Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 200-219)


24 OCTOBER 2006

  Q200  Jim Cousins: Do forgive me, you have just said something entirely different. You have just said that it would change the way you take enforcement action, and that the actions, both in the Legal & General case and the Plumber case, would not have been taken if these new risk assessment procedures had been in force.

  Sir Callum McCarthy: No. With respect, I said—and for the avoidance of doubt, let it be clear—that we would not have proceeded in exactly the way that we did proceed in either of those cases. I am not sure whether we would have taken either of those cases forward, but, irrespective of that—

  Q201  Jim Cousins: You have now told the Committee three different things. You have said that the review of enforcement procedures would not have led to those two cases being brought; that they would have led to those two cases being brought; and that they might not have led to those two cases being brought.

  Sir Callum McCarthy: May I be clear: we have made a series of changes—

  Q202  Jim Cousins: Which of those is it?

  Sir Callum McCarthy: I am about to explain, if I may have an opportunity. We have made a series of changes already to the enforcement procedures. Second, because we now have a definition from the tribunal of what they regard as reasonableness on behalf of the FSA, we will of course take account of that in the way that we adopt our procedures going forward. Overall, I do not expect us to have either an increase or a decrease in the number of enforcement activities or the emphasis that we place upon enforcement, as a result of either of those changes.

  Q203  Jim Cousins: Do any of these enforcement actions involve board approval?

  Sir Callum McCarthy: Very rarely, I think is the answer.

  Q204  Jim Cousins: We have talked about the culture in the insurance industry earlier in our discussion. Is not the enforcement culture of the FSA going to be changed by the outcome of these two cases?

  Sir Callum McCarthy: I am not sure what you mean by enforcement culture.

  Q205  Jim Cousins: The issues to which you have just been drawing the attention of the Committee.

  Sir Callum McCarthy: One of the things that we have made clear is that we will not adopt a policy of only pursuing enforcement cases of which we have 100% probability of succeeding, and that will not change.

  Q206  Jim Cousins: What probability of success are you going to use?

  Sir Callum McCarthy: It is a balance, on any case, and it is not based on a simple arithmetic: "We will do it if it is 98 but not if it is 96." I am sorry, but it is more judgmental set of issues.

  Q207  Jim Cousins: It is quite normal for enforcement authorities to have an internal assessment of the likelihood of success before bringing a case. That is perfectly normal; no one is going to be surprised by that. You have told the Committee that it is not going to be 100% success. That leaves us, if you will forgive me for saying so, really nowhere. What are the internal guidelines you are using to test whether an enforcement action will be brought?

  Sir Callum McCarthy: I would say that, broadly, they are the requirements that we have under the law in relation to criminal cases: a balance of probability—which is the same in those criminal cases. In other cases, it involves a series of judgments. But the only point I am making is that I believe it would be wrong for the FSA to confine its enforcement actions to those where we are completely sure that we will succeed, because, if we were to do that, I think it would be necessarily and improperly lax.

  Q208  Jim Cousins: In your annual report you somewhere say that there were 166 suspicious trading reports that you received. In how many of those was there enforcement action?

  Sir Callum McCarthy: I am sorry...

  Mr Tiner: I do not know.

  Q209  Jim Cousins: You have told the Committee that there was one successful action for insider dealing. The Committee heard earlier that one of your own directors said that 28.9% takeover announcements resulted in a potentially significant sign that there was use of insider information. You have told us of one successful prosecution. What is the baseline? What is 28.9% of the takeover announcement? What is that figure?

  Sir Callum McCarthy: The 28.9% are the instances where there is a public announcement in advance of which there is a significant share-price movement.

  Q210  Jim Cousins: How many cases are we talking about? How many cases are represented by that 28.9%?

  Sir Callum McCarthy: I am sorry, I cannot remember what the number is. I will give you a note telling you that.[6]

  Q211 Jim Cousins: But the successful prosecutions out of that number were one.

  Sir Callum McCarthy: No.

  Q212  Jim Cousins: Successful actions.

  Sir Callum McCarthy: No, there was more than one instance, but, as I said earlier in evidence, one of the continuing problems that exists in this country and other countries is bringing successful prosecutions against the standard of evidence that we have to bring for insider dealing. That is a real problem which we are determined to attack.

  Q213  Jim Cousins: Have you made representations about that to the Government?

  Sir Callum McCarthy: No, is the answer.

  Q214  Chairman: I will tell you what, Sir Callum, because we have to move on, why do you not write us a nice letter to explain all that stuff to us so that we can try to pursue it here.

  Sir Callum McCarthy: I would be delighted to do so.

  Q215  Jim Cousins: Let us be clear about it: there is a problem here and you have not drawn it to the attention of the Government.

  Sir Callum McCarthy: No, I would not say that.

  Q216  Jim Cousins: You just have.

  Sir Callum McCarthy: It is a problem that we had discussed with government—

  Chairman: We are happy that you are going to write to us, Sir Callum.

  Q217  Mr Newmark: My question is for John and it is to do with these split capital trust schemes, which, with certain people, is unfortunately still a running sore, so perhaps I can be very specific in my question. I appreciate this was covered last year but unfortunately I was not on the Committee. I have seen the answers and I also appreciate a letter I received from your head of department of litigation and legal review, which was a very thorough letter on this issue. A particular phrase that was written in the letter, which was how the settlement was reached, was, "As we said in our statement of 24 December 2004, our decision to settle on the basis we did was driven by a view that this settlement was in the best interests of investors." It does not say some investors; it says investors—which I am assuming was supposed to cover all investors. It goes on: "Our main aims were to seek to achieve a settlement which would obtain a reasonable amount of compensation for retail investors"—and, again, it does not say some retail investors; it says retail—so I am assuming there was some process of trying to be equitable to all people who were involved in these schemes. I have had a considerable amount of correspondence from a Mr Roland Fernsby and others who were ordinary income shareholders. From the information I have read, it seems that, while the zeros were compensated, unfortunately the ordinary income shareholders were not at all, so it looks like there was a complete bias to one group of shareholders. I would like to ask John as to why this decision was equitable and fair, and if he would explain to me in very simple language why the ordinary income shareholders really received nothing.

  Mr Tiner: There was a limited pool of money as a result of the settlement on Christmas Eve 2004. We felt that the class of investors who were most deserving of that money were the people who went into it expecting that they had the lowest degree of risk. The nature of split capital investment trusts was that the zeros were the lowest risk category; the income shareholders were next; and then there were the capital investors, who were really taking a bit of a punt. There are a couple of points that differentiated the income shareholders and the zeros. Up to that point—in fact, up to any point but maturity—the zeros got nothing. They were getting no income at all—all of their pay-back of capital and any subsequent income was in the capital repaid on maturity—whereas the income shareholders had received dividends during the course, and in some cases quite reasonable dividends—so they had already received something which the zeros had not. That, combined with the fact that the zeros had been led to believe (in a way which I think income shareholders had not) that they were kind of putting their money into a deposit account—there were some adverts that compared them to building society deposits—whereas income shareholders went in more on the basis that they were buying sort of ordinary shares in a company, led us to believe that this limited pot of money should be divided among the zeros alone. There was also, of course, a backstop then for the income shareholders—and, indeed, for the zero shareholders that did not want to take the settlement—which was the Ombudsman. If they felt that they had been misled into the sale, there was always the compensation system of the Ombudsman waiting to help them if that was necessary. That was the rationale.

  Q218  Mr Newmark: And that is sort of what I have read. This is what surprised me with the way the pot was divvied up: there were clearly a lot of people who were in the zeros but a much smaller group in the ordinaries and income in terms of amount that was at risk. Those sort of people, it is my understanding—and please correct me if I am wrong on this—were people who did not want to sort of wadge away zeros hoping that they would get the capital at the end of the bag; they were more the widows and orphans, if you will, or the pensioners, who wanted to get the income from the income shares. In many ways they were perhaps some of the more vulnerable investors, who relied on that income, and the reason why they feel aggrieved is because when they were sold to go into the income shares, as opposed to the zeros, it was because probably a lot of them were older and were sold on the idea that they were going to get some sort of steady stream of income. I think that is why a lot of that sort of investor feels hurt and aggrieved. Is that a fair analysis?

  Mr Tiner: I am quite sure there are a number of ordinary shareholders who are in that category, but, if they were advised to take those and they feel as though they were inappropriately advised, by taking the case to the Ombudsman and succeeding with the Ombudsman they would get a much higher payout than if they received a part of the settlement, which would then have to be divided by a larger population, and they would get—because this is the Ombudsman's normal way—interest on the capital settlement as well. That has always been available to them. We just felt that in terms of the actual settlement, given that for all the investors this was a full and final settlement—you could not take the money and then go to the Ombudsman—we were better keeping it to the zeros, to let those people who were genuinely badly treated in the income shareholder category to take their case to the Ombudsman.

  Q219  Mr Newmark: You do not think, given the relatively small size of the income category and who they were, that, in having a settlement, there should have been any consideration for those income people? I still do not understand why, in a settlement, you only settle with one group of investors. This is a question I have been asked to push you a bit with. Why, in trying to come to a settlement in a case which involves a series of classes of investments, did only one group get anything out of it?

  Mr Tiner: From the settlement?

6   Ev 76 Back

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