Examination of Witnesses (Questions 765-779)|
TUESDAY 29 OCTOBER 2002
765. Welcome to the Committee and apologies
for keeping you behind but as you can see we are asking some interesting
questions and we have a long road to travel in getting the answers.
Could I ask you to identify yourselves for the shorthand writers
(Mr Godfrey) My name is Daniel Godfrey,
Director General of the Association of Investment Trust Companies.
766. A common question to you. Is there anything
in Aberdeen's evidence with which you fundamentally disagree?
(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
767. Keep it simple.
(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.
768. There was so much obfuscation this morning
on that particular aspect but we are determined to get to the
bottom of this. You have helped us an awful lot on that aspect.
Really what you are saying, and you have put it in simple language
for the consumers who are confused by the whole situation, is
that gearing and other changes changed the product so markedly
that we have ended up in dire situations in some cases?
(Mr Godfrey) Yes.
769. That is indeed very helpful to us but what
about you as an association? When did you spot this change in
the nature of the product?
(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.
770. When that concern struck you, what did
(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.
771. As those concerns grew in your mind and
you started to take that action, did you contact any regulator
to express to them your concerns?
(Mr Godfrey) By that stage we were in
contact with regulators. I have to confess
772. Which regulator?
(Mr Godfrey) With the Financial Services
773. When did you first notify them of your
(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.
774. So you are accepting you were too slow
off the mark? You were aware of the structural problems here but
you now, in retrospect, looking back think you took too long to
take action on it? Is that what you are saying?
(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.
775. Such as?
(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.
776. Mr Godfrey, you have been commendably clear
in your analysis. Tell me this: where on earth was the regulator
when all this was going on? I ask you as a trade association,
where was the regulator? What were they doing?
(Mr Godfrey) There are a number of aspects
that the regulator has control over, they have control now through
the listing authority
777. 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
Chairman: Stick to the material time,
and we can come back to the issue of regulation later because
we have not got time now.
778. When it should have been foreseen. Tell
me where the regulator fits in on that.
(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 believeI
cannot remember verbatimthey 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.
779. What about zeros?
(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.