Examination of Witnesses (Questions 140
THURSDAY 11 JULY 2002
140. Your evidence has been very interesting,
Mr Godfrey, because it contrasts with that which we heard this
morning from the Aberdeen managers who were saying it was reasonable
to market these products as low risk, and then unfortunately a
big fall in the stock market came along and that is where the
problems arose, but you are saying that the portfolio characteristics
deteriorated over the last few years to make them higher risks.
When do you think it was no longer reasonable to market these
products as low risk?
(Mr Godfrey) Again, we are getting into slightly technical
141. Not that technical.
(Mr Godfrey) Well, the income shares and the capital
shares were always marketed as being higher risk. Now, I believe
that even in the income shares and capital shares the quality
was to a certain extent deteriorating and the risks were increasing.
142. What about the zeros?
(Mr Godfrey) Well, this is where we are not the rocket
scientists. It is clear now to me that the introduction of bank
debt has caused the destabilisation of the zeros in that, when
they become uncovered, what previously was a degeared asset exhibiting
low risk qualities suddenly became geared and started falling
off the cliff pretty rapidly.
143. When do you think that changeover came
and these instruments should no longer have been marketed as being
(Mr Godfrey) The changeover came when bank debt started
being introduced in a big way, which is probably 1999/2000. It
became clear to us the impact this was having, as people who were
not the designers of the product, really only as things deteriorated
very severely towards the back end of this year.
144. So after 1999/2000 it would have been wrong
for people like Aberdeen to be marketing zeros as being of low
(Mr Godfrey) I am not sure I would go that far. What
I would say is that probably they should have been marketed with
a clear explanation if they understood at the time that the existence
of the bank debt gave new characteristics to the zeros that investors
should be aware of.
145. And they were not?
(Mr Godfrey) They were not.
146. Could I say that I think your evidence
has been refreshing because you use some stark language in relation
to the split capital sector. You say its good name has been blackened;
you say the stain has started to spread, and we welcome that.
That is not true of the whole sector but it is true of certain
players in that sector. You talked about a magic circle; you said
there was no evidence. Are you still looking for evidence of a
(Mr Godfrey) We are not the regulator
147. I did not ask you that; I know you are
not the regulator. Are you looking, as a trade body, keeping your
eyes open, for evidence of any description of a magic circle?
(Mr Godfrey) Well, I will tell you what we are doing
because it may not fit exactly into that
148. Why not just answer the question I have
(Mr Godfrey) Well, we are not going looking but we
are keeping our eyes and ears open.
149. How are you doing that? What are you finding?
(Mr Godfrey) I think you can put what we find into
a number of different categories. Firstly, you have rumour and
speculation, which comes to you as hearsay evidence: secondly,
you have circumstantial evidence that we can see for ourselves
by looking at facts and figures as to what has happened in the
past; and, thirdly, we have what I would describe as being soft
evidence in that it comes to us from people who claim to have
been in meetings and heard what was said but which has not been
given to us in the form of written deposition or corroborated
by a second person at that meeting. Now, all of these we have
passed on to the Financial Services Authority, who clearly are
the appropriate agency to deal with that information.
150. That is helpful: I just wanted to get to
the body of it. Your organisation obviously hears a lot and you
have been passing over allegations, because that is all they can
be presumably at this stage, to the Financial Services Authority.
Is that the position?
(Mr Godfrey) Yes.
151. Have you been picking up evidence of this
activity to date? Are the pieces of evidence relating to a time
period in the last twelve months or the last five years? Tell
me over what period these allegations are being picked up in relation
to the magic circle.
(Mr Godfrey) I would say three and a half years.
152. Could I ask whether you would care to tell
us which funds and organisations have been the subject of these
(Mr Godfrey) I think it would be inappropriate for
me to do that in the context of the Financial Services Authority
having an investigation about to start or already being in the
midst of an investigation into the facts that we passed to them.
I think it would probably be prejudicial to people who may be
innocent in this, so if the Committee would allow me I would rather
not answer that.
153. I absolutely accept that but can I confirm
this: you are very concerned by the sound of your language, and
I think you are right to beyou use the words "blackened"
and "stained". What sort of sanctions will be available
from your point of view, not the Financial Services Authority's,
if any charges against various fund managers and their employers
(Mr Godfrey) The Association of Investment Trust Companies
is a trade association and we represent companies that are eligible
by our rules to be members, and those rules are that the companies
should be eligible for listing as closed-end investment companies
and so forth. Under the Competition Act you can be deemed to be
acting anti-competitively if you try to keep people out so we
do not have a formal structure of sanction against members.
154. In the case of the losses of some individuals
who have written to this Committee, some of them are being wiped
out through alleged mis-selling. Who do you think is to blame?
Is there a structural problem in the way that some of these products
were devised or do you think individuals are to blame? In a sense
who do you think is to blame for this?
(Mr Godfrey) Firstly, on behalf of the industry as
a whole I want to apologise to shareholders who have lost so very
much money. It is something that the industry collectively deeply
regrets. I would have to say again that, clearly, it is individuals
who do things and they do not just happen by a process of osmosis,
but we have passed all the information that we have to the Financial
Services Authority. There has been a combination of development
and circumstances which has brought us to this position, which
is a combination of development in the product in terms of introduction
of bank debt, in terms of investing in technology companies or
high yielding bonds or in shares of other splits, combined with
what was to them the unexpected behaviour of stock markets globally
that has made this happen, as I am sure anyone will tell you.
If markets have gone up about 20 per cent in each of the last
two years we would be congratulating them all on having won the
155. Lastly, what are you doing about the cross-holding
problem which, despite the previous witnesses, is clearly a problem:
it is not the sole reason for some of the disasters that have
occurred but it is a large component in this fiasco. What are
you going to do about it and what can you do?
(Mr Godfrey) Some things are self-regulating and others
need a push. What we are doing proactively is trying to improve
transparency and understanding so that people who perhaps have
a very significant appetite for risk know what they are getting
into and may still want to buy shares, and people can take a more
informed judgment about what they are getting when they buy a
share. So we have encouraged both members and non memberswe
think it is so important for the industry as a whole that we have
made this facility open to members as well as non membersto
supply details of their holdings in other splits that we will
then put up on our website so that people can take an educated
view about not just the extent of the holdings in other splits
but the quality of those holdings as well. Secondly, we have a
very significant and costly data project going on at the moment
where we have asked every split trust to supply us with their
entire portfolio, albeit in confidence, so we can run some very
detailed analytical work to understand just exactly what non split
assets are underpinning the value of the whole sector, and we
think that will provide boards with information that they currently
cannot get. One of the difficulties about holding splits that
hold splits that hold splits is that, once you go beyond a second
layer, it becomes impossible for the director or the manager at
the top to know exactly what their effective holdings are, what
their effective level of gearing is, and what their effective
expense ratios are.
156. Will you publish the conclusions of that?
(Mr Godfrey) Yes. We will publish the broad conclusions
but not details about individual trusts.
157. A lot of the discussion this morning has
focused on the issue of deliberate collusion. Now, if I am the
leader of a local council and every year a property developer
gives me £5,000 and from time to time decisions are made
which are favourable to that property director, it is not necessary
to show that we have sat down and agreed the link. If I have not
declared the interest and I have taken part in the decision, I
will be assumed to have colluded effectively. Do you not think
that the fact, as you say in your very helpful report, that we
have a situation where as much as 70 per cent of the income shares
issued last year were bought by split funds and other funds whose
managers also manage splits comes down to a de facto collusion?
That it became industry practice to support each other, even if
they were not all in a room agreeing to it?
(Mr Godfrey) I think that in itself is not beyond
reasonable doubt evidence. When combined with other circumstantial
evidence and the soft evidence that I referred to earlier, I do
not believe that the whole sector of split capital managers and
every player in it were all colluding with each other but I think
there is no doubt that there have been some instances of bad practice
by some individuals.
158. Would you agree that it is fundamentally
unhealthy for management charges to be levied in this situation
not on the real value of the assets but on the paper value, including
(Mr Godfrey) No, not wholly. It is always a question
of the quantum, is it not? If it looks as though there is a lower
charge because you are saying it is only, say, 1 per cent on the
gross assets but the shareholders only amount to 50 per cent of
that and the income shareholders only 33 per cent of the total,
then the effective cost against the income shareholders is no
longer 1 per cent but 3 per cent, and I think that needs to be
159. You say in your report at paragraph 4.8,
". . . the true value of the assets underpinning the share
price [in this situation] can be impossible to calculate. If fund
A buys shares in fund B that are at a premium, it is fund B's
share price, not its net asset value that becomes a component
of fund A's net asset value. As the group expands, one gets premiums
on premiums on premiums and an increasing premium at the top level
that may prove unsustainable". Should the Association therefore
not be issuing binding guidelines on its members to make sure
this does not happen?
(Mr Godfrey) We are not investment managers or investment
experts, so I do not think we are the best people necessarily
to make that sort of judgment. What we have tried to do is increase
transparency so that people who know more about it than us can
analyse it and take a view and communicate that view.