TUESDAY 29 OCTOBER 2002
Mr John McFall, in the Chair
Memorandum submitted by Aberdeen Asset Management
Examination of Witnesses
MR MARTIN GILBERT, Chief Executive, MR CHRISTOPHER FISHWICK, Formerly Head of Global Closed End Funds, MR PIERS CURRIE, Marketing Director, Investment Trusts, Aberdeen Asset Managers, and MR GARY MARSHALL, Managing Director, Aberdeen Unit Trust Managers, Aberdeen Asset Management, examined.
(Mr Gilbert) Good morning, Chairman. I am Martin Gilbert, Chief Executive of Aberdeen Asset Management.
(Mr Fishwick) Good morning, Chairman. My name is Chris Fishwick. I was previously Head of Closed End Funds at Aberdeen, responsible for the offices in London, Jersey and Dublin. I would just like to say at this point in time, Chairman, that I apologise for my non-appearance at the last meeting. It certainly was not intended as a snub to the Committee. I was not specifically asked to have been here and I would have been very happy to have changed my meeting and have attended, so I would just like to apologise for that misunderstanding.
(Mr Fishwick) I do not know her personally, no.
(Mr Fishwick) Sorry, I was not aware of that at all, Chairman.
(Mr Marshall) My name is Gary Marshall and I am the Managing Director of Aberdeen Unit Trust Managers, the Group's retail division.
(Mr Currie) I am Piers Currie, Marketing Director, Investment Trusts, Aberdeen Asset Managers.
(Mr Gilbert) That is correct, Chairman.
(Mr Gilbert) Yes, we did, Chairman, but ----
(Mr Gilbert) Yes, they did, Chairman.
(Mr Gilbert) Yes, they did, Chairman.
(Mr Gilbert) Chairman, I defer to my colleague Mr Currie on that point.
(Mr Currie) Yes, referring to the wrapper products which cover Share Plans which `are a low-cost way for people to buy securities and individual shares, the 42 shares were trusts managed by Aberdeen. The risk document in the back complies with all the standards set out in compliance departments about outlining the risks attached to each security.
(Mr Currie) Well, there are two answers to that. We did not describe it as low risk exclusively in that documentation and, no, the documentation did not say that total loss was an expected element of that.
(Mr Currie) I think there are two points in this, Chairman, which I would like to point out. One is that investment performance itself is something which is independent of the literature and the second one is that the risk warnings that were in the literature at the time described the risks that were identified.
(Mr Currie) That is correct.
(Mr Gilbert) I do not accept that. There is a big difference between retailing a product, which we did, and being a unit trust and an execution-only type wrapper product which was to allow people to buy shares on a cheaper basis than they could themselves.
(Mr Gilbert) That is correct, Chairman.
(Mr Currie) I think the answer is that there is a difference between an equity and a collective investment scheme and what you are buying is a share, an individual share, and the information on that share describes what the characteristics are of that share and the risks within it. Otherwise, the alternative to this is that every equity investment in the land that is available through any type of wrapper vehicle has fundamentally got to be underwritten by either the companies or by the management.
(Mr Currie) No, you can actually get the information through the website and ----
(Mr Currie) I am afraid they cannot buy through our website, Chairman, but if you look at our website, you will find you can get the literature in which you will read the risk documentation and you cannot buy ----
(Mr Currie) You cannot buy through the website ISAs and PEPs.
(Mr Gilbert) The answer, Chairman, as to why we are concentrating on the unit trust is that we marketed that as a low-risk product, Chairman, and whilst we can look at the marketing literature we produced for the unit trust and legally it stands up and everyone at the time thought they were low risk, we have taken the view that we are not happy with the performance of that fund. Therefore, we are proposing and are still committed to an uplift package for all the people who have bought our unit trusts, not just those who have bought directly from us, but everyone who has bought, taking your point, regardless of how they bought it, either through an IFA, direct or off the page.
(Mr Gilbert) We did not put ----
(Mr Currie) It is the Share Plan actually that has been marketed, Chairman. I very much doubt you saw that on the Internet and if it is on the Internet, I would like to be notified because it should not be and an advertisement appearing one-off in The Times in 1999 ----
(Mr Currie) Sorry, you said that in surfing the Internet, you saw this advertisement ----
(Mr Currie) Well, one insertion in The Times in September 1999 at the time when the zero market was deemed to be low risk by all measures of standard deviation used ----
(Mr Currie) We marketed ----
(Mr Currie) We marketed the share plan in which all participating shares of closed end funds managed by Aberdeen are there. We have never hidden that. That is not undisclosed.
(Mr Fishwick) I am delighted to be here actually, to be honest with you. Did I jump or was I pushed? It became quite clear to me that it was not benefiting Aberdeen Asset Management being there any longer with the constant press scrutiny, looking for a scapegoat to be driven out. Actually I went to Martin and said to him, "This is not in our shareholders' interest, it is not in my colleagues' interest and it is not in mine or my family's interest. Let's come to some kind of compromise agreement to part ways". Martin tried to persuade me to stay and I said, "Look, at the end of the day I just do not think it is right for the company or my family. The press will hound us until they get a result, rather like they hound ministers", and I said, "We might as well give them what they want. I want to get on with my life. I am very happy to stay and help out" -----
(Mr Fishwick) It was a compromise agreement between us both, yes.
(Mr Gilbert) No, Chris did not resign. He approached us. I tried to persuade him to stay and he said, "Look, it's really the best thing for the company if I go", and the Board agreed with that assessment and reached ----
(Mr Gilbert) No, he did not resign.
(Mr Fishwick) A bit of both.
(Mr Gilbert) He resigned and he was pushed, a mutual agreement.
(Mr Fishwick) Why did I not go on the 30th August?
(Mr Fishwick) It is no different from why I did not go at Christmas last year. It makes no difference. At the end of the day when you have got TV cameras flying over your house, and I did not seek public office, and cameras sticking through your doors, eventually it just became unbearable.
(Mr Fishwick) Well, my level of pay, as you are aware, is not set by myself. It is set by the independent directors of our company who meet every year. They decide what my remuneration is and they then put it to all our shareholders who vote on it every year, and I abide by that decision of what is paid. I would love to be able to pay myself, but unfortunately that is not the way it is.
(Mr Fishwick) I think they would do. They awarded me my remuneration and they voted in favour of it. In fact I checked this out the other day because I thought you would ask me that question and the vote in favour of our remuneration last year was 95.6 per cent in favour.
(Mr Fishwick) Well, some did vote against.
(Mr Fishwick) I am getting out of the City, quite frankly, but I am prepared to work and answer questions for yourselves and the FSA for the next 18 months or as long as it is necessary. I am at the beck and call of Aberdeen to answer any questions, but yes, I am having a career direction change.
(Mr Fishwick) Yes, I am on the Board of Treasury Holdings.
(Mr Fishwick) No, it is not correct. They are not bidding to take control of Real Estate Opportunities, no.
(Mr Fishwick) No. Treasury Holdings has a stake in the company, as it has had from launch, which it is not allowed to add to under listing rules and what has actually happened is that the press have misinterpreted the story and not checked the facts. Each time the company buys in its own shares, its percentage of the company goes up because that is what is left. It is simple mathematics. It is just scaremongering. If Treasury Holdings was intending to bid for REO, it is a public company, it would have to announce it, and it has made no intentions to do so. It has always been an investor in the company from the very beginning, eight years in total.
(Mr Fishwick) As a company, only its holding in REO. It has no other investments in split capital trusts.
(Mr Fishwick) Yes, I am a non-executive director of Treasury Holdings, not a shareholder, so in effect quasi, yes.
(Mr Fishwick) No.
(Mr Fishwick) To me or to you?
(Mr Currie) A zero has a pre-determined redemption price.
(Mr Currie) Well, it is a bit like a gilt. It is meant to be guaranteed, but if governments go under, it is not paid out, is it? What we are saying is that the zero as a share class is the lowest risk share class of any capital within split capital trusts and the guarantee was that the expected element of the returns would be that here we have the pre-determined price for which that zero has the first call on all the capital on a certain date at a certain time. If you look back over the history of split capital investment trusts and zeros from 1987 to 1999, the document that we are saying quasi-guaranteed was actually factually correct. What we are now looking at is, with retrospect, what happens when markets fall and what we are saying is that the characteristics of the zero has now changed as a result of falling markets.
(Mr Fishwick) I would like to try and answer that question because you asked me actually. You have asked, "What does 'quasi-guarantee' mean?" We, together with the whole industry, including the AITC, reading their campaign, let's say, on zeros, their words are, "If, for example, you are prepared to take only a minimal amount of risk, then zero preference shares might prove to be the best choice. As their name suggests, they offer no income at all, but do provide a low-risk opportunity for a pre-determined amount of capital growth", and that is what I perceived, together with them and I endorse what they were saying, as a quasi-guarantee.
(Mr Fishwick) I do not believe so.
(Mr Fishwick) I do not believe so.
(Mr Fishwick) The reason I do not believe so is because they have had split capital trusts for years and years and years.
(Mr Fishwick) I think that is a question you have got to ask them. I do not speak for firms like F&C and I have no idea why.
(Mr Fishwick) I think that is a question you have got to ask them.
(Mr Fishwick) Yes, I do.
(Mr Fishwick) I know Tony Reid, I know Nigel Sidebottom, I know William Van Hesewick, I know John Holder, I know ----
(Mr Fishwick) Probably ten or 15 times, probably the same as I met with the people of all the investment houses in London or less actually with Tony because his business is based down in Guildford. I have actually only been to that office three times.
(Mr Fishwick) I would guess that we were in constant contact with them, asking them for various information about their trusts, as everyone is.
(Mr Fishwick) I believe so, very much so, yes.
(Mr Fishwick) Yes.
(Mr Fishwick) Yes, very much so.
(Mr Fishwick) We own 25 per cent of probably 50 split capital trust shares.
(Mr Fishwick) I think there is an interesting point in that because ----
(Mr Fishwick) The answer is yes. Seventy-eight of the 135 splits, one of the classes of shares has a value of nil, so you pick one, but you can have any of the other 78. Half of them, 56 per cent of them have no value, irrespective of debt.
(Mr Fishwick) I would have been aware at the time of what it would have been, yes, but that is not unusual. I can give you 50 other cases of that from ourselves and 30 cases of the ----
(Mr Fishwick) It is not unusual.
(Mr Fishwick) Do you mean the Board of Aberdeen plc?
(Mr Fishwick) Were there any concerns as they plummeted? I think we all started to get concerned 18 months ago as markets continued to fall because the Board of Aberdeen are intelligent people, as are most people in the City, and quite clearly if you borrow money and assets go down, you start to get in trouble. It is straightforward mathematics. Anyone who thinks any different must be crazy.
(Mr Fishwick) We and the Board of Aberdeen Preferred - it is interesting because it is a very old fund, a fund which was launched just before I arrived back in 1991, so it is a twelve-year-old fund which met between six and twelve times a year, full of some pretty clever, sophisticated people. They completely understood the portfolio evolving.
(Mr Fishwick) No, I think when assets start to fall, you are not relaxed and that is why they took the action, as we did, to try and repay the debt, significant amounts of debt. We have repaid £100 million of debt in the last twelve months in conditions that were very, very difficult, so we have been attempting to de-gear these assets. We have not just borrowed a lot of money, sat there, let the markets fall and do nothing, as people believe. We have repaid over £1 billion in the last twelve months against hostile conditions. The thing is that we actually should have sold all our stock when the Index was at 7,000 and re-paid all our debt, but we actually have been working tirelessly, 18 hours a day, and the Board were meeting every two or three days over the last two months, so yes, they are working.
(Mr Fishwick) I think at the end of the day on the basis that the shares have now become of no value, did they take action early enough? One would have loved to have taken action before. I will repeat it again: that we should have sold every single share at the very top, but I think the best way of answering that question would be for you to read the minutes of every Board meeting of Aberdeen Preferred and you can then see totally, just like the FSA, how they were aware of what was going on.
(Mr Fishwick) I was the only Aberdeen representative on the Board.
(Mr Fishwick) No.
(Mr Fishwick) No.
(Mr Fishwick) Well, certainly one member of the Board was on some other trust.
(Mr Fishwick) Yes, and, to be fair, he was a director of a company because Aberdeen bought its business before I came. He sold the business to Aberdeen in 1988.
(Mr Fishwick) No, it is the same man.
(Mr Fishwick) Yes.
(Mr Fishwick) The Chairman was not on any other boards, Neil Osborn was on some of our other boards, Harry Hyman joined the Board, Robert Wild never was, Ian Marks never was.
(Mr Fishwick) There were six members of the Board. Two of them has past connections to Aberdeen in different guises, ie, selling your business to them, et cetera.
(Mr Fishwick) Well, as you know, because we sent you a piece of paper yesterday, they were involved in other people's trusts, yes.
(Mr Fishwick) No, I do not because I think again there is a huge misunderstanding in this sector. The UK Listing Authority wanted directors with the relevant experience. They welcomed and wanted people to be on more than one board. That is exactly what they were looking for. They were looking for people who had the appropriate experience to help direct these trusts. That is exactly what they wanted.
(Mr Fishwick) I do not agree and let me answer you with what my colleague Mr Currie was saying to me this morning. He was reading something at breakfast actually which I did not know because it was some time ago and I think this puts it in context. Piers, do you want to read what you read to me this morning?
(Mr Currie) Well, it is not found from the Internet, but a friend from Scotland has just passed me a copy of The Economist describing, "There seems to be a ring of trust directors where we find certain names, such as those of Lord Cecil, Sir C E Lewis, Sir P F Rose, Major General McLan and Messrs Clark, Trotter, Monkton appearing and reappearing on the boards of a great number of trust companies while the brokers who act for them and advise them are also naturally confined to a few well-known and old-established investment firms." This is The Economist, but it is from 113 years ago in 1889 regarding the foundation of the investment trust movement. I think all we are arguing there is that the same issues----
(Mr Currie) Well, it proves, regarding directors -----
(Mr Currie) Well, it is possible, but 113 years ----
(Mr Gilbert) Apologies, Chairman.
(Mr Gilbert) No, that is not true. That is a misunderstanding, Chairman.
(Mr Fishwick) We, as asset managers, together with our clients, the investment trust, were de-gearing the trust. It was not a request from the main Board of Aberdeen plc, but it is totally separate.
(Mr Gilbert) Each individual trust has its own board which makes its own decision on de-gearing.
(Mr Fishwick) And they are all different.
(Mr Fishwick) I do not believe I said that.
(Mr Fishwick) No, I did not.
(Mr Gilbert) No.
(Mr Fishwick) What I think I said that the FSA actually approved of by the Listing Authority was having directors with the relevant experience, but everyone has been aware of the de-gearing in the sectors.
(Mr Fishwick) You are making announcements every day on the screen.
(Mr Fishwick) If you repay a bank debt, even if you repay a penny or £100 million, it is a disclosable event and you have to make a Stock Exchange announcement immediately, so you see on the screen that there have been hundreds and hundreds of announcements of debt repayments by many of these 130 companies, and it happens every day.
(Mr Marshall) No.
(Mr Marshall) No.
(Mr Marshall) I think you are probably referring to the newspaper reports of the potential asset sale of unit trusts and alike business. I would say that there are no plans to do that. I am not sure where the reports in the papers have come from.
(Mr Marshall) I think that is a legal requirement once the trust has moved into receivership, that all correspondence regarding that trust falls with the receivers and we are not in a position to correspond with clients at that point. We will of course attempt to answer any questions which are relevant to the period for which we were involved.
(Mr Fishwick) Can I take that because it is an investment trust rather than for Gary. The reason that the Aberdeen High Income Trust failed is very, very simple. At the end of the day we had less assets than we owed the bank and the debenture holders.
(Mr Fishwick) In September 2001 Aberdeen acquired another investment trust which had got itself in trouble, a trust called HL Income & Growth. They were in trouble and they actually approached us and said, "Look, why don't we get together and try and strengthen the balance sheets of both companies because both are having difficulties?" It made sense to make a merger and at that period of time, in that three or four-month period, a number of trusts were in trouble, their assets were starting to fall, so the sector generally, the brokers said, "Look, let's make an attempt to try and rescue these trusts" rather than go bust earlier, and the one thing that I am disappointed about is that we and the sector generally have been heavily criticised for attempting to rescue and save funds from going bust. Quite frankly, you wonder why we bothered trying.
(Mr Fishwick) Well, no, because what it allowed us to do is that it allowed both companies to de-gear and to take on the most attractive form of debt and we raised some new money which left the companies, both of them, in much better shape than either one was in before it occurred. However, it was not enough and I think the point I am trying to get across here now is that one of the problems that people have been saying is, "Oh, everyone in the City just blames September 11 for the problems", and this occurred at that time, but one of the consequences of September 11, forgetting the fact that stock markets fell, which has never been relayed, is that interest rates collapsed around the world to what is now deemed to be emergency levels, and interest rates falling means that it costs you more to repair your bank debt. If you borrowed £100 million, to repay it two years later would have cost you a further £15 million, so that is £15 million of assets that disappear to the bank. It is just like breaking a fixed-rate mortgage. I do not believe before September 11 that anyone was forecasting US interest rates at 1.75 per cent.
(Mr Fishwick) I do not think that markets or any investments are better off than they were before 11 September. I do not think that is particularly misleading. I think that was an appropriate thing to say in October, five weeks after 11 September. The whole world was pretty shook up.
(Mr Fishwick) I think part of this attempt, and they had full documentation about the merger going forward, yes, I think it was a reasonable attempt to ----
(Mr Fishwick) Of course it did.
(Mr Fishwick) Yes.
(Mr Fishwick) That is exactly what it did do. Just on that point, I think it is quite useful that you make it and you can press me further actually because it is easier, but the Chairman of the AITC, Tony Townsend, was on the Board of that fund that was merged, so ask him whether he felt it made sense at the time rather than just myself because you obviously cannot believe that it is the case. What we did, and it was not enough, I admit that, and I am very, very sorry, this is not very nice, people losing money, but we did attempt to try and save the money of both classes of shares. It was not enough, we failed, but I do not apologise for trying.
(Mr Marshall) No, I do not think we took that attitude. I think what we have tried to do is to ensure that we give as much information to people as possible because they are asking lots of questions. The correspondence you are referring to would be precisely the type of question which was being asked at the time, which was, "What does this mean for me?" and once people had got over, if you like, the initial shock of the September events, they were looking to see the implications, seeing stock markets fall. Now, on an ongoing basis what we are trying to do is to communicate as much as possible with the information that is provided out there. Some of that information regrettably is very unpleasant and we are having to tell some people some very bad news in terms of their investments and it is not very pleasant.
(Mr Marshall) I think there are probably two aspects to that. In terms of existing investors, and I think you have to look at each individual in terms of their own risk profile and appetite for risk of the holdings they are referring to in terms of their overall portfolio and see where that stands, but the one thing we would certainly encourage people not to do is to take a knee-jerk, panic reaction and the mistakes of the past, particularly in the retail market, are that people do sell out at the bottom and buy at the top. It is unfortunate and it happens, so what we are trying to do is to give people as much information as possible so that they can make a reasoned decision. You try and put that in the context of historical events and allow people to weigh that up and hopefully in conjunction with their own advisers. We at the end of the day do not give financial advice and it is up to people like us to supply as much information as possible.
(Mr Marshall) No, I think that is an objective piece of information. That is true. It is undoubtedly true that history has shown that over the long term investments tend to improve and the situation, as Chris was outlining, at the time, post the re-organisation, investors were in an improved situation from where they were before and had conditions improved from that or had conditions even remained stable from there, then I think that information would have been borne out. In practice, clearly that trust has failed and, as Chris has said, the reconstruction failed, but what we were giving was a piece of information which was valid and remains valid, that in the long term investments do tend to go up. What we are actually experiencing at the moment is the longest downturn since the 1930s. It may not be the deepest, but it is the longest downturn and that is patently very unusual circumstances.
(Mr Gilbert) I just repeat what Chris said which is that we are desperately sorry that people have lost money. It is awful as far as we are concerned because this was one of the most successful funds we have ever had. It has won so many awards during the 1990s, it has a string of awards. It is tragic that it has gone the way it has and circumstances have just been against it. I was going to make one point, that it is not just us that decided that the merger between the two funds is good for the shareholders, but the advisers to both funds, the advisers to both trusts have to sign off on a document and it goes through the UKLA, so I think to suggest that Aberdeen is totally at fault for this is wrong. We tried our best here, we really did try to save this.
(Mr Fishwick) I do not think there is one analyst in the City who would say that the merger of the two funds and the attempted rescue was not in the interests of shareholders. It failed and I apologise for that and I apologise to the investors. We know these people. They are not faceless people. They come to our meetings and I know them personally, but attempting and trying to do it was the right thing. I still believe it was the right thing. All that would happen instead is that people would have lost their money earlier and we would have been sat around this table earlier.
(Mr Currie) I think it is retrospect.
(Mr Currie) Yes, it is trying to explain how the mechanics of the trust work and it is enhanced zero because it uses bank gearing, typically borrowings at 6 per cent, to try to return at 9 per cent and that was a clear description of what the policy of the trust was at the time, but in 1999 we were in very different circumstances from now and it is very easy to issue little soundbites, to cherry-pick information to suggest that somehow now -----
(Mr Currie) In 1999, and in 1999 the zero market was vibrant, it was growing, everyone had rosy views of where markets were going and that was then and now is now.
(Mr Currie) I think I was trying to describe, and you are using reported speech as well, how the operation of the company works. The company borrowed money to invest into the zeros market. It was borrowing lower and trying to invest higher. That is what it was there to do.
(Mr Currie) Well, with many thousands of words written on this subject over the last five years ----
(Mr Currie) What is the source of your information. I cannot remember every ----
(Mr Currie) So the Herald has reported me as saying it.
(Mr Currie) No, I am saying that all I was trying to do was explain how the functioning of the trust worked and that is what it was.
(Mr Fishwick) Well, I do not think that is a correct quote of mine because I do not believe, or no one who knows me will, that I have ever said the word "unfettered". I find it quite hard to say, but yes, I believe that though I did not say that, and I say the same and I come back to what everyone says ----
(Mr Fishwick) I certainly deny that I have actually physically said the word "unfettered".
(Mr Fishwick) They had not at that time. If you look at the chart and the AITC and every single person in the sector, if you look at the chart and look at the movement, and if you remember the LTCM crisis when the stock market fell dramatically and the Russian debt crisis at the same time in 1998 when the stock market fell from 6,000 to 4,800, the zero market hardly moved. It did not fall 10 per cent, it did not fall 5 per cent. There was hardly a blip and the zero line went up pretty much like that (indicating). The markets went up and down throughout the 1990s at various levels and it had not been. At that time that was very much what people believed, what we believed, what the AITC believed, what every broker believed and every journalist believed. There was no one saying any different at that time. Now, it has been proved to be wrong, but that is what everyone believed to be the truth at the time and that is what the history of the past was. They had ridden out volatile markets, as also did income shares. Income shares hardly dropped during the Russian debt crisis and the LTCM crisis when stock markets fell dramatically because it was a very sharp fall and a very quick rebound, a bit like 1987 was. What we are experiencing now is a falling market and a continued fall. We have had three years of markets going down which we have not seen for an awful long time. It is a different type of fall and it is a question of how long it lasts.
(Mr Fishwick) I think it did badly at the time because what it actually was, it was funding zeros and zeros have gone down dramatically, the sector has fallen. It had £100 million of assets where £40 million of that was bank debts and banks do not lend money if they do not think they can get it back. The bank was convinced that it was a very safe bet for them. The bank itself is now losing substantial money on that.
(Mr Fishwick) No, I am not blaming the bank. I am just saying that the bank believed, as we believed, that this was a fair proposition and in the early parts of its life it performed exactly as it did, but at the end of the day if you borrow money and assets go down, you end up losing money. The more borrowing you have, the more the assets fall, the more you lose. It is simple mathematics.
(Mr Fishwick) Well, let's knock this one on the head once and for all. All Aberdeen zeros are not highly geared and they are not all invested in cross-holdings.
(Mr Fishwick) Some are and some are of every single person in the industry. This is not an Aberdeen issue, but an industry issue. Many, many zeros have bank debt and have investments in other trusts. This is not uncommon. It may have proved to have not worked, but it is not uncommon.
(Mr Fishwick) The Enhanced Zero Trust was a trust to invest only in other zeros, so, by nature, is a fund of funds. That is what its name is and that is what it does. It only invests in trusts with zeros.
(Mr Fishwick) Not necessarily because some of the trusts - well, I will try again to get this through, this "pyramid investing". Everyone assumes that because a fund of fund owns lots of other trusts that they necessarily owe the bank and that is not true.
(Mr Gilbert) Fund of funds are not illegal. They have been around for as long as the City has been around.
(Mr Gilbert) Fund of funds generally? Fund of funds in the split capital sector have ----
(Mr Fishwick) There is not one single fund of funds which has survived.
(Mr Gilbert) So they have equally all done badly.
(Mr Fishwick) None of them has survived.
(Mr Gilbert) Three of the seven zeros that Cazenove's are recommending today are Aberdeen zeros, so I refute your point that all Aberdeen zeros are highly geared and pyramid, and I forget your exact word.
(Mr Gilbert) No, the ones that own other split capital investment trusts or zeros are fund of funds. Enhanced Zeros was a fund of funds.
(Mr Fishwick) There are two parts to that question and I will answer the second part at the end. A number of trusts got into difficulty, some of which were Aberdeen, some were others in the sector. The first trust that got into difficulty actually was the most successful trust launch of all time. It was the European Technology Income Trust which was launched by UBS Warburg. It was a placing of £400 million ----
(Mr Fishwick) We managed this one.
(Mr Fishwick) As Head of Closed End Funds, I helped set that up. This fund had no cross-holdings. It was the biggest launch. It raised £400 million. We sent £80 million back to shareholders because we raised so much money. At the end of the day, it got into trouble for two reasons: technology shares collapsed, as we know; and the other side of the portfolio which provided income from high yield bonds and high yield telecom bonds had also been a disaster. So you put together two assets with massive demand and both failed. It had no cross-holdings, and that was the first of the trusts to get into trouble. It was acquired by another technology trust.
(Mr Fishwick) Aberdeen Preferred started to get into difficulty in, and I am trying to remember the year -
(Mr Fishwick) September of 2001.
(Mr Fishwick) Enhanced Zero started to get into serious trouble in October/January the following year.
(Mr Fishwick) None of these trusts, as Mr Tiner said to you, are regulated.
(Mr Fishwick) We never spoke to the regulator, nor did they ever ask us about it. They do now but they did not then, and I am not aware of them asking about the trust being in trouble at all, nor the trade body.
(Mr Gilbert) The proposals would go to the UKLA if we were doing a reconstruction.
(Mr Fishwick) Our regulator at that time would have been IMRO.
(Mr Gilbert) The UKLA is dealt with by the broker.
(Mr Fishwick) Can I take this question because we are getting into trouble here. What you are asking me is when did we first think that we were -
(Mr Fishwick) I will answer the question, if you will let me. The question you asked me is: when did I think they were getting into trouble?
(Mr Fishwick) When did the rescue operation go through? February. When were the authorities aware of it? The document goes to the Listing Authority in January.
(Mr Fishwick) Mr Ruffley, you are getting confused and if you let me answer, I will.
(Mr Fishwick) Aberdeen Preferred: in September of last year, the trust started getting into trouble. You meet with the board and its advisers and try come up with a plan to rescue it or decide not to. Right? That is an option you have. Once you decide a plan, you see if you can implement it. You take the documentation to the UK Listing Authority to be approved, but that is three or four months later. The UK Listing Authority approves your documentation; the plan then gets put to shareholders; it is voted on. If they vote in favour of it, the plan goes ahead, because it is their company. If they do not like it, they vote it down. The shareholders voted it through and accepted it.
(Mr Fishwick) September -
(Mr Fishwick) A company like Aberdeen Preferred was not regulated by IMRO and therefore did not need to go to IMRO for approval.
(Mr Fishwick) I do not believe there are any other regulators for it.
(Mr Fishwick) The board have a duty, as directors of a public company, to look after shareholders' funds.
(Mr Fishwick) There is no one directors of a company can turn to. If the directors of an investment trust are perceived to get into trouble, they cannot just pick up the phone and say, "FSA, I think I am in trouble". He would say, "Look, you are not in my jurisdiction".
(Mr Fishwick) I think it was very important to advise the people who matter, the people who own the company, the shareholders, which we did.
(Mr Fishwick) We have not bogged it up any more than other people in the sector.
(Mr Fishwick) I do not believe that we have bogged it up any more than anyone else in the sector. Let us get the facts straight. There are 19 trusts that have been suspended or are in administration. I think seven of the 19 are in administration or liquidation. The rest of them will go there. Let us not try and con people, they will. There are still four or five trusts whose assets are now currently below their debt and markets need to rise for shareholders of any class to get anything back.
(Mr Fishwick) There are 10 to 15 that will get into further trouble if markets fall. I am not trashing the whole sector. I am saying that we -
(Mr Fishwick) There are 40 trusts in trouble. When you borrow money and assets fall, you get into trouble. As I said, there are 78 of the 135 ordinary shares that have a value of nothing, and the markets will have to perform well to become something. I am not trashing the sector, Mr Ruffley. I am just telling you the facts.
(Mr Fishwick) How many are not going to be in difficulty? It depends on what circumstances you are referring to. If medium-term interest rates keep falling and people do not manage to repay their debt more and more, if assets fall, depending on what asset class you are -
(Mr Fishwick) As we speak at this moment in time, I do not believe that five trusts will make it, and I would suspect that of the following 15, half will have to work very hard.
(Mr Fishwick) Like some of ours. It would leave about 90 to 100 out of the 135.
(Mr Gilbert) Mr Ruffley, we have the top performing split capital investment trusts.
(Mr Gilbert) Yes, we have the whole range. We are bound to have.
(Mr Fishwick) Actually, I do not believe that I am the unacceptable face of the City, quite frankly.
(Mr Gilbert) It is still the case. As I said earlier, we are still committed to the uplift package. The Aberdeen Asset Management Board have specifically stated that they are committed to the uplift package going forward.
(Mr Gilbert) Yes, it will give them their money back. The delay in getting the details out actually is not to the disadvantage of people because the uplift package we are proposing is a certain time period out. What we are trying to do, and my colleague Gary Marshall probably would be better able to pick this up, is work our way through what is a very complex scheme.
(Mr Marshall) I think I clarified the point the last time that when we are talking about compensation to all investors in zeros, we are saying basically that where a zero has been mis-sold, anyone who has been mis-sold a zero, we will compensate. As far as the unit trust is concerned, we remain entirely committed to the uplift package we have proposed. As Martin was saying, the reality is that this is the first time that anything like this has ever been attempted and we are having to go through really a large number of advisers and deal with issues which have never surfaced before. It is not just a regulatory issue. There are trustees to consider. We have to consider legal advice, tax advice, the financial implications, audit and so on.
(Mr Marshall) We are currently proposing that the plan will come into effect in August 2005.
(Mr Marshall) Because what we are looking at here is this. The proposal was always framed around the proposition that any stock exchange investment should be for the medium term. If you make any venture into the stock exchange, however, whatever the risk profile is, we would make it clear that people should be looking for an investment over the medium term. In that case, 2005 would be five years from the launch of the fund.
(Mr Marshall) I am talking purely about our unit trust, which is the Progressive Growth Unit Trust, and I am talking about all investors in that fund. I cannot go into the details at this point about how people will be treated as existing investors compared to people who have sold out and so forth. I do not have that information.
(Mr Gilbert) That is correct.
(Mr Gilbert) We cannot go into too much detail here. Suffice to say, Mr Laws, that they will get their money back. We are still working on the scheme but the key thing as far as people are concerned is that Aberdeen are still committed to the uplift package.
(Mr Gilbert) We have no idea where that story came from, absolutely none. It is absolutely untrue.
(Mr Gilbert) It is absolutely untrue. There is constant speculation every day in the press and we see stories like that.
(Mr Gilbert) What I can say, and this is not answering your question -
(Mr Gilbert) If we are found, as the Chairman suggested, to have mis-sold zeros to anyone, we will compensate.
(Mr Gilbert) I think there is a big distinction between the wrapper products that we have. You could take a PEP or an ISA as a good example, as Piers suggested. It is a similar situation if your stockbroker sold you a PEP and advised you to buy Marconi and you lost all your money. What you were saying, or what the Chairman was saying, was that he should be compensated for the loss in Marconi. What I am actually saying is that we advertised Progressive Growth and put a low risk warning on it. We badged it as low risk, and that is where we feel a certain obligation to the unit holders. At the time it was low risk. We can produce reams and reams of evidence showing that it was low risk at the time. It is an unfortunate set of events and we are very sorry that people have lost money in this product but that is why we are going for this uplift package, and we are the only people so far that are prepared to step forward and do that.
(Mr Fishwick) I think quite clearly we have all learnt lessons, and if we have not, then we should have done. One thing that has come across to me more than I perceived at the time is that investment trusts are all about confidence and I am surprised how the confidence in the sector has been damaged so much and therefore made many investments trade below their assets and caused them to have difficulties with their banks. I have learnt a lot about the crisis of confidence which I did not see before and should probably have seen coming earlier. I just did not believe you could have a situation where no investor will now almost buy any split capital trust. So by nature their prices are falling because everyone is a seller. Everyone wants to have a AAA rating and not own any other split capital trust.
(Mr Fishwick) I think the lesson that has been learnt by the City is very simple, that we seem to be in a situation where we are championing the consumer, and rightly so, and the truth of the matter is that you probably ought to put no risk warning. Every fund manager in the City wants his marketing department now to put on "high risk" because he does not want to get caught from them all. I think the lesson I have learnt is that there needs to be a mass educational programme for investors on all kinds of products. I am staggered how little people understand about their money, be it their pension, their endowments or their investments. I thought we knew a bit more. I think a huge educational programme needs to be done. I do not know how it is going to be done or who will do it, but it is very sad. It is awful when people lose money without understanding why they have lost it.
(Mr Gilbert) We are not paying compensation, Mr Laws. We are voluntarily coming forward with an uplift package on a product that we marketed as low risk.
(Mr Gilbert) Not only did we get it wrong, and there seems to be some sort of - Everyone got it wrong.
(Mr Gilbert) I suppose, if we got something wrong, we would not badge it low risk again.
(Mr Fishwick) No, not at all.
(Mr Gilbert) Yes.
(Mr Gilbert) The disclaimers were on every product we produced, but the problem is that you can argue that the disclaimer is there, and legally our adverts stand up, which is why we have come up with the voluntary package. As I say, if we are found to have mis-sold a product, we will compensate people.
(Mr Gilbert) That markets can go down as well as up? Yes.
(Mr Gilbert) I do not understand the question.
(Mr Gilbert) To future performance.
(Mr Gilbert) Yes, I think so. Past performance is no indicator of what is going to happen in the future.
(Mr Gilbert) Yes, it is.
(Mr Fishwick) Can I take that one because it is interesting. I think if you believe that you learn nothing from history, then maybe that is the case. What you have to remember is that when you look at, let us say, your pension scheme, which is a perfect example, it is the biggest investment for the majority of people. If they have a money purchase scheme rather than a company scheme, they get a statement probably once a year, probably six months after the year-end date, and it says this very simply: "On our current growth assumptions", which are way higher than any splits ever use, "you will receive 27 per cent of your current salary entitlement". They do not say to you, "If these assumptions are not made and if we put in an assumption of -2.5 per cent per annum, you will probably end up with your pension being worth one week's salary"?
(Mr Gilbert) There have not been three down years in the stock market for 80 years.
(Mr Gilbert) I do not believe so.
(Mr Currie) Looking at the same time period and with the benefit of hindsight, what you saw was double digit equity market returns happening to the Nineties, which, to a whole generation of fund manages and analysts and others, led to the belief that equity markets would continue to rise. I am not alone in this. Governments believed equity markets would rise during the period. With hindsight, looking at ratings now, it appeared that that assumption that it would continue at that rate of growth was wrong.
(Mr Gilbert) Are we not speaking about the models being based on that assumption?
(Mr Gilbert) I am trying to find the part of our submission where this point is.
(Mr Gilbert) That is correct, as had been the case for the preceding decades. That puts it into context.
(Mr Gilbert) I am afraid, we will have to come back to you on this. I really cannot answer, it, I am sorry.
Investment professionals over the 1999-2002 period did not in the main anticipate the sustained nature of what has now become the longest bear market in equities since World War Two.
(Mr Fishwick) No. I think it is very easy to explain. The truth of the matter is that if you think markets are going up and you get it right, you want to borrow money. It is like buying a house. If you think markets are going down, and you get it right, you want to have no borrowings. It is a question of when you use the gearing. That is the advantage. You borrow money when assets are rising and you try and get rid of your debt and really to catch up when assets are falling. It is no different from housing. So gearing is the advantage. The question is: do you use it properly or correctly at a given moment in time? That is the issue. In the last three years, whether you had 5 per cent gearing or 50 per cent gearing, you wanted none because things have gone down.
(Mr Fishwick) I think gearing is the greatest advantage for investment trusts. If investment trusts have no gearing, I believe they have no reason to exist.
(Mr Fishwick) Gearing is the biggest single factor.. The companies happened to have large borrowings, or any kind of borrowing, and assets fell and that has hit them. In the previous ten years, they borrowed money when assets were rising, and that benefited them. I cannot understand that you do not understand that.
(Mr Fishwick) Of course it was always there.
(Mr Fishwick) If you borrow money -
(Mr Fishwick) I think that is a question you have to ask the whole industry.
(Mr Fishwick) We believed it to be low and minimal risk. We got it wrong. We as the sector, including our trade body, did not believe that markets were falling to the levels we had. If you had said to me, "If the market falls to 4000 when it was at 7000, and you believed that case, would you remove all your debts?" "Yes." Did the AITC believe, did every other manager believe, did ever broker believe three years ago that zeros were low risk? The answer is: "Yes, they did".
(Mr Fishwick) If you borrow money and you cannot pay it back, of course it is a risk.
(Mr Fishwick) No, it is not a change.
(Mr Gilbert) Gearing is always a risk. If you have a mortgage on your house, it is always a risk
(Mr Gilbert) You are speaking about two different things. We are speaking about zero dividend preference shares and you are speaking about investment trusts.
(Mr Gilbert) That is correct.
(Mr Fishwick) I do not accept that argument whatsoever. I think investment trusts are like markets that are based around confidence. Financials systems are around confidence. It is no different from you saying about a small bank that if you take your money out and you have a run on the bank, it disappears. It is about confidence. I will give you an example of that. You can have an investment trust, for example, that is on a discount of 2 per cent. Confidence goes; the assets do not change, so that it is a discount of 40 per cent. That is what we are seeing in the sector, discounts widening. People would have lost 38 per cent of their money and the assets would not have moved. People say, "Well, don't worry, you can wait to get them back", but you could wait for 100 years if discounts did not narrow. Investment trusts are all about confidence and there has been a huge crisis of confidence in the sector, which has added to the problems and made them worse.
(Mr Fishwick) I do not have shame. I am very, very sorry that people have lost money.
(Mr Fishwick) I did not design the sector.
(Mr Fishwick) I said, "All 35 might go". Let us not complicate it. Nineteen have gone already. Four further ones have assets substantially below what they owe the bank, so that is 23. The rest of them, and it is very simple, and I do not want to name them, you can work out from the guide. It is those which, for example, maybe owe the bank 90p and have got 95p of assets. It does not take much of a fall to go down. That is the point I am making. If they cannot get asset growth from markets or if the cost of that debt goes up, the mathematics say that they will not survive. Those who have got the least amount of assets against their debt are the ones that are likely to fall.
(Mr Fishwick) No. I am saying that I think -
(Mr Fishwick) If markets do not recover or if they fall further, the mathematics are simple: they will not survive. If markets rise, they will survive.
(Mr Fishwick) They have more bank debt in proportion to their assets.
(Mr Gilbert) And repaying bank debt is not just as simple as writing out a cheque to them because the break costs are the things that have come out so dramatically.
(Mr Fishwick) Can I just take that?
(Mr Gilbert) No, I defer to my colleague. He is more expert.
(Mr Fishwick) I would like to answer the question. I was pilloried for not answering questions last time. Very few of the split capital investment trusts were ever invested in technology. There were only four or five of that 135. I do not know where this misconception has come from on technology. Technology could halve again and it would make no difference to the split capital sector. It is not an issue. Cross-holdings or investment in other split capital trusts is not an issue either. All that damage has been done; that has occurred in those 19. That is finished. The problems going forward are different problems. The problems are in equities and if European equities do not rise, the trusts will get into trouble. They will not get into trouble because of cross-holdings because they are down to nil virtually. They will not get into trouble because of technology because there is none. Other things will get them into trouble. I think it is naive to say that if stock markets fall and you have got a lot of debt, you will survive. It is just common sense that you will not.
(Mr Fishwick) Yes.
(Mr Fishwick) It is very, very simple. It is about the amount of borrowing you have. If you have £100 ----
(Mr Fishwick) Obviously everyone else understands the answer. If you have £100 of assets and £50 of bank debt now and the market falls by 25 per cent, you will survive.
(Mr Fishwick) Yes.
(Mr Fishwick) Because I have got the data.
(Mr Fishwick) Yes, and we apologised for that because it is not our data.
(Mr Gilbert) Unless markets fall.
(Mr Fishwick) Or unless something hits you left field that you do not see.
(Mr Fishwick) Yes. There could be something that comes left field. It might be a fund that is invested in Europe and Europe halves again, completely collapses, the currency falls into disarray and it could hit you left field. What is interesting is that the ones which are most geared are not necessarily the ones that get knocked over because if the assets fall faster in another sector that you have, you are in trouble.
(Mr Fishwick) Oh, very much so. We were in constant dialogue on a weekly basis with the bank - auditors, no. I do not know if you have ever borrowed money from banks seriously. They spend an awful lot of time looking after it. What you do with the bank is provide to them a daily covenant. You tell them every day how much assets you have against debt and they are aware of it and there are levels. The minute you get to those levels, they are on the phone. One of the reasons I did not attend last time was because I was in a difficult syndicate meeting with the banks, trying to repay money for one of our funds. The banks are completely on top of it. They do not lend you money without taking care. So these trusts are actually supervised and watched by more than any other investment medium anywhere.
(Mr Fishwick) They started to borrow heavily when there was a huge differential in the cost of borrowing and the cost of zeros, roughly when interest rates got down to about 6 per cent and zeros were still costing you about 8.5 to 9 per cent. That is when it began.
(Mr Fishwick) I think early 1999.
(Mr Fishwick) Yes.
(Mr Fishwick) I think it is one of the ingredients. I would not like to sit down here and try and attempt to put the blame on anyone else or on the banks but banks, when they perceive that their loans may not get repaid, it is their job -
(Mr Fishwick) You have got a falling asset. If the assets did not fall, it did not matter if -
(Mr Fishwick) If you read every prospectus that has ever been published, the situation with regard to the banks' position is very clearly stated; it has to be.
(Mr Fishwick) I do not believe anyone that I am aware of described splits as low risk. They described portions of them, slices of them maybe, but they never described the whole company as that.
(Mr Fishwick) It is part right actually, but not totally because -
(Mr Fishwick) Can I try and help you with the answer because I think it is a very, very good question. I think it is one of the key question I have heard in the last year. It is right at the heart of the matter, quite frankly: should the sector have said that it has changed dramatically with the introduction of bank debt? It is a very, very good question. It is directed at me but it could be directed at anyone in the sector, the listing authorities. Should we have said it has changed? It is a problem. However, all the trusts ----
(Mr Fishwick) I think they have actually; "Yes, it was warning". Should they have shouted louder? Probably.
(Mr Fishwick) Should I have shouted louder at all those things? I do not look after the public. I look after the trust. I have always been aware of the structure. Mr Tyrie, one thing about this actually is that of these 78 trusts who have told you that part of their share structure has no value, many of them have no bank debt, nor ever have had. So it is not perfect.
(Mr Fishwick) I think falling markets is the primary reason; gearing is the next reason.
Mr Tyrie: Of course falling markets is always the primary reason.
(Mr Gilbert) To the owners of the shares.
(Mr Fishwick) To the owners of the shares in the trusts, but as a director of a company, you have a fiduciary duty to your lending bank.
(Mr Fishwick) I wish it was that simple. Of the 19 trusts that failed, on your assumption, you assume that they were all launched post -'99, and that it is not true; seven of them have been around for an awful long time.
(Mr Fishwick) I think you are suggesting that knocking them over is intrinsic in that structure. What I am saying is that seven of them were launched way before that.
(Mr Fishwick) Yes.
(Mr Fishwick) But we did. That is the whole point about it. As assets fell, we repaid debt. Assets fell forward, we repaid debt. We have repaid £1 billion in the last 12 months and half a billion pounds the year before. The problem is that we could not repay the debt as fast as the markets were falling.
(Mr Fishwick) Again, I come back to it; I do not think split capitals have ever been described as low risk
(Mr Fishwick) It is a zero.
Chairman: The fact is that you have "low risk" in there. The aspects that we are going to be looking at as a committee - and we are going to get round the whole industry, we are not finished here today, Mr Fishwick, because everybody is going to get a questionnaire - are the issues of high levels of debt, cross-holding and aggressive accounting practices. We are looking at the whole industry and perhaps we will have you back again on that.
(Mr Fishwick) What steps were taken? I think it is worth bearing in mind the way a split trust capital trust is launched. There seems to be a huge misconception about how that is done. What actually happens is that you have an idea, whichever investment house you are, or an asset skill that you are good at; you approach the sponsoring broker or they bring it to you. In most cases they create a model which you and the board approve for your structure that is stress-tested. It is then independently verified by an accountant separately to make sure the model works. That shows what happens to the assets of various corporates, plus or minus, -2.5, +2.5, over a period of life, and they are stress-tested. You might say to me, "If your model says that the market may fall from 7000 to 4000, will you survive?" The model will say, "No, it won't". But we did not believe the market was going to fall back, neither did the board, or whatever. I could have told you that if the markets fall to this level we would not survive. There is nothing clever about that. The models did not tell you that. They do work; we just did not believe the markets were going to that level.
(Mr Fishwick) In the sector as a whole or by ourselves?
(Mr Fishwick) By us, that was based on the covered and hurdle rates of the funds. There was compensation in the amount of zeros that were in the structure with bank debt. What actually happened was that for the trusts that had zeros and bank debts, you may have had a trust that had 40 per cent zeros instead of equity. When you put bank debt in there, you may have only put 10 per cent zeros at the bottom; with the bank debt in, that is what compensated or attempted to compensate for some of the numbers going through. But these numbers and hurdle rates are live daily. They are there all the way through.
(Mr Fishwick) Oh, no, not at all, none whatsoever. If you are saying that we did not shout loud enough that the bank gets repaid first, then everyone else, and the shareholders did not understand that the bank got their money before them, then -
(Mr Fishwick) I cannot believe, or I find it hard to believe, that anyone believes that they are going to get repaid before the bank.
(Mr Fishwick) It does not. I was a personal investor in all these trusts, as were the directors, as were my family. Of course it does not. You do not invest in products you think are not going to work. It is a stupid thing. You do not launch products that you do not think will work because it damages yourself. We are co-investors. I am an investor in every single product we have launched and I have kept every single share to the very end.
(Mr Gilbert) I just do not agree with that, I am sorry. It is just not the case. It just is not the case.
(Mr Fishwick) It was a very long launch period actually. It actually came to market eventually in July 2001.
(Mr Fishwick) There was an awful lot of money already there, £840 million, the biggest launch. We did not raise the money and get paid for it. UBS Warburg, that is what they got paid a placement fee for.
(Mr Fishwick) Around £110 million out of £840 million.
(Mr Fishwick) It is a lot less than 25 per cent.
(Mr Gilbert) £110 million -
(Mr Fishwick) Out of £840 million.
(Mr Fishwick) It is a very small book because we sold it down. It is worth about £15 million. We have sold quite a number of investment trusts in recent months.
(Mr Fishwick) The sector has fallen 80 per cent, Mr McFall.
(Mr Fishwick) We did not.
(Mr Gilbert) It does not invest in a basket of zeros. It invests in -
(Mr Fishwick) Our fund performed -
(Mr Fishwick) No, I think Alastair Mundy did a fantastic job of running that fund.
(Mr Fishwick) Categorically, no.
(Mr Gilbert) Yes and no, Chairman.
(Mr Gilbert) It is a bit unfair -
(Mr Gilbert) It is a very good newspaper but -
(Mr Gilbert) I see the reporter and it was to that very same reporter I think what I said was -
(Mr Gilbert) I am quite happy to have that headline. What I actually said was that we encouraged diversification of the portfolio, and that was what that quote was about.
(Mr Fishwick) No. We had as big a stake in funds that had no cross-investments as we had in cross-investments.
(Mr Gilbert) No, it was not created that way. The reason that these funds were created was because we were trying to diversify away from having investment in one very, very small sector.
(Mr Fishwick) You are putting that to me? The answer is "no".
(Mr Fishwick) I am very sure of my answers.
(Mr Fishwick) I do not think I have been involved in anything corrupt but I am not quite sure what you mean by that.
(Mr Fishwick) No.
(Mr Fishwick) I do now.
(Mr Gilbert) I will answer it quickly and then pass on to Chris. I think that on the stress-testing the brokers that issued them would have as good an understanding of that as I have. But on specifically, St David's, Chris, do you want to pick that up?
(Mr Fishwick) Unfortunately, what happened with St David's is that the previous manager passed away. Therefore the board had a beauty parade and we attended the beauty parade with, I believe, six or seven other managers, to put forward proposals for a company which we believed at the time was in difficulties and needed a radical restructuring. It already was a significant investor in Income Shares; we did not introduce Income Shares into the structure. They were already there.
(Mr Gilbert) This is a contract we won in a beauty parade.
(Mr Fishwick) Breaching your banking covenant does not mean you are bust because your banking covenant might mean that you have to have two times the debt; you might need to have £200 of assets to cover £100. It does not make you bust. If you fall down to £190, you still have £90 left, which belongs to the shareholders.
(Mr Fishwick) Coming from Wigan, of course not, no, I do not.
(Mr Fishwick) Yes, and I have lost a lot. Just like the shareholders that co-invested, I have lost a lot of money too, and I apologise to these people. I feel sorry. I do know them. These are not faceless individuals.
(Mr Gilbert) I apologise again profusely, Chairman. I am very, very sorry for that. Thank you very much.
MR JOHN HALL, Chief Executive of Brewin Dolphin Holdings PLC and Brewin Dolphin Securities, MR DAVID THOMAS, Head of Investment Trust Corporate Finance, Brewin Dolphin, MRS LEANNE BOWDEN, Compliance Director of Brewin Dolphin Securities Ltd., and MR ROLLY CRAWFORD, Head of Investment Trust Division, Collins Stewart Ltd, examined.
(Mr Hall) I will pass this one to Mr Thomas because that is his role.
(Mr Thomas) That is indeed my role, Chairman. I use modelling, very extensive spreadsheet modelling, to work out the alternatives in front of me as a designer, if you like. I have to work out the set of proposals which is put in front of an existing board. Our aim is to have a prospectus which is gradually written by a team of people, which enshrines those proposals. There is a very considerable amount of discussion about the content which sometimes takes three or four months to settle. Our work ends when the prospectus is agreed by the Listing Authority, when the prospectus is handed over to the managers and the board and when the money has been raised in a placing. That is the end of my real involvement.
(Mr Thomas) I have been in this sector for more than 30 years, so I know all the likely people who will want to buy high-yielding stocks of this kind. I deal only with institutional, professional people who can understand the rather difficult descriptions that I write.
(Mr Thomas) One person around, not you, sir, wrote on Sunday that they could not understand David Thomas.
(Mr Thomas) I hope so, sir.
(Mr Thomas) I am not the Mohammed Ali; I am not the architect; I am not the father. There were people long before me who started the modern split trust companies. I started in 1969, about five years after these people were working. I can give you their names. I just happen to have been around a bit longer than my competitors who have obviously started to die off.
(Mr Thomas) I have a job to do, Sir. I am very sorry that people have lost money which you are associating with the job I do. I am prepared to defend myself and say I do the job properly.
(Mr Hall) That is directly, Sir, the area that our corporate finance department does - that David Thomas does - in relation to investment trusts. It is obviously a small, and kept very separate, segment of our overall business.
(Mr Hall) Yes. David advises and is part of the team that structures the trusts for the companies, and with other advisers.
(Mr Hall) Yes.
(Mr Hall) Yes.
(Mr Hall) Absolutely correct, Sir.
(Mr Hall) Are we talking about a zero here or an income share, or a zero preferred stock?
(Mr Hall) Yes, the answer would be yes so far as zero preference shares are concerned.
(Mr Hall) Yes, and it is zero preference shares.
(Mr Hall) The answer is yes.
(Mr Hall) In certain instances, a minority, the answer is in the affirmative, yes.
(Mr Hall) In some cases we have. In the vast majority of cases I do not believe we did but we have an on-going process where we look at every individual case very carefully indeed.
(Mr Hall) Yes, totally objectively. I have absolutely no qualms on that matter whatsoever. The two arms or divisions of the business are kept totally separate. Mr Thomas only markets his (insofar as he markets at all) to institutional investors. These investments were made with the intention that they were suitable investments for the clients. Suitability is the key issue. Whether or not we were brokers or it was declared, it has never been an issue and frankly has no particular relevance.
(Mr Hall) It certainly should not look a bit odd, Sir. I am aware of the nuance drawn in a particular television programme which was, in my view, both biased and definitely inaccurate in many matters, because we gave them the information and they drew a line through a number of clients who had invested in some of these funds before we bought that particular partnership even, so there was no question of it - it would not have occurred anyway but there was no question. So I am very confident on this particular line, those two businesses are kept separate.
(Mr Hall) The Money Programme.
Chairman: There seemed to be pretty compelling personal evidence from, was it, Ronnie Morrison, Sue Kennedy and others in that programme about losing money. So I think you have a perception problem there.
(Mr Hall) The total number invested in splits - because we have been investing using this medium since the 1960s and we bought and sold them ----
(Mr Hall) I have not concentrated on that figure but naturally I have got figures for all those who have not performed as we would have wished in recent times. Perhaps I can throw that one over to Mrs Bowden who is heading the team investigating this so far as we are concerned?
(Mrs Bowden) I do not have a figure which I am comfortable with of the total number of investors. We do know, for example, by looking at individual trusts how many we have in certain trusts but we do not have an overall figure.
(Mr Hall) What we are saying is that we have not brought here or got a figure for the ones which are in the trusts which are not at risk, which have performed up to expectations, many of which will have taken profits along the way for many years. As we all know they were a very useful, successful investment medium which lived up to expectations.
(Mrs Bowden) Overall, no.
(Mr Hall) We can give the figure of the ones which have not been successful.
(Mrs Bowden) From the information I do have I know it will be a few thousand.
(Mrs Bowden) If we look at the zero shares, they had invested around £200 million out of funds under management at the time of £16.8 billion.
(Mrs Bowden) 600-ish.
(Mr Thomas) Until recently I had about five. I have two less now. It is a very small team and I do not take any part in the marketing-to-retail investors at all.
(Mr Thomas) When I write them I write "David Thomas" underneath and I write, very seldom, quite long pieces. There are other people who can set themselves up as experts on certain areas, I do not have anything to do with what they write for their retail clients.
(Mrs Bowden) David Thomas's research notes which he has referred to are not commonly used by the private client executives, so the people making those investment decisions are not reading the research he is producing for institutional purposes.
(Mr Hall) It certainly should not have been.
(Mr Hall) I do not believe it did, no. I do not know if any did but it certainly should not have done.
(Mr Hall) I believe it did not.
(Mrs Bowden) The responsibility for the documentation going out to private clients is with the private client team. The individual who looks after each private client has full responsibility for what goes to them and, frankly, if his views are diametrically opposed to David Thomas's or anybody else's in the firm, that is absolutely fine, he will do what he thinks is right for his clients.
(Mr Thomas) Yes, Sir. I listened with great care to that discussion ---
(Mr Thomas) Qualifications later.
(Mr Hall) First of all, there is a slight misconception in that there is no marketing in Brewin Dolphin, we are not salesmen, we are investment advisers to individual investors.
(Mr Hall) Yes.
(Mr Hall) No.
(Mr Thomas) Because I have studied the subject quite a long time, would you mind if I answered your question? We come down to the qualifications. I think I am right in saying that your concept is there was a sort of additive, a lump of extra borrowing, stuck on top of existing zeros. Yes? So your conception then would be that you had gearing either in the form of borrowings or in the form of zeros or in a combination of the two?
(Mr Thomas) I would suggest to you that because of the coverage of this subject you are differentiating very strongly between a geared zero and a non-geared zero. Am I right?
(Mr Thomas) To begin with, if I am answering that question, I was not responsible ---
(Mrs Bowden) I can give you a fairly simple answer, from the point of view of the private client executive I do not think there was a huge shift in perception at that time.
(Mrs Bowden) Across the industry I think the market professionals as a whole did not see a huge shift in the way perhaps you are suggesting.
(Mr Thomas) I did not think they were fundamentally different.
(Mr Thomas) There are people who say so.
(Mr Thomas) I would say that the cover for the bank borrowings was there in ample quantity. The cover for the zeros was there in ample quantity. I do not think the level of gearing was unsafe. What has happened is that people have pointed after the event, when the markets have fallen and when the assets were no longer covering these things, to the fact that the zero which is geared by a bank loan is now is very dangerous thing.
(Mr Thomas) Any level of gearing like 90 per cent on a stub-equity is dangerous.
(Mr Thomas) But the gearing was not like that.
(Mr Thomas) I do not think it ever worried any board or any accountant ---
(Mr Thomas) I am saying, in common with everybody else round the table in each one of those design sessions, nobody noticed that.
(Mr Thomas) Including me.
(Mr Thomas) With the numbers at that time it did not show up at all.
(Mr Thomas) I do not think so, sir.
(Mr Hall) There was a huge increase in gearing when the assets fell, was that not correct?
(Mr Thomas) Yes.
Mr Tyrie: I have not got any further questions.
Mr Mudie: Stick with the question you asked.
(Mr Thomas) I think they were using bank gearing long before that. I do not think there is a watershed like that.
Mr Mudie: It was the extent of bank gearing.
(Mr Thomas) I will give you an example, sir, of something which other people did quite easily. One of the failed ones had only bank borrowings and yes, if they had had zeros underneath those bank borrowings they would not have been in such trouble, that is a good example of it.
(Mr Thomas) Our stress testing was very, very extensive; I did understand it.
(Mr Hall) It is absolutely correct that Mr Thomas did not ---
(Mr Hall) He did not feel that he had created anything that was any riskier than earlier. Is that correct?
(Mr Thomas) That is right.
(Mr Thomas) I can throw some more light on it, if you like, sir. I can remember only one case of one potential placee saying, "You have created a zero with a gearing of its own and we do not want to take the placing." That was another large stockbroker who specialised in private clients who bought zeros. He differentiated between that kind of geared zero and the earlier kinds.
Mr Tyrie: When was that, Mr Thomas?
(Mr Thomas) In about 1998-99.
(Mr Thomas) Only one man of all the others I was talking to.
Mr Tyrie: But somebody was coming to you and saying, "You may not fully understand your product but I do"?
Chairman: Who was this honest man?
(Mr Thomas) It was one case, one opinion, one telephone call.
(Mr Thomas) We did not talk in great detail. Nobody had reconstructed what might happen. All he said was, "I do not like geared zeros", and I did not place anything with him.
(Mr Thomas) No, I did not.
(Mr Thomas) I do not think I am giving away any information which would hurt him in any way, sir. There was a father and son relationship I had known in Henderson Crossthwaite for years and years and years. The father is called Pickford and so is the son. That is the only criticism I have ever had of any of my designs.
(Mr Hall) September 2001.
(Mr Hall) No.
(Mr Hall) Absolutely. To the best of my knowledge and belief, 2001, September thereof.
(Mr Hall) So far as I am aware, there was one.
(Mr Hall) I may have got it in retrospect.
(Mr Hall) No, I do not think it was that far and I am not sure of what period I personally would have been aware of the fact that there was one who had thought that there might be a problem earlier.
(Mr Hall) Our advice changed particularly insofar as the risk assessment was concerned. Very sadly, one of the things that became apparent at once was the fact that the marketability of the stocks in this sector dried up, as did confidence. With no confidence it went out like a light, so one became unable to sell any quantity of stock and the prices fell rather rapidly and the best advice I was getting was that although the sector was under pressure, there were problems, certainly if one had bought a zero and advised a client to buy a zero for a particular purpose, it was highly likely that they were looking over the whole of the period when it was likely to be repaid and around September 2001 it became apparent that there were pressures and that it was possible that they were going not to be repaid in amounts that had been expected. It was not suggested to me at that stage that what has happened would happen, in other words, they went bust.
(Mr Crawford) I do not think it was ignored. I think just to go back ---
(Mr Crawford) As I was about to say, I think the lessons of the 1990s were not ignored. If you look back at the 1990s, some of the split structures which came out of there were very simple structures inasmuch as they had maybe half of their capital in ordinary shares and half of them in zeros, so with regard to the ordinary shares, the cost of the ordinary shares was quite high because the zeros were compounding at quite a large number and they represented a large proportion of the structure. It is also fair to say at that time the first zero which nearly did not work was the zero in Olim Convertible, and that was in the early 1990s, so the experience of zeros almost not working had been realised in the early 1990s as well. However, when bank debt did come to the fore, as we said in the late 1990s, bank debt was considerably cheaper and people saw the benefits that would accrue to the ordinary shareholders as well. What you ended up with were structures where typically the gearing was not necessarily the same level as the zeros were in the previous years, so the bank debt was seldom as high as 50 per cent and normally ranged between 25 and 40 per cent, so the gearing was lower in terms of the bank debt but clearly it was a different structure altogether from the early 1990s.
(Mr Crawford) In terms of recognition of it being a problem, it was clearly when assets started falling quite dramatically in equity markets. That is not to say people are not putting out geared structures at the moment. For example, I think it was Cazenove who launched a product for Aberforth recently which was 50 per cent geared, so the concept of gearing is not necessarily negated, it just depends when you take it out, when it is appropriate to take it out in terms of where equity markets are going. I think it is worth pointing out the large investment banks, to whom we all defer in terms of equity market forecasts, were predicting equity markets to continue to grow throughout the late 1990s and the early part of this century. So we cannot say that we were not surprised by falling equity markets, because we were clearly, and we were caught out.
(Mr Hall) The answer is, we certainly were not doing that. Early on, it was certainly felt that the fund of fund approach in fact gave more reassurance rather than less and that it was spreading the risk. Of course, we all can see with the benefit of hindsight where it led. The truth of the matter is, and experience has shown us, that it all depended on the quality of management and how those funds were invested.
(Mr Hall) The prospectus of these splits sets out quite clearly how much they intend investing. Of course, how they were actually invested one did not know, but the structure clearly sets out how much they intended investing and of itself the fund of fund principle should not have caused the problem it has.
(Mr Thomas) No, I have not, Sir.
(Mr Thomas) No, Sir, I do not think so. I see the crash we have suffered slightly differently. I do not think anybody in any of the discussion I have watched so far has pointed out that the geared nature of the equity, that is the geared ordinary income share at the bottom of the capital structure, was the first thing to crack. They lost their assets fastest. Their prices after 9/11 fell like a stone. Because those prices fell and because of the cross-holdings, you found assets fell and the cover of the zeros then started to decrease, and then people started to realise. It is only when you have nothing left for the ordinary share, something but not much left for the zero, and a socking great bank borrowing which you cannot repay that you are suddenly starting to look at this peculiar structure of a bank loan over a zero. A lot of the work which has been done very, very recently has been to try to explain things as they are now, after the event.
(Mr Thomas) I am aware of one other fact which is related to Galbraith and America. They have a phobia for pyramiding and cross-holding and they prevent one fund of funds owing too much of another fund of funds. As I understand it, there is no such legal prevention in this country.
(Mr Thomas) I would not dream of suggesting things to politicians, Sir.
(Mr Thomas) I have been taught not to talk too much, Sir.
(Mr Thomas) Thank you, Sir, that is very kind of you. I suspect that is one of the possible changes in the legal structure which obviously you are going to have to be thinking about.
(Mr Thomas) Yes.
Chairman: That is fine. Good.
(Mr Thomas) I cannot place that document, Sir. Is this the one published by Aberdeen?
(Mr Thomas) I was talking only to my institutional holders. I suppose we might have printed 30 copies of that bit of paper.
(Mr Thomas) I think not, Sir, because at that time if you had looked at the performance of all sorts of zeros - I have an index which started at an index level of 100 in 1991 - and if you drew that graph of the zero index between 1991 and the year 2000, all it did was to go up and up and up and up; there was no interruption. You have heard this said by other people. I think somebody standing in the year 2000 saying, "Zeros are safe" was quite within his rights to say that for that reason. What I was doing was gearing apparently certain growth.
(Mr Thomas) I lived through 1974, Sir.
(Mr Thomas) The others were small in comparison. I looked into that kind of thing very carefully when we were judging the life of a zero, for instance, and how quickly would the market recover.
(Mr Thomas) As you say. That is hindsight, sir. Nobody thought those zeros were going to come undone like that.
(Mr Thomas) I have been working on some completely new way of explaining how to analyse zeros but I have not had time to finish it yet.
(Mr Crawford) Collins Stewart Asset Management, and Collins Stewart Limited are part of the group.
(Mr Crawford) Without seeming obstructive, that is not my area of expertise. I am afraid I can only talk about the institutional business at Collins Stewart.
(Mr Crawford) Indeed they are.
(Mr Crawford) Certainly I will get the relevant person to write.
(Mr Crawford) No.
(Mr Thomas) In fact, sir, the incentives for institutional investment into new trusts used to be one per cent. The IFAs used to want 3.5 per cent. We have actually been placing stock with no placing commission for quite some time.
(Mr Hall) Shall I answer that one, Mr Chairman. So far as I am concerned, there is no magic circle. We are not, of course, investment managers so we would not know what arrangements if they had made any, and this is a matter that is being investigated of course by the FSA.
(Mr Hall) I would go to the stake saying if there was one we did not know of it.
(Mr Hall) I would not be in a position to know. None of us here would.
(Mr Hall) No.
(Mr Crawford) If you are talking about a magic circle to refer to a small number of fund managers who ran funds of funds then clearly that was the case. There was a small number of fund managers, particularly in the early 1990s, and that group of fund managers who ran fund of funds vehicles did grow towards the latter part of that decade, indeed.
(Mr Crawford) Let's break that down a little bit. We, along with other brokers in the sector like UBS Warburgs, HSBC and ABN AMRO, would have a number of institutional clients who would come to us and ask us to sponsor vehicles, and it may be that we would have more than one institutional client who would come to us and ask us to sponsor a vehicle round about the same time so clearly we would say to them, "There has to be an order because this client came first and you came second", or, "We are aware in the market that there are other issues that might be going around so maybe we would be better to delay that a little bit", as we are doing at the moment where there are a number of property funds coming into the market and we have to decide whether we want to compete head on with them or do we want to try and go before them or after them.
(Mr Crawford) What I am saying is if people commonly believe the term "magic circle" to refer to a small number of fund of managers, and I believe that is what is commonly referred to as the magic circle, then yes.
(Mr Crawford) I am not saying that. That is a description being put out by the newspapers.
(Mr Crawford) There is a magic circle if that is what is referred to by the newspapers as a small number of fund managers who run funds of funds.
(Mr Crawford) It is all about descriptions. It true to say that the term "magic circle" also refers to the small number of leading legal firms in the United Kingdom.
(Mr Hall) My understanding of what is being suggested by a magic circle is not just the element of a fund of fund, which is what is published in the prospectus, it was going further than that. The suggestion appeared to me to be that the magic circle is one fund manager investing in another's to support them and "if you give me something back ...", and if that is what you are referring to go as a magic circle, so far as I am concerned I have got no evidence of it.
(Mrs Bowden) I do not know.
(Mrs Bowden) That is at the time of placing you are interested in?
(Mr Hall) We will write to you with those figures, sir.
(Mr Hall) Mr Chairman, I can answer that terribly straightforwardly. We certainly were not supporting issues at the time. They may have bought shares that we are brokers to in the after market or shares that we were not brokers to in an after market, and I am totally clear in my own mind that whether or not we were brokers to those companies had no effect on the decision.
(Mr Hall) We will.
(Mr Hall) Again Mrs Bowden will answer because she is heading this team that is investigating.
(Mrs Bowden) The trouble is I have not got an analysis which separates those holdings which were taken in placings compared to those which were purchased thereafter.
(Mr Hall) We can give you figures for what we know our clients have lost overall but we, frankly, do not think in terms of whether or not we were the sponsoring broker because we do not have any reason to, but I will give you those figures.
(Mr Hall) Yes we have.
(Mrs Bowden) It is a fairly small number we have paid compensation on, but from memory I do not think any of those were actually taken up in new issues. I think every one of the stocks was purchased in the market.
(Mr Hall) Thank you very much. May I just say, because I did not have a chance at the beginning, how extremely upset and sorry we are that clients lost money in this and we are extremely keen to help yourself and your Committee and the regulators and the industry to try and get to a quick conclusion on this matter because we do feel an awful lot of damage is still being done to the shares and we have a lot of investors in shares that are still quoted who are, frankly, dependent now on the winding up value because they are not able to trade in them.
(Mr Hall) You will get that from us.
Memorandum submitted by Association of Investment Trust Companies
Examination of Witnesses
MR ANTHONY TOWNSEND, Chairman and MR DANIEL GODFREY, Director General, Association of Investment Trust Companies, examined.
(Mr Godfrey) My name is Daniel Godfrey, Director General of the Association of Investment Trust Companies.
(Mr Godfrey) I think there were some aspects of what was said which could have led to some misconceptions today. Since we want to get to the end of this road as quickly as possible, I would like to try and make a few things clearer if I may. One of the first is that one of the areas where I think the Committee has really been virtually hitting the nail on the head but where perhaps some of the responses could have made you wonder if you were getting confused, is this distinction between what we might call traditional zeros, where the companies had no bank debt, and the way in which these companies, sometimes subtly, sometimes very obviously, changed over time. The fact is there were a number of different ways in which the structure became, as I would describe it, stretched. It is stretched because interest rates were falling, manufacturers were keen to deliver products to the market which had very high yields, obviously as interest rates fall it is easier to market and bring in new money which offers a very high differential between the rate you can get from a gilt or the rate you can get from a building society. The fact there were a number of different ways of stretching the product I think has confused the issue. The ways were, introduction of bank debt, introduction of more aggressive accounting policies, introduction of investment in very high yielding instruments, whether that be technology share bonds or telecoms bonds as we have heard today, or whether that be investment in other income shares. Some of these factors, sometimes all of them, sometimes some of them, are evident in all the trusts which have got into trouble. So whilst you can, it is true, have a trust which has no bank debt which has got into trouble, and you can have a trust which has no cross-investment in other income shares which has got into trouble, there are these factors. If you will forgive me for making an assumption, what you have been trying to get at is ----
(Mr Godfrey) --- the fact that the manufacturers, the sponsors of these products, are clearly telling us that they were not aware that these types of stretching made the zero dividend preference shares more likely to go belly-up. I think that does open a question as to whether they should have known, but the fact they are telling us they did not meant they were not in a position to warn their customers. That is what has led to the disastrous consequences.
(Mr Godfrey) Yes.
(Mr Godfrey) We have to separate the product from the zeros, because there are two elements to this. We began to spot changes in the product really quite early, probably in 1998/99, but that did not lead us, wrongly as it turned out, to consider the possibility that zero dividend preference shares would go belly-up. It did lead us to start having concerns that income shares were more likely than they had been before to pay out less than their initial subscription price, and we started writing to companies in about September 2000 asking them to provide details of all their holdings in other splits as we became more aware not just of the bank debt but also the extent of cross-holdings. I would say it was only really after September last year we began to become concerned that zero dividend preference shares might lose all their value.
(Mr Godfrey) We started writing to the boards of split capital investment trust companies trying to draw their attention to the sort of actions they could take which we felt would help to preserve capital for zero dividend preference shareholders, such as changing their accounting policy perhaps to more conservative practices, and also to look very carefully at the rescue rights issues which were taking place to ask themselves whether this could end up in destroying further value for the zero dividend preference shares.
(Mr Godfrey) By that stage we were in contact with regulators. I have to confess ---
(Mr Godfrey) With the Financial Services Authority.
(Mr Godfrey) I think it would be contemporaneous, that they began to take an interest in the sector when funds started breaching their banking covenants, and we started talking to them probably in the summer of 2001. I would have to confess that by that stage it was too late, and I regret the fact that we became aware of the problems developing for zeros at a point at which it was actually too late to save them.
(Mr Godfrey) When you say "took action", we have to remember we are not a regulator. I look back to ask myself what we could have done and I wish we had done something which would have stopped people losing a lot of money. Actually at that stage I had not worked out that bank debt was potentially dangerous because, as we have been told today, the cover was there and to somebody who is not a rocket scientist like myself I do not actually blame myself for not working out that the bank debt was as dangerous as it was. Perhaps the manufacturers should have realised this, perhaps not. That will be a matter for the FSA and perhaps the law courts and yourselves to pass judgment on. Had we had said publicly that this cross-investment could make these shares much less likely to return their initial subscription price, would it have made a difference? I am not convinced it would have done. We would have been two years too early, the market carried on going up, people would have been saying, "You said this and the market has gone up, you have really just stopped people making money by stopping them", so I do not think it would have made a great deal of difference. But I do, with the benefit of hindsight, wish there was something we had done which would have stopped it.
(Mr Godfrey) Such as being able to predict that the markets would not enable the funds to deliver on what they were promising to do for people in a way which would have been believable at the time. I think we would have been ignored, in other words.
(Mr Godfrey) There are a number of aspects that the regulator has control over, they have control now through the listing authority ----
Mr Ruffley: No, I do not want any retrospection. At the time this was going pear-shaped and just before it went pear-shaped, when people should have known but did not, what I want from you is a very simple account of what the regulator was doing, whether or not indeed they had the powers. We have just heard from witness after witness that the regulator did not have the powers, nothing could have been done. I want your version of what the regulator or regulators could and should have been doing at the material time, not after the event, when it should have been reasonably foreseeable.
Chairman: Stick to the material time, and we can come back to the issue of regulation later because we have not got time now.
(Mr Godfrey) As I say, I think by the time it became clear that the problems were intense, which was after September last year, there was very little the Regulator could do to prevent it and I think the Regulator before that point in the early part of 2001 issued guidance to advisers to ensure that they understood the risks. They issued new guidance on the way in which the risks should be described and I believe - I cannot remember verbatim - they said if you were selling income shares (none of this applied to zeros, it applied to income shares and splits) that you had to bring the small print warning which says you may not get back the amount invested from the small print into the main body copy either of the advertisement or the sales letter. That applied both to investment managers and to advisers.
(Mr Godfrey) It did not apply to zeros. As I said, given that the manufacturers of these products clearly had not understood the impact of what they were doing to the structure, it is not surprising that neither the trade association nor the Regulator worked that out for themselves given that the so-called rocket scientists did not.
(Mr Godfrey) We did not ask them to; we asked them to consider whether the accounting practices they started off with were still appropriate, and the sort of things we were talking about in general were the amount of the expenses that were being charged against capital. This is quite an esoteric accounting point but I think you understand my angle.
(Mr Godfrey) That is the key thing.
(Mr Godfrey) We felt that some of the interpretation of recommended practice was rather aggressive.
(Mr Godfrey) Some of them did.
(Mr Godfrey) Some of them did change their accounting practice.
(Mr Godfrey) Some did not, yes.
(Mr Godfrey) The accounting policy of the board would not be a matter for the Regulator.
(Mr Godfrey) No, generally UK listed investment trusts will follow the statements of recommended practice.
(Mr Godfrey) We are not a regulator and a statement of recommended practice is, as you say, just that, but auditors, to my knowledge, do not like to sign off accounts which do not comply with the SORP and we are going through the final stages of issuing a new SORP, but the point on here is that under our statement of recommended practice, it says either you charge all your expenses to income or you split them by giving thought to the way in which you expect the total returns to be delivered. So if you expect half your total returns to come from income and half from capital you can split 50/50.
(Mr Godfrey) We felt that some of the assumptions being made were overly aggressive. Of course, the perceived benefit from the fund's perspective of doing this is that they think the zeros are covered, so it is not hurting the zeros and by charging expenses to capital you are enabling a higher level of income to be paid out. That is all very well when the zero is covered because although you may be robbing Peter to pay Paul, at that moment in time Peter and Paul are one person.
(Mr Godfrey) This is why we wrote the letter.
(Mr Godfrey) I doubt that most professional investment advisers would have had the competence or experience or level of knowledge to have dug into this and found that which the product manufacturers themselves did not find.
(Mr Godfrey) Clearly Alistair Munday was somewhat ahead of the curve. All credit to him and his performance, which you quoted earlier, bears that out. By that point in 2001 we had already initiated the process to get all fund managers to disclose (which we would then do through our monthly figures) the extent to which they were investing in other split capital investment trusts. That was in September 2000. You do not suddenly go from a point of being absolutely relaxed to absolutely terrified; there is a process, and we moved from a state of some nervousness to sheer terror. That happened over a period of years. By the point that you mention, February 2001, we had already started undertaking initiatives which reflected a sense of unease. Had I been managing money perhaps I would have arrived at the same conclusion, that it just was not worth taking the risk, but we certainly at that stage had not come to the view that there was a likelihood that the zeros which had been sold as low risk would not perform. Although we hear a lot of "well, low risk means lower risk than the other shares in the portfolio", I can tell you that is not what the consumers understand by that.
(Mr Godfrey) You asked about financial advisers. To expect advisers to have spotted it, I would not have expected them to, given what I know.
(Mr Godfrey) For the vast majority, yes.
(Mr Godfrey) Well, I wish he had.
(Mr Godfrey) It is a very difficult question which is why I pause and the reason is that I do not have his knowledge. I did not design them and it is very, very difficult for me to put myself in that position and look back and say should I have known because I wish I had known and I am sure he wishes he had, but we have heard he and others today saying that they did not and I can only echo that; they say they did not know.
(Mr Godfrey) That is the point. The point is not whether they should have known or not. The point is ---
(Mr Godfrey) We have two areas of activity which we think will prevent this happening again and indeed strengthen the industry going forward, because we very much appreciate the Committee's approach to this in wanting to help the industry and restore its good name. On the one side there is transparency and disclosure, and we have written to the boards of all split capital trusts - and you have a copy of that letter - setting out our proposals on this. They are, to disclose very clearly the full list of investments in other split capital trusts, the full details of their borrowings and the banking covenants attached to that, and also to provide investors with a tool that they can use to plug in potential returns from different aspects of the portfolio and see what would happen in those circumstances. So investors and their advisers would be able to, if they want to buy shares, go into them with an intelligent understanding of what the risk/reward trade-offs are and how sensitive that share might be to a relatively small movement in the value of the underlying portfolio, effectively the effect of the gearing and the underlying portfolio. If they see that, they can either say, "I like the idea of that reward but the risk is not for me" or "I do not like the idea of it, I am not buying that one". So I think it would give them the information they require between themselves and their advisers to understand whether something is appropriate for them. The other element is corporate governance which perhaps we will come on to later.
(Mr Godfrey) There has certainly been a period of time during which advisers did not have sufficient information to make intelligent decisions.
(Mr Godfrey) I cannot give a blanket whitewash to the advisers but in general terms I think it would be somewhat unfair.
(Mr Godfrey) Firstly, this was put out, he said I think, to his institutional clients rather than advisers; institutional shareholders, big pension funds or big fund managers. Be that as it may, they believed what they put out but if they get it wrong they have to take the consequences of that potentially. If it is shown they did not take reasonable care or they did not understand what they were doing, there may be consequences for getting that wrong.
(Mr Godfrey) I say it has been a disappointment to me it has taken as long as it has. It has taken a long time because it has taken us longer to get the data ---
(Mr Godfrey) I think some of them have found it difficult to get the information and there may have been some foot-dragging.
(Mr Godfrey) We are regulated. Where we are not regulated is in the same way as other collective investment schemes. We are regulated by the FSA with regard to the issuing of prospectuses and the continuing obligations of directors under the listing rules. The way in which the fund managers manage investment trusts is regulated by the Financial Services Authority; the ISA schemes and the savings schemes operated by the fund managers and the marketing of those products is regulated by the Financial Services Authority, and so is any advice given to customers by financial advisers.
(Mr Godfrey) What I would say is that investment trusts are clearly not regulated as financial products in the way others are.
(Mr Godfrey) I have never should we should not.
(Mr Godfrey) That does not mean ----
(Mr Godfrey) I do not think that constitutes saying we should not be regulated. We would be very happy to participate in any review of the regulation of investment trusts and we certainly would not close our minds ----
(Mr Godfrey) Actually it would make no difference if that were regulated because there is a statement of recommended practice for unit trusts and OICs as well, and that is just a statement of recommended practice too. So on that point there would be no difference anyway. What I am saying about regulation is that we would happily participate in any review on regulation. We would not close our minds to investment trusts becoming regulated products in the same way as open ended funds, but in the meantime, because this will take quite a long time, we are not going to sit on our hands and we are going to move forward with initiatives on corporate governance and initiatives on disclosure because we believe that with the right pressure, I would accept not just from the market but perhaps from this Committee and perhaps from the SFA as well, we can achieve change that will make a big difference.
(Mr Godfrey) I think that very many investors have benefited very greatly from investments in investment trusts over a very long period of time.
(Mr Godfrey) One would be too many to have lost in the way they have, and clearly a number have lost. I do not believe that the structure of investment trusts or the integrity of the concept as a whole has been destroyed. Clearly the perception has been badly damaged and we need to make real change. We cannot just do it through spin or PR; we need to make real changes to restore confidence in the sector and it is important.
(Mr Godfrey) Absolutely, yes.
(Mr Godfrey) I said I saw differences and if you want to know what the particular difference was it was that we began to become aware of managers of splits buying shares in new split launches and that gave me some concerns.
(Mr Godfrey) No, I do not think so. We did not see ourselves as neutral observers of the scene. We went over this to some extent last time I was here and what we did was we tried to investigate as to whether we could find evidence of any ringing, if you like, of the market at that stage, and we could not find any evidence of it. We also, as I said last time, observed that the flotations were taking place by way of placing rather than public issue and so we took the view that the shares were going out to professionals rather than to retail investors. Remember, the new launches are not actually members of ICC and very many of these did not become our members even after their launch, so the information that we had available to us was by no means complete and, as I said, we did gradually move from a state of relaxation about the industry before that period to a concern by the third quarter of 2000.
(Mr Godfrey) I think there is a distinction.
(Mr Godfrey) I am not going to sit here and say I have not made any mistakes over the last four years. I think you are ignoring in that the use of the word "most" and most splits, as you have heard today, are not in the dire straits that some are, although too large a number, and the fact is that I did use the word "most" and that does imply some differentiation.
(Mr Godfrey) Zero dividend preference shares "might" prove to be the best choice, and many of them would have been and many of them still will return their pre-determined entitlement because, as I have said, they have no back debt, no cross holdings, no exposures to technology and no exposures to high-yielding bonds.
(Mr Godfrey) I said a moment ago that I am not going to stand here and say we made no mistakes. I wish by then we had changed our wording about zeros, but I have said to you that it was not until after September 2001 that we began to begin to think that zeros would go belly up.
(Mr Godfrey) That is why I say I think we also made mistakes in this.
(Mr Godfrey) I cannot think of one off the top of my head. Prospectuses normally do not leave many hostages to fortune, they are written by lawyers.
(Mr Godfrey) Do you mean a rescue issue or a flotation of a new company?
(Mr Godfrey) I think we were concerned about some of the rescue issues, but there were none that could not possibly strengthen the balance sheet. In our letter we said that the strengthening could be fairly temporary if markets did not improve.
(Mr Godfrey) Gone and tried to get more money.
(Mr Godfrey) Yes.
(Mr Godfrey) Could you read the whole sentence?
(Mr Godfrey) What do I say next? Sorry. At the moment I cannot remember why I said that. I need a little more context.
(Mr Godfrey) I think the reason I said they were conducted behind closed doors is because these corporate actions are price sensitive, and therefore you are never told about them whilst they are being put together. We knew in general that these types of fund raisings were being put together and this letter was by way of trying to give a steer to boards and to give them information which we hoped would enable them to make sure there was not further diminution of value for the zero dividend preference shareholders by way of rescue issues which just kept the whole thing spinning for longer whilst their value ebbed away. That is what that was about.
(Mr Godfrey) We do not need to remind a board they have a fiduciary responsibility towards their shareholders. What we were trying to do was to discuss the application of what was fairly uncharted territory at the time, and we could see developments in the market which we were concerned might not have over the longer term the intended effect. We were therefore I think doing our duty to the shareholders of our member companies by writing to boards and suggesting a number of things, whether it be a new look at the accounting policy, or suggesting that having a rescue rights issue where no real cash came in but what came in was a group of stock swaps of other splits in exchange for your new rescue rights issue might not prove to be the best thing. Had markets turned up, we would have been wrong, but as it happened we have turned out to be entirely correct.
(Mr Godfrey) Yes.
(Mr Godfrey) I think this has become a bit of a red herring because the Guernsey regulator did not have any contact with the AITC at any stage. It appears he did have an exchange of correspondence with a gentleman called Hugh Aldous. Hugh Aldous is someone who is known to us, he is a director of an investment trust, he is a member of our representative committee, he is not an officer of the Association, and that correspondence was never reported in any way, shape or form to me or any other member of my staff. Why I say it is a red herring is because the Guernsey regulator was not the only person who had concerns about cross holdings, so whilst I do not think that that story hangs us or anybody else, neither do I think it gets us off the hook.
(Mr Godfrey) No, I am not, because, as I say, the Guernsey regulator is not the only person who ever had concerns about the cross holdings. As I said, I myself was concerned about the fact that managers were investing in new launches of other splits before that.
(Mr Godfrey) We are going to improve transparency and we are going to undertake some very big initiatives on corporate governance.
(Mr Godfrey) It certainly turned out to be wrong.
(Mr Godfrey) If you believed it, you were misled. So please can I stand on that. I am glad you asked this because there is a very, very important point.
(Mr Godfrey) There are a couple of very important things here. Firstly, we have been told by Aberdeen that they are going to offer an uplift package on their unit trust because they advertised it and marketed it direct to the retail investor. They said that it is not the same for the invidia shares of the zeros because they are not funds, they are equities. Well, excuse me, but I believe when somebody buys a share in an investment trust they believe they are buying a collective investment. If you say what is an investment trust, there are three things: it pools your money, you get professional management; it is low cost and it can gear. One of the key features of an investment trust is it pools your money with other people's so it is viewed as a collective investment. It may be convenient to say it is only an equity just like Marconi and you do not get compensation if shares in Marconi go down, but it is bought by the consumer as a collective investment and it was made available as that. Also they said that that advert does not count because it was not advertiseing the share, it was advertising the savings schemes. I think that is the point you were trying to make.
(Mr Godfrey) The savings scheme was made available and marketed to retail investors and ISAs were made available and marketed to the retail market. I fail to see what the difference is between a consumer -
(Mr Godfrey) The key point is what difference is there between somebody who goes to Aberdeen direct and buys a unit in their unit trust and somebody who goes to Aberdeen direct and buys a share in a zero through their ISA product? None that I can see.
(Mr Godfrey) Not formally.
Chairman: We will leave that one with you. It is a good point.
Mr Cousins: It is a pretty formal way of communicating with Aberdeen.
(Mr Godfrey) We are looking for support from this Committee and the FSA to ensure we do not get hold-ups.
(Mr Townsend) Mr Chairman, I rather anticipated that would be your response and in anticipation I said exactly that at an investment trust conference yesterday.
(Mr Townsend) We will have to wait and see on that.
(Mr Godfrey) We have already sent out a research paper on corporate governance to boards telling them what the market thinks about them and the practices which are currently there and what they would like to see. We expect boards to respond to us on that by the end of the year and we expect to promulgate in the first quarter of next year a corporate governance code for investment trust companies. But we are not going to stop there. We have to once and for all take action sufficient to put beyond question the integrity, the ability and the independence of boards and their competence to act at all times in the interests of shareholders. We intend to do that.
(Mr Godfrey) Yes. It is pretty hard for me, I am spending a lot of money doing work in the split sector ---
(Mr Godfrey) There are Competition Act considerations here. We would like to have every investment trust as a member.
(Mr Godfrey) We have heard this too. I think that has died a bit of a death at the moment but we would like to increase our membership rather than see it fall.
(Mr Godfrey) Yes, some do.
Chairman: Very clear.
(Mr Godfrey) I think there will be a number of people who will be liable to pay some compensation. I think in the main it will be advisers, perhaps managers and perhaps sponsoring brokers.
(Mr Godfrey) Thank you for picking me up on that. I also said I would not give the advisers a complete whitewash. I think where advisers have gone beyond the very optimistic statements even which were made to them by the managers, they may be liable too. For instance, I have heard of instances where some of the letters which have gone from advisers to clients clearly went beyond the promises or the statements made.
(Mr Godfrey) I think there is still a long way to go to assess who has been either sufficiently misled or whether impact of wrong-doing has ---
(Mr Godfrey) Yes, we have. We have continued to receive information which we have passed to the Financial Services Authority. I would say there are probably two key areas of new, dubious conduct that we have heard about since we were last here. One has been a practice whereby we have been told that a manager was selling shares in a split that had gone ex-dividend, from one split they owned, and immediately buying them back for another split they owned with something which is called a special cum dividend being applied by the market maker, thereby enabling them to effectively get two dividends for two different funds from the same share. Therefore if the fund involved had a zero dividend preference share which was under water at the time, it would have involved effectively taking money from the zero dividend preference shareholders and giving it to the income shareholders as income. So we have reported that to the Financial Services Authority. The second thing we have heard which has caused us some concern has been an allegation that you heard today - I cannot remember who from, I think it was either Mr Thomas or from Aberdeen - that when they modelled these trusts, they had a model which the accountants looked at and the accountants signed off independently but that model comes by way of a dummy portfolio and says, "These are the sort of shares we will invest in and this is how it will work". We have also been told there were instances towards the end of the launch glut where trusts were beginning to run into trouble and there was not so much cash available from the other funds to invest in new funds but when they went out to do the marketing, they were told, "We cannot give you cash but we can give you these shares in other splits as a swap for your new issue", and the broker would go back to the fund manager and say, "Do you want these shares?" and the fund manager would say, "Yes", and as a result of that the starting portfolio may have looked quite different to the model on which the sponsoring broker, the accountant and even the board had signed off and may have been of lower quality than had initially been ---
Chairman: These are very serious issues.
(Mr Godfrey) No, no indication whatsoever.
(Mr Godfrey) We should be driving through our initiatives on transparency, we should be working with the regulators to make sure they get a result and get to where they are trying to get to, and we should be making sure that we bring in changes on corporate governance that will forever ensure that trusts are able to meet their potential, which is great.
Chairman: You have been very clear and direct with us, in marked contrast I should say, to Aberdeen. However, we look forward to working with yourselves in the future to ensure that this industry does recover. Thank you very much.