we have heard are very substantial, are charged on the overall amount, including the debt. People have lost a very large proportion of their savings as a result. Harking back to a previous era, do you not feel that this is the unacceptable face of Capitalism and this is just not acceptable behaviour?
  134. (Mr Marshall) If you look at the Progressive Growth unit trust, the fee on that unit trust is one and a quarter per cent which would be standard for a unit trust product in the marketplace. Where there are any zeros which are also managed by Aberdeen, and obviously as a larger player in the market you would expect to see some holdings in there, we do not double-charge. The charge is clear and it is laid out in the fund, that is the net charge which is paid by the investor as far as the products which we manage are concerned. The other holdings that are in that portfolio are shares in the market, that is no different from a holding of any other equity product in the marketplace. The charge that is laid out is clear and is not in excess of that, there is nothing hidden as far as I am concerned.

    (Mr Gilbert) I think the key issue which Gary referred to on Progressive Growth is we realised that the adverts we had were not as good as they should have been when they were made and that is why we are proposing the guarantee to give the investors their money back, which is a key component in this guaranteed uplift package. I do not know where else people in this industry or in these markets at the moment are actually going out and guaranteeing that their investors get their money back.

    Chairman: It is all down to hindsight though, is it not?

    Mr Fallon

  135. Let us just pursue this. I am still not quite clear about this cross-holding. If you have got ten investment trusts investing, say, nine million quid each in each other's trusts and they raise one million each from the general public, it looks as if the total assets of the total trusts are about 100 million but, in fact, the real underlying assets are only ten million, the other 90 million is simply cross-holding, the money is not changing hands, is it? If you have got a bull market the whole thing keeps going up but the real burden of producing the dividends on capital growth is raised on a very tiny proportion of the assets. This is pyramid selling, is it not?
  136. (Mr Currie) I do not think that construction is quite right. When any new issue comes to market, the stockbroker takes the prospectus to several hundred institutions who take equity and shares, so you may have 150 investing institutions putting cash in to buy income shares or capital shares or whatever is on offer. But institutions buying closed end funds is not in itself peculiar, that is how the stock market works. Some private investors then may take the view that they will buy shares in the after market.

  137. You have got a group of investment trusts buying shares in each other. You have constructed a pyramid which when there was a bull market was fine but the minute the market turned down the whole thing collapsed.
  138. (Mr Gilbert) I do not accept that. On one of the last trusts we launched, which was the European Technology and Income Fund, there were 95 institutions - I can check that figure later - invested in that. They invested 100 million of equity in that fund. I just do not accept those figures.

    (Mr Currie) And then that portfolio gets invested --

  139. How many cross-holdings did you have in other people's investment trusts?
  140. (Mr Gilbert) That particular fund I think was less than 1 per cent of other funds. In fact, when it initially started it had no cross-holdings at all.

  141. But how many of your funds were invested in other people's funds?
  142. (Mr Currie) We have got the statistics here.

    (Mr Gilbert) We have three that were funds of funds.

    (Mr Currie) We have four AAA-rated which means they have no income shareholding at all; three AA-rated which means they have less than 5 per cent invested in income shares in their portfolio; and then eight which are A-rated which is less than 25 per cent; so 15 out of the 18 split capital trusts invested by Aberdeen have less than 25 per cent in income share ownership, four of which have none at all and three of which have less than 5 per cent, and each of those individual holdings in income shares - and I think the FSA report touches on this - is less than 2 per cent of the portfolio so the actual quantum of individual holdings into a particular trust is pretty small. What we have tried to cover in the paper is to say that, where cross-holdings become an issue, is if you have circular elements attached with fund A back to fund B back to fund A, and then you have a problem if there are falls. Nigel Sidebottom explains in the article for Credit Lyonnais that by the third iteration of a cross-holding its effect on NAV falls is de minimis. What matters, therefore, is whether investors are investing in the right type of income share, and income shares have become somewhat demonised generally. They do something very good that other equities cannot: they can offer high yield and capital appreciation in a way that corporate and government bonds cannot, and conventional equities cannot as well. Where you have a problem is if you have income shares falling generally because bank debt is then putting pressure on the portfolio that remains.

  143. But did nobody designing these products think what might happen if there was a sustained bear market?
  144. (Mr Gilbert) At the time they were launched the market was significantly higher and the projections from all the experts were of continuing stock markets going up at rates of 7 to 9 per cent per annum. It is very easy sitting here today with the market down 200 points and 100 points this morning to laugh at that but that was the reality at the time. Not only are we caught by surprise but so are pension funds, insurance companies - the whole industry is caught out by a fall of this magnitude.

  145. Let us just pursue, finally, the issue of charges again. Was it clear to your individual investors that the fees were levied on the gross assets before borrowings rather than on the net assets?
  146. (Mr Gilbert) Yes. Absolutely clear.

  147. And investors understood that fees could be as high as 2 or 3 or 4 per cent, rather than 1 per cent?
  148. (Mr Currie) They were not as high as that. They were 1 per cent of gross assets.

    (Mr Gilbert) 1.2 per cent of gross assets.

  149. That was your highest figure?
  150. (Mr Gilbert) And no fees charged on holdings in other Aberdeen funds either.

  151. So you had nothing higher than one and a bit per cent?
  152. (Mr Gilbert) No.

  153. Do you think the investors understood what that meant?
  154. (Mr Currie) Yes, and relative to initial distribution costs, say, of a unit trust of 5 per cent or 3 per cent, such charges are not unusual. After all, you are investing one hundred per cent of the portfolio not just 50 per cent of it, so the charging structures which apply to these trusts and which have been set for all investment trusts are pretty much the industry standard.

  155. And you think they are reasonable?
  156. (Mr Gilbert) Yes, I think they are. They are the industry standard.

    (Mr Currie) Unless they run into difficulties, which I think some of them have. We have been the first to waive fees on distressed funds - we were the first manager to do so - although we appreciate that was not much consolation given the extent of the sector's difficulties. People have lost a lot of money. But the important thing is how we as an industry, and we as Aberdeen, can make best efforts to try to restore investor confidence and produce information that is genuinely helpful and that people can understand, and we are taking a number of initiatives with the AITC and others to try to achieve that end.


  157. Mr Gilbert, there is a problem for the ordinary person. What you are saying is that the problem for you was the future - that everything seemed okay at the time but the future was a problem. But the ordinary person would say that if you are going to climb Mount Everest, because it is a good day when you start you go in shorts and trainers but you anticipate what could happen at later date. It just seems that you are not anticipating what could happen, and that is the issue here. It is your responsibility, and that is what the ordinary citizen writing into us is asking us to question you on.
  158. (Mr Gilbert) We stress-tested these products to a 30 per cent fall in the market; we did not expect the falls to be greater than that. Now, you may say, "You should have known that the market was going to fall to the extent it did", but I either was not clever enough or did not know enough to foresee that the market was going to fall to those levels

  159. Forgive us but we feel as a Committee that, on this issue of cross-holdings you have been vague and selective to us, and we therefore ask for you to write formally into this Committee about the whole issue of your cross-holdings, and we need figures on that issue.
  160. (Mr Gilbert) We would be delighted to do so, Chairman.

    Chairman: Then maybe we will have you and others back at a later time so we can go over it at leisure.

    Mr Cousins

  161. You have referred, Mr Gilbert, to measures you are taking to restore confidence in the market in general and measures you are taking with regard to your own particular trusts. I wonder if it would be helpful for you just to explain that in rather more detail? What are these repayment mechanisms?
  162. (Mr Marshall) If I could start, there are basically three broad initiatives we have been looking at. As far as the retail investors are concerned there is the Progressive Growth Unit Trust which has the widest retail exposure and there, as I mentioned previously, what we are aiming to do is put an uplift package together which will ensure that investors receive their original investment back at a future date. Some of the details of that are still in the course of being finalised and we will be discussing those with the regulators and others. I am not in a position to give you all the details right now but that is the broad thrust of it. Elsewhere we have mentioned the fact that we are waiving fees on a number of the distressed investment trusts that are having specific issues - we are looking to waive fees in order to allow those funds the opportunity to recover - and in a particular instance we have also invested in a particular fund which has been in trouble in order to try and secure that fund's future; we will perhaps be a participant in the recovery of that fund. So there are a number of things we are doing there, plus I think the document you have in front of you, the monthly monitor document which we produced, is really all about trying to give as much information and be as open to the market as we possibly can so that the issues are understood, because there clearly is evidence in the marketplace of misperception, of generalisations going out, whereas when you draw down to the detail the problem is much more localised and much more specific and we have tried to be clear on that. I think there are various initiatives we are trying to do there.

  163. I wonder if I could just try and clarify some of the points you have been making to us there. There are 19 of these split capital trusts. I do not know, and perhaps you could tell us, how many of those split capital trusts you regard as being trusts with the greatest exposure on the retail market, because in your own mind you are separating your trusts into two categories: one category has a high retail exposure - this is your assessment of the situation - and one does not. Could you just tell me how many of these 19 trusts you regard as being in each group?
  164. (Mr Currie) I think why we are putting this into two different boxes is because the ownership pattern of split capital investment trusts is different from the ownership of unit trusts. Investment trusts generally have an ownership of about 1 per cent of the adult population - about 600,000. On split capital investment trusts as a universe, as far as we can calculate it, there may be about 50,000 owners. A lot of conventional trusts became split capital trusts in the early 1990s. But drilling down into the type of trusts we have, as far as we can tell, of the trusts launched in the last three or four years there may be about 10,000 or so private investors, many of them direct investors who know what they are doing, DIY investors, but we cannot keep track of the registers because quite a lot of names are buying through nominee accounts. We know more about the unit trust ones because the names are all coming through the unit trust on which Aberdeen itself maintains the register. With an investment trust, in terms of the buying and selling of nominee accounts, it is really very difficult to keep track of who owns it, so the 19 that are managed are all very different with different histories. Three or four of them came with the acquisition of Murray Johnstone in Glasgow so they arrived with their own shareholders and their own history. Two or three others came from a Jersey-based company, Graham Investment Managers, acquired by Aberdeen, so trying to know the shape and the structure is quite difficult but we monitor the registers as best we can. Zero holders typically are more owned by the private investors than geared, ordinary or capital shares, and therefore to generalise with the 19 it is quite difficult to say which is more retail than the other. What I can tell you is that a unit trust is a retail-focussed vehicle and generally split capitals and the higher risk share classes are owned by less people but generally wealthier people with bigger sums, who are using them as part of an overall portfolio.

  165. I am grateful to you for that but the answer would seem to be that, of the 19 split capital trusts, in fact you are not offering a guarantee repayment on any of them?
  166. (Mr Currie) Correct. These are independently quoted listed companies.

  167. I am glad I worked that out and that I was not, and I am not suggesting it for one moment, intentionally misled but I am glad we have clarified this point: that you are saying you are offering a repayment mechanism to protect people from losses in the case of unit trusts but in fact that does not apply to any of the split capital trusts that we are more particularly talking about today?
  168. (Mr Marshall) The split capital funds, the zeros we are referring to, are individual shares. The Progressive Growth unit trust is a managed fund of zeros.

    (Mr Gilbert) Marketed as low risk. It is the marketing aspect that is the important aspect on a split capital investment trust and it is wrong to talk of the split capital as one class of share - it has very different classes of shares and the low risk class of share is the zeros. If someone bought a geared ordinary income share that tells you that there is gearing in that, and that it is not a low risk product.

    (Mr Currie) The FSA have given guidance on this area and from the individual investor's perspective it is, "How is it you came to acquire either your share or investment? What happened in the process? How were you advised to make an investment in this case? If you were advised and came in and were misled saying 'Buy this share and it is going to be as safe as gold bars' or whatever, you go to the person who told you that and raise your issue with them for the complaints procedure", because we are all regulated firms and by going through the authorised procedures it means that we are able to identify how somebody came to buy something. If I want to go off and buy Japanese warrants because I have a dead cert belief that the market is going to go up and gamble my way to whatever it is and they go down, I did it, if I did it through my own execution-only broker saying that that was a great thing for me to invest in, on my own cognisance and if I come back afterwards and the Japanese market underperforms, the position on that if I have made my own decision is pretty clear - that was done on my own expectation and my own cognisance. So we are turning back to talk about how things were perceived because what we have with the issue of the zero funds in particular is that private investors saw this as an asset classed as low risk and that is the one which we have the most concerns about - not the capital shareholders. I myself invested in a technology capital share which was a bit of a gamble and it did not work, but I am not writing to the FSA or yourselves to say I have lost my money on it. Do you understand why I am trying to differentiate?

  169. Yes, I do.
  170. (Mr Currie) The Ombudsman has looked at some of these cases and has pretty clear guidance on his website.

  171. Yes. To be fair I would need to know a little bit more about your financial affairs than I either need to know for the purpose of this occasion or wish to know to form a judgment of that, but let us be clear about how we are teasing out your own attitudes to this. You are saying that people who acquired these shares in these split capital trusts through execution-only brokers is a sign that they ought to wash their own face, and really "Tough" is your response to that, is it?
  172. (Mr Currie) No. What I am saying is look at the sales process because there is an issue to do with how people bought and sold things, and if people made their own decisions and they elected to buy an equity or a share or whatever it is, then I think you would find they made their own decision and that is their responsibility.

  173. But I am just trying to clarify your attitude to this. If they bought these shares through execution-only brokers - "Tough". If they brought them through advisers, then your advice is to track back to the adviser and see if the adviser was to blame.
  174. (Mr Currie) I think that is FSA's guidance on that and that is quite right. If they are a customer of ours, they should come back to us.

    (Mr Gilbert) It is more complex than that. I think that is over-simplifying it. We have examples of people who have read in the newspaper that zeros were a good thing and they went and bought through an execution-only stockbroker and now they are reading that zeros are not such a good thing, and it is very difficult to say to that person "Well, look...". And then there are clear examples where people have bought zeros - and we have to keep this to zeros rather than shares, if I might say so, because the zeros are the low risk shares - and where they have been advised to buy it by advisers, obviously the first stage to go back to is the person who advised them to buy the share.

  175. Do you think that the attitude you have just expressed towards the people who have acquired these investments, which is in the one case "Well, tough" -
  176. (Mr Gilbert) I do not think that is correct. I think those are words that have been put in our mouth.

  177. In that case could you explain to me what measures you are taking to restore the confidence of those investors in those products?
  178. (Mr Gilbert) We are doing all we can to restore confidence in the zero share market. As I said, we are giving a guaranteed uplift on the unit trust: we have injected cash into one of our investment trusts that invests in zeros - we are doing all we can to restore confidence in that sector of the market because that sector underpins the rest of it.

  179. Would you be happy to give an account to the Committee, not now, of these 19 trusts and the various measures you are taking with regard to each one to underpin confidence?
  180. (Mr Gilbert) We would be delighted, yes.

  181. The other point is this: in this document which you have been kind enough to send us, essentially you are saying that there are underlying assets that back these shares, these investment products, which retain the possibility of considerable value.
  182. (Mr Currie) Yes.

  183. But your assessment varies in different categories of this rather complex share ownership structure. It would be nice to have that explained to the Committee either firmly now --
  184. (Mr Gilbert) We would be delighted to do so, yes.

  185. Do you feel, then, that basically these trusts are going to trade out?
  186. (Mr Currie) The vast majority.

    (Mr Gilbert) As long as markets do not go down. If markets go down further from here, others will get into difficulty. If markets go up, a lot will recover. We are heavily dependent on stock markets.

  187. What timescale are we talking about? What is the recovery term?
  188. (Mr Gilbert) The problem is everyone is getting more and more depressed on markets now. Six months ago everyone thought markets would recover in three months; now people are speaking about two to three years and that makes lenders nervous - everyone more nervous.

  189. How many of these 19 trusts could survive a two or three year continual decline?
  190. (Mr Gilbert) I could not say really. We would need to do a more detailed assessment of that. I could not answer that now. I could come back to you on that though.

    Mr Laws

  191. Can I ask you what proportion of the retail investors who bought the zero dividend preference shares will receive compensation from you?
  192. (Mr Gilbert) One hundred per cent, if they bought through us or bought our unit trust.

  193. One hundred per cent if they bought directly through you?
  194. (Mr Gilbert) Through us or bought our unit trust, so not only are we compensating retail investors who bought the unit trust, but anyone who bought our unit trust.

  195. And what proportion of those retail investors who have zero dividend preference shares would that cover? A large proportion or a minority?
  196. Chairman: I think Mr Marshall wanted to come in on the previous point as well.

    (Mr Marshall) To clarify, the package we have proposed for the unit trust applies to all investors in the unit trust. What I think Martin is explaining is if there were a case of a zero dividend preference share having been mis-sold in any way by us to a retail investor outside the unit trust then obviously we would compensate for that, but our package applies for the unit trust and is only for the unit trust.

    Mr Laws

  197. Do you not think that the compensation that you pay yourselves should go further than that, given that Mr Plaskitt earlier on quoted from one of your investment trust managers who was commenting upon the low risk characteristics of these particular financial instruments? You yourselves at that time said that you perceived these to be low risk, and actually you said a second ago, Mr Gilbert, that the zeros are the low risk shares, so is it not the case that you did get this wrong: that your view was that these financial instruments were low risk and then, of course, the stock market unravelled and the gearing effects and the cross investment effects came through, so is it not the case that all of those private investors who bought really on the back of your perception and assurances should be compensated?
  198. (Mr Gilbert) I do not think they bought on the back of our reassurances - I do not believe that. There were numerous, hundreds of articles on zeros at that time saying they were a safe investment and they have not turned out to be as safe as we thought. "Low risk" does not mean "no risk". "Low risk" does not mean that you cannot lose money.

  199. But your view of them was that they were low risk and that is why you kept selling them.
  200. (Mr Gilbert) No one has lost money yet. Most people are still in their zeros so they have not lost any money yet. They have not sold.

  201. I am not sure that is the way the investors will view losing 90 per cent of their assets --
  202. (Mr Gilbert) Then they are being naive, Mr Laws. We all know that until we sell an investment we have not lost money on that investment. You may think otherwise but -

    Mr Laws: I think most people will view it otherwise. If you have lost 95 per cent of your assets -


  203. Maybe we should still be happy.
  204. (Mr Currie) We have covered the risk profile made on page 11 of the document submitted to you which tries to take forward the attributes of zeros as an asset class and how it was being written by various other investment managers at the time. We have the data on redemption yields on zeros going back to July last year and before that, and if the market had seen the risk in these shares it would have priced them accordingly.

    Mr Laws

  205. But you did not see it. You regarded these assets as being low risk and on that basis you marketed them, discussed them and sold them directly and indirectly to retail investors who assumed they were low risk --
  206. (Mr Currie) A low risk share class.

  207. -- And they have turned out not to be at all. They have turned out to be extremely high risk given the gearing and the cross-investment as well as the decline in the equity market.
  208. (Mr Gilbert) There is a very good statistic at the time. When we were marketing these as low risk, some could have lost 11 per cent of their assets per annum over the remaining time of the zeros for them still to pay out, so we were looking at a situation where we could see that they could lose on some zeros 11 per cent per annum, say, over seven years and still pay. Now, obviously the markets have fallen further than we expected and everyone else expected.

  209. Can you tell us what steps were taken to make clear to the holders of zeros that their security might be compromised by the issuance of new debt?
  210. (Mr Currie) I think we must distinguish between us and the boards running the companies themselves - that is the first point. If there is any substantive change the boards of directors write to the shareholders for shareholder approval; shareholder democracy kicks in; people vote if there are going to be any substantive changes to capital structures or reconstructions, and that is done by the board. You can go to AGMs and EGMs and you can vote against these things - and actually we would like more shareholders turning up because often shareholder apathy is a bit of a problem. Boards meet and put out annual and interim reports, we put out monthly fact sheets - investors are getting information on the structure of the company all the time.

  211. Actually I wanted to ask about investor apathy because one of the individuals who wrote to us who lost 98 per cent of their investment was very upset about the position earlier on in the year when, in May, the size of decline in her asset base became evident and she said to us in a note that Aberdeen was obliged under the Companies Act to convene an emergency general meeting on 22 May. The stock market prepared invitations on 7 May but Aberdeen made an administrative error and forgot to invite the investors. Is that correct?
  212. (Mr Gilbert) That is nothing like the case.

    (Mr Marshall) The fund you are referring to is our High Income Trust and the position there is that all of the registered holders of that fund are entitled to receive a notice of the meeting. We have one registered holder on there which is the Aberdeen share plan which contains within it a whole raft of other people, and unfortunately they were not mailed. In fact, the position was that the meeting was for information only and there were no votes involved and we did --

  213. I think they would have liked to have known what was going on.
  214. (Mr Marshall) We offered everybody the opportunity to attend a subsequent meeting, and that was available to them. So they had the opportunity to put any issues and concerns to the board quite shortly thereafter.

  215. Why were those investors not told?
  216. (Mr Marshall) It was administrative error. You have one shareholding and the shareholding represents all of the subholders.

    (Mr Gilbert) They were not obliged to be told but we normally out of courtesy tell them. They were in the Share Plan basically but, Mr Laws, I accept it was not acceptable practice and it is not something we are proud of.


  217. We are coming to the end, Mr Gilbert. Could you tell us why your memorandum to the Committee did not include information on the performance of your own trust? I am reminded of that by a front page article in Business AM this morning which indicates that Aberdeen Asset Management was forced to suspend its shares in Aberdeen Media and Income and is in talks with its bankers. Is that correct?
  218. (Mr Gilbert) Yes.

  219. So why did you not give us all of this information upfront?
  220. (Mr Currie) Which information?

  221. On Aberdeen Media and Income.
  222. (Mr Gilbert) I think it is in the performance monitor.

  223. You have not given us this information.
  224. (Mr Currie) In the monitor we supplied, which also includes pages on the income shareholdings that you were asking us about, each individual trust in the split capital market is covered.

  225. This is the memorandum you provided us with?
  226. (Mr Gilbert) We also provided that. I am sorry - we should have included it.

  227. But you provided that after this meeting started. It did not help any of us.
  228. (Mr Gilbert) I do not think it was provided after the meeting started - well, I am sorry. I apologise, Chairman.

  229. I quote from the Financial Times of 17 May and Martin Dixon who is a respected financial commentator and he says that you deserve no sympathy; you have given the sector a bad name; you have tarnished the whole of the split capital sector and the stain may have spread to the investment trust industry as a whole. Do you agree with that?
  230. (Mr Gilbert) No, I do not.

  231. Why do you not agree with it?
  232. (Mr Gilbert) Well, (a) there are 36 other fund managers in the split capital sector - I know from reading the press you might think there was only one but there are 35/36 others - and (b) this has happened before. This happened in the 30s and in the 70s so this is history repeating itself. I know that causes general mirth, but that is the case: this is caused by a prolonged bear market. Now we cannot ignore that.

  233. A number of people have written to us, Mr Laws mentioned someone and I had a letter from someone who took out an ISA with you for 7,000, now worth 98, and they are very angry, as you can imagine, and they have been very rude about it, so I will be less rude and formulate a question to you. They tell me that you are sophisticated snake oil salesmen. Tell me what the answer to that question is so I can go back to these people and reassure them that there is 100 per cent integrity behind everything you have done?
  234. (Mr Gilbert) There is 100 per cent integrity behind everything we have done.

  235. That is good because we have asked for written information from you, and I hope that at a future date, along with Mr Fishwick, we will reknew our acquaintance and take this further. Thank you very much.
  236. (Mr Gilbert) Thank you very much.

    Memorandum submitted by the Association of Investment Trust Companies

    Examination of Witnesses

    MR ANTHONY TOWNSEND, Chairman, and MR DANIEL GODFREY, Director General, the Association of Investment Trust Companies, examined.



  237. Good morning, gentlemen. Can I welcome you to the Committee meeting. Would you formally identify yourselves, please?
  238. (Mr Godfrey) I am the director general of the Association of Investment Trust Companies.

    (Mr Townsend) I am the chairman.

  239. I have a general question to start with which is what are your observations on the previous session?
  240. (Mr Godfrey) Clearly the split capital trust sector has been having a very difficult time, and the managers of that sector are under a great deal of pressure. I think that was evidenced in the session we have just witnessed.

  241. Can you empathise with the views we have put across on behalf of ordinary investors and what reassurance do you have for ordinary investors? It is a rather short answer you have given.
  242. (Mr Godfrey) The Association of Investment Trust Companies' mission is to work with our member investment trust companies to add value for shareholders. We are an organisation funded by the shareholders' funds of investment trust companies so we regard our primary objective as being to work in their interests, and we share this with the boards. In the context of that, therefore, we are deeply distressed by the losses that they have experienced.

  243. Putting it another way to you, given the quote that I gave from Martin Dixon regarding the fact that they deserve no sympathy, they have tarnished the whole of the split capital sector, and the stain may have spread through the investment trust industry as a whole, do you agree with him?
  244. (Mr Godfrey) I think it is a matter of the greatest possible regret that the good name of the investment trust industry --

  245. But do you agree with Martin Dixon's quote?
  246. (Mr Godfrey) I would agree with it in part.

  247. What parts do you agree with and what parts do you disagree with?
  248. (Mr Godfrey) I would agree that the good name of the investment trust sector, certainly of the split capital sector, has been blackened and that the stain has started to spread through the investment trust industry as a whole.

  249. So you do agree with the whole quote, because there are two parts to it: that they have tarnished the split capital sector and that the stain may have spread.
  250. (Mr Godfrey) Yes, I do agree with that. I thought you were asking me whether I had any sympathy for Aberdeen Asset Management or not as well.

    Mr Plaskitt

  251. In your view, should zeros ever have been marketed as a low risk investment?
  252. (Mr Godfrey) There was a long period of time during which I believe it was entirely appropriate for zero dividend preference shares to have been marketed as low risk investments. One of the things we heard in the previous session was that they were low risk, and one of the statistics mentioned was that some of the zeros issue could suffer a fall in the value of supporting assets by 11 per cent per annum and still pay out. That is only one of the methods of analysis. Clearly what one also has to look at is the quality of the assets underlying that structure and then take a view as to how risky one thinks it is that those assets will fall by 11 per cent per annum. The assets are not necessarily related to the market as a whole, so if you feel that you have assets which are vulnerable to falling considerably then clearly the chances of them falling by 11 per cent a year become much greater.

  253. What do you think an ordinary investor understands by the phrase "low risk"?
  254. (Mr Godfrey) I think an ordinary investor understands by the phrase "low risk" that they are not likely to lose very much money. If they lose anything at all it will not be very much.

  255. Is that what happened in the case of zeros?
  256. (Mr Godfrey) It is not what happened.

  257. So they were not low risk then?
  258. (Mr Godfrey) From that perspective they were not low risk but if I can please just return for a moment --

  259. But the industry cannot hide behind its own self-helpful definition of what "low risk" is. You used the phrase, or they used the phrase, or your people used it, in promotional material and in articles.
  260. (Mr Godfrey) I could not agree with you more that the industry should not hide behind its own definition of "low risk" which may not accord with that of its customers. I think it is incumbent on us to make sure we understand what the customers believe and make sure we inform them accurately about what they are getting but the fact is that zeros, up until a few years ago, could suffer big falls in value and were backed by fairly conservative portfolios as well so the chances of them suffering any catastrophic loss were infinitesimally small. What happened over the last few years was that the portfolios backing that supposedly low risk investment started to change because of the introduction of investment in other split capital trusts - what we have referred to today as cross-holdings - and it started to change also because of the introduction of bank debt which destabilised the whole structure in the event of serious falls in the market. So I do believe that the risk profile was changing, and it is also my belief that the industry did not go out of its way to communicate with potential investors that the risk profile was changing.

  261. So investors were being misled in that sense?
  262. (Mr Godfrey) Investors were not in receipt of sufficient information.

  263. Which means they were being misled?
  264. (Mr Godfrey) It depends what you mean by "misled". If you mean that they were being told something proactively that was wrong, I think probably not; if they were not being told something that perhaps they should have been told, then yes.

  265. Pretty crucial information was being withheld from them?
  266. (Mr Godfrey) They were not given crucial information.

  267. And you accept that that in a sense defines being "misled?"
  268. (Mr Godfrey) No, I do not.

  269. I thought you did.
  270. (Mr Godfrey) I cannot go to the motivation of the people who did not give them the information so it is impossible for me to say "withheld". It would depend on whether they recognised it themselves or not.


  271. So they could have been absent-minded?
  272. (Mr Godfrey) They may not have recognised it themselves --

  273. Fair enough.
  274. (Mr Godfrey) -- And that is a separate issue, whether they should have done or not.

  275. According to your memorandum, concerns about the merits of splits emerged in the press as long ago as November 1998. What action did you take?
  276. (Mr Godfrey) The concerns that were being raised in 1998 were concerns about what has become known as the "magic circle". We started to hear rumours about the magic circle; we were reading reports in the press; we looked into those rumours and we could not find any corroborating evidence. Again, there is a big issue of intent here and intent is always the hardest thing to prove. The fact that a number of managers issue new funds and invest in each other's shares is not of itself evidence of collusion. They may think that those shares are the most wonderful thing since sliced bread and may want to invest in them without any collaboration between them, and that is something that is quite difficult to prove. The rumours we were hearing were only of the nature that managers who were not participating in this were being invited to participate, and that in itself does not represent a misdeed being done - just an attempt to purloin them. We then, I think perhaps wrongly, after that period began to get more comfortable and the reason was that the argument was being made - and I think to a certain extent we accepted it - that the fact that more managers were coming into this sector and more of these holdings with other splits were being launched was leading to diversification which was reducing risk. The other factor which made us more comfortable was that increasingly the new issues were being issued purely into the institutional market place by way of placing. What we were not picking up on was that the intent was to push them out into the secondary market over time so I think we may have been wrong in buying that argument.

  277. So in hindsight - that sacred word - you made a mistake?
  278. (Mr Godfrey) I am not going to use the word "hindsight": I think we made a mistake.

    Mr Laws

  279. 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?
  280. (Mr Godfrey) Again, we are getting into slightly technical grounds here.

  281. Not that technical.
  282. (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.

  283. What about the zeros?
  284. (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.

  285. When do you think that changeover came and these instruments should no longer have been marketed as being low risk?
  286. (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.

  287. So after 1999/2000 it would have been wrong for people like Aberdeen to be marketing zeros as being of low risk characteristics?
  288. (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.

  289. And they were not?
  290. (Mr Godfrey) They were not.

    Mr Ruffley

  291. 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?
  292. (Mr Godfrey) We are not the regulator -

  293. 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?
  294. (Mr Godfrey) Well, I will tell you what we are doing because it may not fit exactly into that --

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

  297. How are you doing that? What are you finding?
  298. (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.

  299. 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?
  300. (Mr Godfrey) Yes.

  301. 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.
  302. (Mr Godfrey) I would say three and a half years.

  303. Could I ask whether you would care to tell us which funds and organisations have been the subject of these rumours?
  304. (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.

  305. 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?
  306. (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.

  307. 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?
  308. (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.

  309. 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?
  310. (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

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

    Dr Palmer

  313. 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?
  314. (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.

  315. 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?
  316. (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.

  317. 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?
  318. (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.

  319. Who should be stopping it?
  320. (Mr Godfrey) I am not sure that someone should be stopping it; I think it is probably the other way round. I think people should have sufficient information that they do not buy it if it is not for them.

  321. Well, "increasing premium... that may prove unsustainable". You think there are people who feel that is a good thing and want to do it?
  322. (Mr Godfrey) Yes, absolutely. I think some people might say, "This has a three year timeframe; there is a risk that these premiums may prove unsustainable but if markets go up by 6 per cent a year it will shoot the lights out and I will have some of that- not all my money but some of it". I think it is dangerous territory to start saying, "Let's stop it happening". What we have to be absolutely sure about is that people understand what they are getting and what the risks are so they can take an informed decision for themselves, or their advisers can, about whether it is the right thing to buy.

  323. For legal reasons it is obviously of interest to people whether they were incorrectly advised when they bought the investment. Do you consider that people who bought zeros were adequately advised that their security might be compromised by new debt?
  324. (Mr Godfrey) Although we have had letters directly from people who have invested directly, we have not had letters of complaint against advisers and we have not seen what advisers were saying to them so I can only give you a hypothetical response. If an adviser was simply following the information that they received from the promoters of the product in the first place, personally I do not think I would hold them to blame. They are reasonably entitled to expect that the information they get is accurate and sufficient. If, however, they go further than they have been told by the promoter, if for instance they were to write to a client and say, "You should buy these; they are as safe as gilts", then I think they might be held up to have gone too far in their communication with their client.

  325. Finally, in paragraph 4.13 you make a distinction between your statement recommending practice for United Kingdom based funds and for offshore funds which are more free to do as they like. Do you not feel that offshore funds operating out of the United Kingdom should also follow the guidelines you outline here?
  326. (Mr Godfrey) Given that it is our statement of recommended practice I could hardly do otherwise than say I would like everyone to follow it, absolutely.

    Mr Cousins

  327. Do they do so?
  328. (Mr Godfrey) No, they do not all do so, but they do follow the international generally accepted accounting principles.

  329. Could you identify, not now but at a later date, for the Committee those that do and those that do not?
  330. (Mr Godfrey) Yes.

  331. Are any of those that do not follow that good practice your members?
  332. (Mr Godfrey) It is our recommended practice. I do not know whether any of the offshore funds that have not followed that practice are our members but we will include that in our additional information for you.

  333. Are all your members co-operating in the information gathering exercise that you have just set out to the Committee?
  334. (Mr Godfrey) We have two exercises, one of which is to supply data to the website of holdings in other splits, and we have probably about 80 per cent co-operation with that. We have not aggressively pursued that over the last couple of months because of the second exercise we are engaged in which is to collect the full portfolio for the data exercise that we have, and that we have had complete co-operation on, or virtually. The reason why we have not pursued the former is that my feeling is that once we have gone through that data exercise we will establish probably a new way forward for what would be the optimum form and frequency of disclosure of holdings, so there is not much point in going back and asking people to co-operate with something which was likely to become redundant fairly quickly.

  335. You say that 80 per cent of your members co-operated with that first exercise and 20 per cent failed to provide information.
  336. (Mr Godfrey) 80 per cent of the universe. As I said, we regard this as such a significant problem for the industry as a whole that we have opened our doors, if you like, even to those who are not members offering to put their information up on our website, and I do not have a breakdown of the 20 per cent that has failed to co-operate between members and non members, but I can include that in the data as well. I do not regard this as just a problem for my members if people are losing money in investment trusts but a problem for the whole industry, and we have to tackle it as such.

  337. But generally you are getting co-operation from people who are not your members in these exercises?
  338. (Mr Godfrey) Generally, yes.

  339. That is 80 per cent. What sort of fund value is that?
  340. (Mr Godfrey) I am sorry, I could not break it down by value, but I would imagine it is fairly representative of the sector as a whole.

  341. You told us in your memorandum what you would like split fund managers to do in terms of presenting the assumptions they are making about the value of their portfolio and breaking it down to the different components. How many of them do that?
  342. (Mr Godfrey) I think in the format we have presented here that is not being done at the moment but to be fair to -

  343. Not being done by anybody?
  344. (Mr Godfrey) Not in this format, no, but to be fair to the managers --

  345. So no one is doing it?
  346. (Mr Townsend) To be fair, there are no new issues taking place in the current market so the opportunity just has not arisen.

  347. I had not understood paragraph 5.8 of your evidence to apply solely to new issues.
  348. (Mr Godfrey) I think it is a very good point you are making: that the recommendations we are making there are something that we would like to see appearing in prospecti of new issues, but certainly the projections we refer to could be put out on a regular basis by managers. There is no reason why they could not be.

  349. And how many do?
  350. (Mr Godfrey) No one is doing it to this extent; it is something we would like to see. This is something we have only recently proposed, however, and in fact it is fleshed out in more detail in this document than we have yet been able to do elsewhere. It was first mentioned in our submission to the Financial Services Authority's consultation document that was due in at the beginning of this year. Of course one spends a good deal of time racking one's brains to think about what one can do to improve disclosure and information for shareholders going forward, so I would say this is a new idea and therefore we have not had the chance to get it adopted by people as yet.

  351. In paragraph 5.4 of your evidence to the Committee you set out four categories of split capital trust. How many of the trusts are in each category, do you think?
  352. (Mr Godfrey) This is a matter of judgment but I will give you my opinion. We have about 136 trusts in this universe altogether. My guess is that the number of trusts who are unlikely ever to return anything to shareholders, even zero dividend preference shareholders, is probably in the order of just below ten. Depending on what happens to the market, it may rise to as many as twenty. The group which in the previous session was referred to as possibly working themselves out if markets go up in the sense that they may return monies to zero dividend preference shareholders, and may even return some to shareholders but probably significantly less for the shareholders than they invested in the first place, probably numbers up to in total 40 between those two categories. Then we have perhaps another twenty who have had to take some action to avoid getting into further difficulties such as cutting bank debt, and then we have about half the sector which I believe will recover given any reasonable market returns over the next few years.

  353. That is quite important, is it not? We are dealing here with a significant category of investments and you are saying that half of it is sustainable on any basis that anyone investing in it might consider to be even halfway reasonable, and half is not?
  354. (Mr Godfrey) No. I think probably more than half is sustainable. The last twenty who have had to take some action I think are not in deep difficulties and may well recover. I think we probably have about forty, or about a third, which stand either to lose everything or a very significant proportion of their assets.

  355. So a third of the investments in this particular range of investment products, split capital investment trusts, are unlikely to get any of their money back or, if they do, it will only be a small proportion?
  356. (Mr Godfrey) Up to a third or it could be as little as, say, a sixth. As I said, it is very much dependent on what happens in the future, but it could be up to a third or it could be as little as a sixth.

  357. How would people know in which category of split capital trust their money was?
  358. (Mr Godfrey) It would be difficult for a private shareholder unless they did a lot of research work and educated themselves as to how they work, but there are advisers and analysts, the same as those who analyse any plc, who are making judgments about what category these trusts are in and giving ratings to them as such. One of the outcomes we hope to achieve from the data exercise that we are undergoing is to be able to develop a more robust system - not saying, "This is good", "This is bad", "This is risky", "This is low risk" but giving people a measure of to what extent this particular trust is exposed to bank debt or is exposed to other splits and also some measure potentially of the quality of the exposure to other splits.

  359. Do we have a coherent ratings system that covers this category of investment?
  360. (Mr Godfrey) We do have coherent ratings systems; I think they could be improved. I think the primary one is an analyst called David McFadyen with ABN Amro, who has a rating which measures the amount of bank debt and the quantity of exposure to other splits which is a very good starting point and very useful. I hope that with our data project we can perhaps add something which will speak to the quality of the split portfolio not just the quantity, because clearly that is very important.


  361. What are the advantages for firms setting up in the Channel Islands, and are you able to influence their conduct in the same way as United Kingdom based firms?
  362. (Mr Godfrey) One might ask just how much influence we might have over the conduct of any firm given that we are not a regulator, but there are advantages to being in the Channel Islands, both with a more flexible accounting regime but also with the tax advantages. You have heard about barbell trusts already from Aberdeen, and barbells as part of their structure are often invested in high yielding bonds to provide the income part of the portfolio with shares in other splits and, on the zippy side, shares in technology and so forth, and there is a tax disadvantage to holding bonds through being in the United Kingdom compared with being in the Channel Islands, so there is more than one reason for being offshore and it is not just a more flexible accounting regime.

  363. Is there the same amount of transparency in the Channel Islands as in the United Kingdom?
  364. (Mr Godfrey) The companies are listed on the United Kingdom Stock Exchange so they have to fulfil the United Kingdom requirements in the same way as if they were United Kingdom domiciled. There is the same amount of transparency required.

  365. And you have no concerns in any way about that?
  366. (Mr Godfrey) I have no concerns about that element, no.

  367. Do you have concerns about any other elements?
  368. (Mr Godfrey) Only to the extent that our view was that some of the accounting policies went too far.

    Chairman: You heard us extend an invitation to Aberdeen Asset Management at another stage. We are very much aware that the investment trust sector itself is worth 50 billion but the split capital sector accounts for just 13 million of that and, as we mentioned at the beginning of this session, we do not want the stain to cover the whole of the investment trust sector so I think all of us have to work on that issue. You have been very helpful to us this morning and constructive in your evidence but we would like to keep a link with you, and if you feel you can inform the Committee on the way forward then we will be very grateful for any advice you can give us. Thank you very much for your appearance and your evidence this morning.

    Memorandum submitted by the Financial Services Authority

    Examination of Witnesses

    MR JOHN TINER, Managing Director, and MR KEN RUSHTON, Director, Listings, the Financial Services Authority, examined.


  369. Good morning, Mr Tiner. Please would you identify yourselves?
  370. (Mr Tiner) I am the managing director of the Financial Services Authority and on my right I have Mr Rushton, director of the United Kingdom Listing Authority.

  371. You have heard the previous evidence this morning - a bit of a mess with lots of unanswered questions, a route map non-existent. What are your comments?
  372. (Mr Tiner) Chairman, I think this sector has got itself into a mess. I think that is self-evident not just from the evidence we have heard this morning but from what we have learnt from the work that we have been doing over the last several months. Our concern now is to determine firstly whether there have been breaches of regulatory rules and, if there are, to investigate those and pursue enforcement proceedings but at the same time, and not waiting for those proceedings to come to a conclusion, to make sure that arrangements are put in place to enable consumers to get redress where that is warranted.

  373. The AITC say that there are up to 10-20 splits who stand next to no chance of repaying anything to shareholders, even zero dividend preference holders, and that they are only solvent because the bank has not yet recalled their loan. They also say there could be a similar number that return less than shareholder due entitlement. Do you share that assessment and, if you do, what can the Financial Services Authority do to help?
  374. (Mr Tiner) I would not disagree with that assessment overall. From the update report in May that we published, you can infer that there are those kinds of numbers of trusts which are facing more severe difficulty and will probably for their investors result in very significant write-offs of their investments. What we are doing about that is to make sure that investors are fully apprised of their rights to complain to the relevant firms - and that is not a straightforward matter and I can talk about that, if you like, Mr Chairman - and if those firms do not deal satisfactorily with those complaints they will go to the ombudsman who will hear those complaints in the proper course.

  375. Has all the bad news come out?
  376. (Mr Tiner) As has been said this morning, we do live in very volatile stock markets and the state of a number of those trusts is clearly stock market sensitive and, whilst we read overnight that there has been another one that has got into difficulty, if we have markets sliding further we could see more trusts getting into difficulty. Mr Godfrey suggests that there are 10-20 in the category where there may be almost a total loss to all classes of shareholder but we have not got 10-20 reported yet - it is a much smaller number than that - which suggests that, if markets go lower, there could be more coming into the pipeline.

  377. I mentioned to Aberdeen Asset Management, and they were not forthcoming to us, that Aberdeen's Media and Income has gone and it is estimated that the Bank of Scotland and the Royal Bank of Scotland joint liabilities from split capital trusts could be running as high as 2 billion. Could you give an indication of what other banks' liabilities could be?
  378. (Mr Tiner) As I understand it, the debt side of these trusts is fairly concentrated into a small number of banks. The two you have mentioned are significant lenders and there are I think, as I understand it, a small number of other banks who are lenders, but their actions and when they decide to call in their debt or push for reconstructions or whatever of course is a judgment call for them.

  379. Can you give us a ballpark figure in terms of the amount of money?
  380. (Mr Tiner) On the debt side?

  381. Yes.
  382. (Mr Tiner) I suppose it could be something like 4 billion in total, perhaps 3.5 billion. I think that is what we said in our report.


    Mr Laws

  383. Just to clarify this issue of compensation, the recourse that private investors have in terms of compensation is either to the sellers originally of these particular assets or through the Ombudsman, is that right?
  384. (Mr Tiner) Yes. Perhaps I should explain that. The source of recourse initially is always to the firm. The question is which firm, and there are a number of ways in which investors have been put into these split capital investment trusts. In some cases the investors have bought on the basis of marketing material promoting these trusts that has been sent to them, and they have been persuaded by that information to buy on the basis that there were comments such as some of those that were raised this morning about their very low risk characteristics --


  385. I think you mentioned more safety features than the Volvo?
  386. (Mr Tiner) That has been mentioned in a newspaper article, and the baby that sleeps at night has been mentioned in marketing material more specifically, so those investors who have bought on the basis of that promotional material that promoted the trust would have recourse to that firm to complain. Investors that have bought on the basis of advice from a financial adviser would also have recourse to complain to that adviser if they felt they had been given misleading advice. Now, the advisers may be relying on that promotional material themselves in giving that advice to the customer, so there is an issue there about against which firm does the client have a case - the adviser or the fund manager, the promoter. The third area is where stockbroking firms have run discretionary portfolios for clients which have certain risk mandates/limitations on them, and they have been put into instruments which do not follow those mandates. Again, they would have a case. But in all those situations the investors' first port of call is the firm. If the firm do not deal with that adequately within eight weeks, then they go to the Ombudsman.

  387. What do you think is the Financial Services Authority's role in determining whether there has been mis-selling and facilitating compensation if that has been the case? Do you see it to be very limited, or central, or what?
  388. (Mr Tiner) What the Financial Services Authority did when it was set up was to put in place a structural arrangement to cope with mis-selling of this kind and that is the Ombudsman service, so the important thing from the Financial Services Authority's point of view here is that we are able to give consumers enough information to make sure they know what they can do and what their rights are, and then it is for the complaints system we have set up to deal with this.

  389. We heard earlier from the witnesses from Aberdeen Asset Management that they considered some of these assets, particularly the zeros to be low risk investments, and that basically the only thing that went wrong was that the stock market took a big dive, but we heard from Mr Godfrey that the nature of some of these assets changed over time to become more risky as the gearing effect came into play and the cross-investment. Do you believe it was reasonable to regard these assets as being low risk and market them on that basis over the last few years?
  390. (Mr Tiner) No, I do not. It is important to draw a distinction here between those trusts that have got what I called in my report a contagious cocktail of high gearing and high cross-holdings. It seems quite self-evident to me that those kinds of arrangements cannot be low risk to the investor because, as I explained in the report, they have an exponential kind of risk profile so when markets are going up they do terribly well and, when they go down, they do badly indeed. That is not a low risk product, to my mind.

  391. Do you think there is a good case for compensation for many private investors going beyond those that have been identified so far by Aberdeen?
  392. (Mr Tiner) I think that has to be an issue for the Ombudsman to consider.

  393. Do you think there is a good case for him to consider it?
  394. (Mr Tiner) I think the Ombudsman will consider them properly --

  395. But should he, because there is a good case?
  396. (Mr Tiner) Absolutely, yes.

  397. Finally, we have had a note from the Financial Services Authority consumer panel that basically they are concerned that consumers are not getting enough information about what is going on, and they are suggesting you should take a more proactive approach in getting individual firms to get that information out. Have you taken up those proposals?
  398. (Mr Tiner) No, not yet. The letter from the consumer panel makes a comparison to the information we have asked firms in the mortgage endowments market to give to the policy holders in those firms, and we think this is quite different. The only way you can get information on mortgage endowments at all is from the firm. Here there is a lot of information in the public domain; these investment trusts are quoted shares; you can look them up in the newspaper; and there is quite a lot of information that is out there. You have to remember these shares are listed companies and I am not sure that it would be right for us just to take a selection of the listed Stock Exchange market and put those on our website.

  399. So you are not going to take their recommendations?
  400. (Mr Tiner) We will have a think about it further - we have only just got the letter - but my initial reaction is it could be quite difficult. What we are trying to do is to encourage, through the offices of the AITC, the industry itself to get much better quality information to consumers.

    (Mr Rushton) Can I add a comment? Back in April, on this question of disclosure, I wrote to all the sponsors of investment companies and investment trusts reminding them, first of all, of their obligations under the listings rules to ensure that any price-sensitive information is communicated in a timely way but, more importantly, I asked them if they would advise their clients to co-operate with the AITC in their disclosure initiative which you heard about. I then called a meeting of some of those sponsors who are particularly representative in this sector and suggested to them that this would be a good thing in terms of restoring and protecting the reputation of the sector and I believe, although you did not go into this with the AITC, that the figures show that there has been pretty good co-operation on that. If there is not good co-operation with an AITC voluntary initiative, then I think it is reasonable for us to consider whether the disclosure rules we have for investment entities should be reconsidered.


  401. But there is an issue of a lack of formal advice from professional advisers, and a lot of people are relying on the press to inform them so I think there is a big issue here, is there not, Mr Tiner?
  402. (Mr Tiner) I accept that. I think there is an issue and people are confused about whether they have a bad or good one - people are confused about quite what these instruments mean, quite frankly. We did put a consumer information bulletin on our website some months ago to help consumers try and work through what kind of trust they are in, and we provided advice in terms of who to talk to about their own particular position.

    Mr Plaskitt

  403. Following on on the issue of marketing, we heard Aberdeen Asset Management trying to plead that it is all the fault of the tumbling stockmarket and everything would have been all right were it not for that, and to some extent the Association has taken the same line, but interestingly you quote in your policy statement in the section on marketing, paragraph 3.5, and this is where the "safe as houses" phrase is used and the famous "more safety features than a Volvo" phrase is used, but more significantly you go on to say they have also been marketed as products that "tend to come into their own when stockmarkets are flat or falling". You do not attribute that and I think we would be interested to know who it was that made that claim. How widely was that claim made do you think in the marketing material for these kinds of products?
  404. (Mr Tiner) I cannot tell you who made it although I can find out and let the Committee know, and I cannot tell you how widely that term was used. We put these in to give a flavour, quite frankly, of the sort of material that we have observed as being out there, or which has been.

  405. But the whole notion that we have been hearing this morning that everything would have been all right if only the stock markets had not fallen crumbles if these products were promoted on the basis that they give you protection when the markets have fallen, because it is patently untrue.
  406. (Mr Tiner) Well, particularly where you have this combination of gearing and cross-holding. That is what makes that statement particularly unreliable.

  407. Misleading?
  408. (Mr Tiner) If you like, yes.

    Mr Ruffley

  409. Mr Tiner, can I thank you for your analysis in the report, particularly of the shortcomings of the cross-holding structure. On that we have heard a bit about the possible existence of a magic circle and possible collusive behaviour. How many managers and split capital trusts are you looking at in relation to possible collusive behaviour? How many investigations are you undertaking in the Financial Services Authority?
  410. (Mr Tiner) As we have said in the section of the report that deals with what we will be doing in the future, we have said that we have found enough data to cause us to go on and investigate this issue of collusive behaviour but without at that point progressing with enforcement proceedings against any particular firm. We have collected a lot of data about what is referred to as stock swaps, where one trust will swap stocks with another, and a lot of analysis of I cannot tell you right now how many trusts but quite a number and quite a number of managers --

  411. I do not want to interrupt unnecessarily but you say "quite a number". Indicatively are we talking about half a dozen, or three dozen or what?
  412. (Mr Tiner) We are talking probably more about a handful than three dozen.

  413. A dozen?
  414. (Mr Tiner) No, a handful. One hand!

  415. I thought you meant a handful of dozens.
  416. (Mr Tiner) No, because it is a relatively concentrated industry and there are a small number of firms who have quite a big market share.

  417. Can you tell us what powers you have to compel the disclosure of information from these companies in the context of possible collusive behaviour? Let us just stick with that.
  418. (Mr Tiner) As a regulator, under our normal rights we can call for information we require for the purposes of fulfulling our regulatory responsibilities. When we commence an enforcement investigation then we have rights to call for information which is relevant to that particular investigation, and so I think we do have the necessary powers to pursue this if we think we have a case to pursue.

  419. In how many cases do you anticipate utilising such powers to pursue the case to the bitter end?
  420. (Mr Tiner) I really would not want to speculate on that now. I think we have to look at the evidence we have gathered: we have said here that we have commenced enforcement proceedings in a number of cases in relation to misleading marketing information --

  421. I am talking about collusion.
  422. (Mr Tiner) On the collusive side we are still gathering data, and I would not want to be drawn on how many cases we will then pursue.

  423. Finally, and I know you will say this is an open-ended process but could you give this Committee some indication very briefly of what the penalties are if a case of collusion is proved to your satisfaction in the course of your inquiries? Secondly, when might you expect the first cases to be wrapped up? In other words, what are the penalties and when do you think the first penalties might be implemented? What is the earliest date or are you going to say to us, "Look, this could be several years down the road"? Could you give us a flavour of the timescale that the Financial Services Authority might be working to - and we would not expect you to give us firm deadlines but a clue would be helpful.
  424. (Mr Tiner) Do you mean just on the collusion issue?

  425. Yes. I am only talking about collusion.
  426. (Mr Tiner) The first point I should make is that we do not know when we will commence any action because we will not do that until we decide we have the evidence, so I cannot tell you whether we will at all if we do not get sufficient evidence to suggest that we should pursue a formal enforcement investigation. If we then do commence an enforcement investigation against any firm, under the enforcement procedures established in the Financial Services and Markets Act it could be a matter of possibly twelve months from the time at which that investigation commences to the time at which a decision would be taken. It could stretch even longer than that if the firm concerned, if there is such a case, then takes the issue to the Financial Services Tribunal.

  427. What is the ultimate sanction that you as regulator can impose?
  428. (Mr Tiner) It is quite wide: it is a range of fines. We can change firms' permissions to do business in particular sectors and we are able to ban individuals.

  429. Can you put them out of business?
  430. (Mr Tiner) Yes, we can.

    Dr Palmer

  431. Picking up on two small points: the AITC evidence included a suggestion that certain recommended practices on the home market were not being generally followed in off-shore investments, even for United Kingdom owned companies, and I think you probably have heard a specific example of how funds were charged against income and capital. Do you think it would be helpful if the Channel Islands were to review their regulations and codes of conduct for split capital trusts?
  432. (Mr Tiner) Of course, the entire system here is a voluntary system, even in the United Kingdom, because investment trusts are not regulated. They are regulated through the United Kingdom Listing Authority but not as investment products by the Financial Services Authority. I would suggest, therefore, certainly in the light of what has emerged in this sector that it would be in the interests of all jurisdictions that have these products which have been sponsored from those jurisdictions to adopt a code of best practice.

  433. Should it be made mandatory?
  434. (Mr Tiner) I would like to see if the market, through the work of the AITC, could deliver the necessary standards themselves first without necessarily making it mandatory.

  435. You mentioned earlier the problem of getting compensation that arises if I had gone to an IFA who relied upon the propaganda of a company to make a recommendation, because it is not quite clear against whom I might have a claim. Does the buck stop anywhere, or can the company say, "Hey, it is the IFA" and the IFA say "No, it is the company"?
  436. (Mr Tiner) No. In that case, if there was that kind of dispute between the adviser and the promoter, in essence the complaint would not have been dealt with to the customer's satisfaction and the customer would go to the Ombudsman and the Ombudsman would decide who is at fault.

    Mr Cousins

  437. How long are you going to give the AITC, the trade association body that covers this investment sector, to clean up?
  438. (Mr Tiner) We are in quite close touch to see how their information-gathering efforts have been progressing. I think they had one go at this at the end of last year which was, as I reported in a speech at the beginning of February, relatively unsuccessful but I think since then the determination of the sector to clean this up has been much greater and they have been much more successful more recently, so I am minded to give the AITC the time, perhaps a few months, to see if they can get the information they need and put it in a format which is of use to the market, advisers and consumers and to be able to put more relevant, more timely information out there into the market place.

  439. So you are going to give them a few months and your expectation was that, if there were cases that you were going to bring against particular individuals - who knows, that might take anything up to about a year?
  440. (Mr Tiner) Yes.

  441. How long do you think it is going to take the Financial Services Ombudsman to deal with the issues that may be put to him?
  442. (Mr Tiner) The Ombudsman has a service standard which we have set for him which is to hear all cases within six months, but in fact the average period by which he has judged a case is rather less than that. It is about four months.

  443. In a paper to the Committee you describe the market capitalisation of the split capital investment trust sector as being 13.2 billion as at 31 March 2002. What value would you put on it now?
  444. (Mr Tiner) You need to do a daily evaluation of this given that the market is down sharply overnight. This was in May --

  445. No. March.
  446. (Mr Tiner) I am sorry. I suppose the stock markets have probably fallen 10 per cent since then. I have not done an up-to-date valuation but my guess would be that it has probably fallen by more than 10 per cent because of the collateral damage that has been done throughout the whole sector from the bad splits, if I can put it that way, but the work would need to be done.

    (Mr Rushton) Regrettably some of those splits are no longer in existence, of course. They have gone into liquidation since March. It is a small number, but --

  447. So what value would you put on the sector?
  448. (Mr Rushton) I have not got a figure either. As John Tiner says, you would have to calculate that day-to-day with the market moving as it is.

  449. Clearly something which had a value of 13.2 billion at 31 March is at least worth talking about. I was very concerned by your statement that there could be 3.5-4 billion of exposure to banks within that sector. Do you think, quite apart from the considerable sums of money that clearly investors are losing, there is any issue of systemic risk here?
  450. (Mr Tiner) No. I do not think there is a systemic risk here through the contagion that might take place within the investment trust sector itself because, as has been discussed several times this morning, the problem is restricted to a minority of trusts, albeit quite a significant minority. On the banking issues, not all of the debt - whatever the right number today is in terms of the level, 3.5 billion or whatever - is at risk because much of it is in trusts which are not on the hospital list. Some of it is, of course, but also the banks get paid out first. This is the problem for the investor - the banks get their money first - so I think it is not right to assume that the banks are going to pick up a hit of that sort, or anywhere near it.

  451. In a context where we are talking about a value of over 13 billion, which if we are going to use a unit of measurement roughly equates to what the pensions mis-selling issue cost the insurance industry so it is a big ticket item, 13.2 billion, and that value is eroding, you yourself said that upwards of 10 per cent of that value may have gone in the month since then, and your own activities are projected, waiting to evaluate actions by others which may lie 6-12 months in the future. Do you think that is an appropriate response to this situation? Do you think it is good enough?
  452. (Mr Tiner) Yes, and I think the reason that they have fallen in value further since the report in March is because the stock market has gone down, not because new structures have been created that have created some new dangerous financial scenario. What is happening now is market-related, not structure-related. The structure bit happened before because there is no new gearing or anything like that coming into this sector.

  453. But this sector was almost - well, substantially - created within the bull market of the 1990s.
  454. (Mr Tiner) No. There has been quite a lot of trusts issued since 1999. I think we have said in our paper that there were about fifty.

  455. Your own figures to the Committee were that 89 of the 134 splits that at that time you drew our attention to had been created since 1990. Those are your figures.
  456. (Mr Tiner) Yes, but I have also said there has been an acceleration in the last three years which is the period during which we have had the bear market, so I do not think all of these have been just launched in an upward only market. They have been launched since the market has started to turn, as these figures suggest.

  457. So from your own point of view as a regulator you do not regard this situation as producing any major issues of prudential regulation for you?
  458. (Mr Tiner) I would not say that. I think there is a difference between concerns about prudential regulation and systemic concerns. I think there is a difference there and it is an important difference to point out. There are issues here that are concerned, of course, with consumers, as we discussed, and there are issues here relating to whether firms are able to deal with the consequences of any redress that may be due to those consumers. They will have to be dealt with and we are monitoring that and watching that very closely indeed. I do not believe, however, that that will then become a systemic crisis for the sector or for the financial services industry.

  459. The creation of the Financial Services Authority brought together prudential regulation and conduct of business regulation. You seem to be taking the view that the conduct of business issues here involved in this, despite the large sums of money, is not urgent and can wait for some months or years to go by before you look at it?
  460. (Mr Tiner) I do not think I would agree with that. I think that we have been working very hard to identify the breaches of conduct of business rules - the mis-selling and the misleading information that has been given to the consumers - and that is why we have started to pursue enforcement proceedings. Unfortunately, because of the provisions of the Act, we cannot wrap up those proceedings very quickly. We have to go through quite a lengthy process, which is not one that has been determined by us but is determined in the Act, which can delay the outcome for quite some months, but we are moving as fast as we can.

  461. When do you expect the first action on your part to initiate proceedings to be, because the impression you gave in answer to questions from my colleagues earlier was that twelve months was your expectation?
  462. (Mr Tiner) It could be that, yes. The process could take that long.

  463. Do you think against the background of this situation that is an appropriately urgent response to what is a critical conduct of business issue?
  464. (Mr Tiner) We have to follow due process. We cannot and should not cut due process. I would hope that we can get it done, frankly speaking, quicker than twelve months but I would not be able to promise that. In the meantime what is important for consumers is that they do have a right of access to the Ombudsman so that this process that we might take against firms does not slow up consumers getting redress, because it is the Ombudsman who will hear their complaint and who is able to deal with those complaints while those enforcement investigations continue.

  465. But the cases that will go to the Ombudsman, given the rather peculiar hybrid regulatory situation of this particular sort of investment trust, are going to be very difficult for the Ombudsman to deal with, are they not? These cases are not going to be easy.
  466. (Mr Tiner) The Ombudsman incidentally at the moment has not got very many complaints, which is an interesting statistic. He only has 280 at the moment out of 50,000 people investing in this sector, but my belief is that quite a number of those will be relatively straightforward because people will have bought them through advisers or off promotional material. There will be some where it is a little bit unclear and it may take the Ombudsman a little bit longer, but he still has to deal with it within six months.

    (Mr Rushton) A number of investors will be claiming redress against their independent advisers before going to the Ombudsman.

  467. So that is all right then.
  468. (Mr Rushton) It is all right if they get compensation.

  469. That is your view? You are happy with the situation in which the adviser sector, the intermediary, will bear the brunt of this?
  470. (Mr Rushton) If the intermediary is at fault, he should.

  471. Do you think you have bottomed out your approach to this as a conduct of business issue? Are you bringing to this issue the urgency that seems to be required?
  472. (Mr Tiner) I think we are. I think we are pursuing the cases with real vigour and, if we can get these cases completed within the process established within the Act, then we will do that. We have made this a clear priority within the Financial Services Authority and we are progressing as fast as we possibly can. That is the only assurance I can give you - we are literally pursuing it as hard as we can.

  473. Perhaps you would care to clarify the prudential regulatory issues that you see being involved in this, because your documentation is mostly going down a conduct of business track and mostly going down as being not issues for you but for advisers, the Ombudsman, and the AITC. The conduct of business issues in this you see as not being in front of you, so let us look at the prudential issues and tease out what prudential regulatory issues you can find in this because I do not see it clearly in the documentation you have given to this Committee.
  474. (Mr Tiner) I think the prudential issues emerge if and when firms are required to pay redress to the consumers, and the issue for those firms is whether they can afford to pay that redress, either because they choose of their own will to make those payments to consumers or because they are instructed to do so by the Ombudsman.

  475. So we will not know what the prudential issues are until we have been through the conduct of business issues, and the conduct of business issues you see as largely being issues for people other than yourself?
  476. (Mr Tiner) That is the system that has been set up. The way in which investors get compensation for breaches of conduct of business is through the Ombudsman - that is the system. We have put the system in place and we will make sure that firms deal with the complaints according to our rules, but the backstop is the Ombudsman.


  477. Just to take up the point you made there about the exposure of the banks and the fact that the banks will be paid out first, to the ordinary investor that seems unfair but you have to allow for that ignorance. Let me put a question for the banks, though. Do you feel that the banks have been unwise in lending in this way? Do you feel that they have been cavalier and they have fuelled the bubble, because at the end of the day the big boys are the first in the queue?
  478. (Mr Tiner) I am afraid that where there is secure bank debt they are always first in the queue - that is the nature of a lot of bank lending.

  479. But the thing is, Mr Tiner, if they are going to be first in the queue the consequences for a lot of people could be dire but they get their money, and the point I am making to you is whether you feel there have been unwise decisions by the banks in this sector? 4 billion is a lot of money.
  480. (Mr Tiner) No, I do not. I think the responsibility, if there has been irresponsible gearing, if that is the right term, falls with the firms that have raised that gearing. I think the banks need to look at whether they are able to judge the risk from their perspective and it may well be that the banks will be out of pocket as well, but I think it is those who are structuring the fund that you have to look to to make sure that you are happy that there is consideration of the interests of the different groups of shareholders vis-a-vis the banks, and that the banks need to make sure that they have got sufficient protection to get their money back.

  481. But should the banks not also have recognition to the gearing when they make the risk assessment?
  482. (Mr Tiner) I would have thought so.

  483. We have heard this morning that the gearing in a number of cases has been extremely high and very unwise, so does it not follow that maybe some of the decisions that the banks have made have been a bit unwise?
  484. (Mr Tiner) I think as it turns out, if the banks lose money because a fund has been over-geared with their borrowings, then history will tell you it has been an unwise lending decision but that is the same as --

  485. I am trying to make this simple so that people like ourselves can understand. Some of the gearing has been over 60 per cent and that is a heck of a lot of gearing. Do you agree?
  486. (Mr Tiner) I do agree.

  487. But when an ordinary person goes in for a bank loan do you think the bank makes a risk assessment for the ordinary person? "Excuse me, I am unemployed but I want to borrow", what does the bank say? You are dodging the question, Mr Tiner.
  488. (Mr Tiner) No, I am not. This is an issue for the banks. If the banks want to take that kind of risk with their shareholders' money and we think from a prudential point of view, going back to Mr Cousins' question --

  489. With some gearing being over 60 per cent, do you think that is excessively high?
  490. (Mr Tiner) I think it is.

  491. If somebody came and asked you for money when the gearing was 60 per cent, what would you say?
  492. (Mr Tiner) If I was a banker, I would think twice about it.

  493. Ergo somebody must have made an unwise, imprudent decision?
  494. (Mr Tiner) Maybe.

    Mr Laws

  495. Can I ask a couple of questions about a different sector which there are concerns about, which is the United Kingdom insurance sector? There was recently a relaxation by you I think of the resilience test applied to this sector. Can you tell us whether you think that was wise and why you took that judgment?
  496. (Mr Tiner) Yes. I would like to respond to that by reading a note I have written because I think the precision of words is rather important.

  497. Perhaps before you do that I could ask the other question I have, the answer to which I assume may be in your statement but if not perhaps you could tack it on to the end. The question is to find out from you whether, as of today, with the recent falls in the equity market you are confident that all of the United Kingdom insurers meet their solvency tests, and should therefore be able to take on new business?
  498. (Mr Tiner) On 28 June 2002 the Financial Services Authority issued revised guidance to the life insurance industry on the stress testing of their portfolios, generally referred to as the resilience test. The resilience test is an important element in the prudential framework which is designed to protect policyholders as it helps to determine the appropriate mix in risk assets to the term, size and nature of policyholder liabilities. Recent events in the markets have revealed some problems with the formula which tapers down the stress test from a maximum of 25 per cent to a minimum of 10 per cent. We have been considering for some time possible changes to the resilience test which would take into account recent stock market movements in anticipation of the new Integrated Prudential Sourcebook that comes into effect in 2004. In the light of market conditions and the problems identified with the resilience test, we considered it appropriate to make this amendment at an earlier stage such that there would not be market distortions created by the problems that may be inherent in the current test. Our research among life insurance firms suggests that the significant majority were not close to being sellers of equities at the FTSE 100 level on 28 June of 4,540, based purely on the application of that resilience test. Of course there may have been some sellers, and buyers, depending on their analysis of the market. Hence the change to the resilience test was not made with any immediate pressure to sell in mind. As we have said, the suspension of the test on 24 September last year was under very different circumstances and we have seen no need to further suspend the test in recent market conditions. Based on stock market movements over the last three months, the new test will require firms to stress their equity portfolios as a decline in the FTSE Actuaries All Share of approximately 15 per cent or a 650 point fall. This new test will remain in force, as temporary guidance, until 31 May 2003 when, having consulted, we anticipate that it will become permanent. The financial returns of life insurance firms show that their free asset ratios have fallen in each of the last two years. However, as is suggested by my earlier remark on firms' resilience to equity price movements, the insurance sector continues to meet the minimum solvency requirements we have set, and this is in the light of a 33 per cent fall in equity markets over the last 22 months. This also takes into account the guarantees made to policyholders in with-profits funds which make up the majority of insurance company funds and which, of course, are not provided within unit-linked products. It is also useful to remember that whilst, of course, changes in asset prices on a day-to-day basis must be monitored closely, the liabilities of insurance firms are over the longer term. Of course, these are nervous markets and we continue to monitor closely the impact of market movements on the life insurance sector as a whole, and on individual firms. Members of the Committee may recall that the Financial Services Authority is rolling out its risk-based approach to regulation across all sectors of the financial services market, including insurance. We will perform risk assessments on some 200 insurance firms, being the larger firms in both the life and non-life sectors. These assessments are presently in progress and we will write to firms with our findings and conclusions. A recent report by the rating agency Fitch that the Financial Services Authority has 200 insurance firms on its high-risk list is wrong as the risk assessments have not even been completed. It is true to say that the Financial Services Authority is engaging in a much more intensive relationship with these 200 firms, as this is part of the risk-based approach. We have taken the opportunity during the last two or three months to meet with CEOs of the major insurance firms to explain this new approach, to explain the proposed policy reforms we propose in insurance regulation, and to discuss matters of current interest. We have also written to CEOs of insurance firms to remind them that they should be proactive in the management of their firms' financial resources.


  499. I respect your desire to answer that question in written form, and perhaps we will come back to that at some later stage. Lastly, Mr Tiner, and without going into any great detail, looking at the evidence that has been provided to us this morning from the beginning, do you have any concerns about that evidence? Is there anything you will take away that will make you think and reflect and, maybe, act?
  500. (Mr Tiner) I think that we have been hungry for data, information and market intelligence on this sector and, as Daniel Godfrey said, he has given us some and we have had other types of information from other sources and without, frankly, wanting to go into specifics I have heard some information this morning which is quite interesting.

  501. Food for thought?

(Mr Tiner) If you like.

Chairman: Good. Thank you very much.