Members present:

Mr John McFall, in the Chair
Mr Nigel Beard
Mr Jim Cousins
Mr David Laws
Mr George Mudie
Dr Nick Palmer
Mr James Plaskitt
Mr David Ruffley
Mr Andrew Tyrie


Memorandum submitted by Mr Stephen Alexander, Class Law Solicitors

Examination of Witness

MR STEPHEN ALEXANDER, Class Law Solicitors, examined.


  1. Good morning, Mr Alexander, and welcome to the Committee. You look like a lonely figure, sitting there, in the background. For the sake of the shorthand-writer, could you introduce yourself, please?
  2. (Mr Alexander) Yes, indeed. My name is Stephen Alexander. I am a partner of Class Law Solicitors in London.

  3. Fine; thank you very much, and thank you for coming along to help us with our inquiry into the split capital investment trusts. We are having this meeting today and another meeting next week, and thereafter we will be seeking written evidence from the entire investment community on the issue of split capital investment trusts, and we will be returning to the issue after we have received that written evidence and having other witnesses in as a result of it. The main aims of our inquiry are to look at this issue from the consumer's point of view, many consumers have written to us expressing anguish at what has happened to their savings and funds; and we are also looking at it from the industry point of view to ensure that good corporate governance exists in the industry. So you are the first of a number of witnesses along those lines. In your submission to us, Mr Alexander, you mentioned in your last paragraph that "there may be important evidence to give to the Committee on the knowledge of the FSA long before the crisis emerged." Now just two or three minutes ago we were handed a document entitled "Documents supplied to Class Law by the BBC obtained from Guernsey Financial Services Commission", and my attention, in the brief time I have had this document, was focused on a paragraph which stated that "Prospective investors should be aware that many of the split capital or high income investment trusts and companies in which the Company invests may themselves have cross holdings in the same split capital or high income investment trusts and companies. This may be considered to give rise to a systemic risk should there be failures within the sector." How significant is that paragraph and the document in its entirety?
  4. (Mr Alexander) I was handed these documents late on Friday night, and, having considered them over the weekend and also with leading counsel, I think the significance of these documents actually is far greater than merely the possible effect it has on the FSA, and I would like actually to look at it from the point of view of all the parties involved. There were a number of funds that were floated in Guernsey, and it is interesting to note that it is only the Guernsey regulator who insisted upon this sentence: "This may be considered to give rise to a systemic risk should there be failures within the sector." Now the first point, and it is a very important and serious point, is this, that, according to the evidence I was given, these documents were sent to the FSA. It is of extreme concern as to why, when those documents were handed to the FSA, serious, immediate action was not taken to notify the public in the strongest possible terms; because it is my view that that one small sentence indicates that these investments were of high risk, yet right up until July, August 2001 we were continuing to see low risk, medium risk documents being put out to the market-place. And it is quite fair to say that many of the people that have instructed us only invested during the spring, summer of 2001, when there seemed to be a frenzy of raising more and more money to keep the thing going. Now the effect of that is the following, that it is our view that there may well be issues involving misfeasance in public office on behalf of the FSA; it would seem to satisfy the tests laid down by the House of Lords in the Three Rivers case, about recklessness and failure to act. If that is right, in my view, it brings into question whether or not the FSA can properly continue with investigations. It is well known that you cannot be a judge in your own cause, and equally as well, from those complained about and for those complaining, if you have got a party involved in the investigations who themselves may now have to answer questions and give explanations and may be party to a possible suit, if it is found that they have, in fact, not acted correctly, then I would just raise with the Committee the possibility that there needs to be some other form of inquiry into this. Because, clearly, for a period of time, and it may well have been, according to the document, certainly from, I think, sort of December, January, December 2000 through to when the thing finally blew up, there is a period of time when the FSA themselves may be under serious inquiry. So that is the first point in relation to the FSA. The second points relate to the actions of directors. What we also have now is certain directors signing themselves to this statement related to systemic risk, yet they were part of companies in the UK that were continuing to put out marketing material that was not in keeping with the prospectus. It also raises a question of the auditors, because the auditors were signing off on this document, and they themselves were auditors in relation to other UK funds. So I think the whole question of these Guernsey documents, which, as I said, have only just come to light, raises whole issues as to how many other people, who perhaps up until now have not been, shall we say, directly involved, may be directly involved. There is a lot more to be done, these documents are not readily available from Guernsey, these were only extracts supplied, and so we are now trying to obtain the full set, for you and for ourselves. So that is the evidence that arose over this weekend.

  5. Fine; thank you very much. In terms of the date of the document, this is a photocopied document and there is 24 August on it; is it 24 August 2001?
  6. (Mr Alexander) I think that is 2001. I think the earliest one is the BC Income and Growth, which seems to be 23 February 2001, but until we get the final printed forms I think it would be unwise to comment on it.

  7. On how many clients' behalf is Class Law acting?
  8. (Mr Alexander) Currently, about a thousand, and rising by the day. It is across the board, it is ranging from those that have lost millions down to those that have lost five or six thousand pounds; it is not a respecter of any social group.

  9. What trusts and management groups feature most frequently?
  10. (Mr Alexander) Obviously, in most of the complaints, it relates to a number of Aberdeen funds, BFS funds, Exeter funds, those are the principal three, although there are others. In terms of advisers, it relates to Brewin Dolphin, who, as the Committee are aware, were not only discretionary fund managers for a lot of people but were also brokers to some of these trusts, probably, out of all the brokers and advisers, we have the largest number of complaints against them, many other of the private client stockbrokers in London, right the way through to small IFAs in the provinces; across the board.

    Mr Laws

  11. Mr Alexander, you have provided us with this chart, which is just to the right of the Chairman; without going into too great a detail about it, could you just summarise the significance of it for your clients?
  12. (Mr Alexander) What we attempted to do was try to plot some of the cross relationships, focusing not so much on the cross holdings themselves in companies but actually the cross relationship between the directors; and we did not put every single one of them, because it would be simply too big and too complex and hard to understand, but we focused perhaps on some of the people, such as Mr Fishwick, Mr Read and Mr Gilbert, to name three, who feature quite heavily on the chart. The implications are, with all these cross relationships and sitting on each other's boards, it brings into question, on a corporate governance issue, the independence and objectivity of directors; because, in my view, if you have got directors sitting on different companies' boards, making investment decisions, to invest effectively in each other, how can those directors be independent and not have a conflict of interest. It is a normal part of company law that if you are a director with an interest in a contract you cannot vote on it at a board meeting. So I think one of the important questions to be asked of these people is, what was the actual decision-making process when investment decisions were made; because what this chart is showing is there were too many people sitting on boards with conflicts.

  13. And do you have any evidence of collusive behaviour?
  14. (Mr Alexander) Evidence of collusive behaviour; to a degree. All one can point to is the fact that the same people keep cropping up, in the same companies, all the time; and if you look at the shareholdings, if you look at even some of the later shareholdings, it is the same people, with substantial shareholdings in each other's companies. If you look at BFS Managed Properties, which came out of Guernsey, they have Mr Hyman, an Aberdeen director, on that board, and Mr Read on that board, and if you look at the shareholdings it is Aberdeen, it is BFS and others. So, in terms of do I have a specific thing showing it, no, but I think it is fairly clear, from the searches, from the records, that the same people keep investing in the same companies time and time again.

  15. And does that give you just a general concern for the interests of your clients, or do you think that they may have been engaging in activities which the FSA or any other regulatory body would consider to be inappropriate and outside of the law or regulation that is relating to this area?
  16. (Mr Alexander) I think there are grave concerns about it. I think you have to look not just at the way they invested but the fact they continued to invest in the same - if you think about it, with all the investments out there in the market-place, with all the good splits that there were around, because there were some good splits around, why did they keep investing in the same things, time and time again. So you have actually, seriously to question the motivation. It is quite clear that some of these fund managers were paid a great deal of money, dependent on the value of the funds, the performance of the funds; and obviously that is also an area of great concern. Because what is their motivation, is it to earn large sums of money, in terms of increasing the value of the company, or is it to look after the interests of the people investing, because, obviously, the more the funds went up, the more they purchased each other's shares, the greater they earned out of the funds. So I think that is a matter of great concern.

  17. So are you inclined to think that there might have been some kind of conspiracy by default, as opposed to just a cock-up, in relation to the disaster that has occurred in this sector?
  18. (Mr Alexander) There is one set of mistakes, that I will come on to in a minute, which relates to advisers generally, but, in terms of the way these funds were run, I do not think there was a mistake, I think that the people knew what they were doing from the beginning. If you go back into some of the records, Mr Currie, of Aberdeen, is quoted in the Financial Times, in 1997, as stating, when they start these new types of split capital trusts, he stated that they are really only suitable for, effectively, the professional investor, or somebody with an adviser; which begs the question, if he said that in '97, why were Aberdeen marketing these directly to the public and to people who had absolutely no access to the markets. So I think that everybody inside Aberdeen, BFS, etc., knew what they were doing.

  19. And can I just ask you whether you have uncovered any evidence of higher cross investment between those trusts where there were common directors, in comparison with those where there were not?
  20. (Mr Alexander) Yes; we have lots of evidence of investments. We are at the moment plotting another chart showing the actual cross investments, but, clearly, where there were common directors there was significant cross investment.

  21. And where there was not?
  22. (Mr Alexander) Yes, higher than where there was not.

  23. By a very significant amount?
  24. (Mr Alexander) By a very, very significant amount, and involving the same people time and time again. It is sort of fairly clear that an awful lot of people did not touch this with a barge-pole, particularly from the investment community.

    Mr Beard

  25. There have been investment trusts around for a long time; why does this particular type of investment trust, the split capital trust, induce this cross holding and cross appointment of directors? Is there something inherent in the concept of a split capital trust that induces that sort of behaviour?
  26. (Mr Alexander) No. I think that what happened was that up until 1997 the split capital market was a fairly settled, well-ordered market; interest rates started to drop and these new schemes were put together, I think, actually to try to get a hold of the market, to offer people a higher rate of return than they might otherwise have got. There were significant structural differences between, if I may call them, the old-style split capital trusts and these new-style ones, they had very high levels of borrowings in them, and they invested in each other, and they had, on top of that, a high level of management charges. One of the factors that was not apparent to people was that the management charges, which was usually between 3 and 4 per cent of set-up, was charged on the total amount of the fund; now that means, if you had a fund of, say, 30 of equity, 70 of borrowing, the management charge would be 3, which was charged to the equity, which means, on day one, 10 per cent of the equity of that fund went away in management charges. So, from the beginning, it was up against - - -

  27. But what induced that sort of behaviour in these new trusts?
  28. (Mr Alexander) If you have to look, why did they do it, I think the fund managers thought it was a fantastic opportunity to make a great deal of money; because they were building up huge - - -

  29. Individually?
  30. (Mr Alexander) Corporately and individually, because, by putting in huge levels of gearing, it meant that the fees were significantly greater; by investing in each other it ensured a ready supply of purchasers for the shares in each other. So, therefore, you had an animal that was significantly different. Now the failure by the industry, by the IFAs, by the brokers, in my view, and it is borne out by all the correspondence I have seen, is that they got a leaflet through and it said, "This is a zero;" they then said, "Zeros are good; this is a zero, therefore it is good." They did not look into the documentation, because had they looked into the documentation in the prospectus themselves the risks were generally spelled out; and IFA after IFA, when he writes his mea culpa letter to the client after September 11, talks continuously about "zeros being a good thing," and they never focus on the fact that these particular zeros were not the same as those that they had previously looked at. And so, if you like, the failure by the industry was to continue to classify these instruments as the same thing as things that had gone before, and failed to read the documents.


  31. So really what you are saying to us is that, if a manager went to the bank and got 100 million of bank debt for these funds, and they charged 3 per cent, then they would get 3 million?
  32. (Mr Alexander) Yes.

    Chairman: Not bad for a day's work.

    Mr Plaskitt

  33. In essence, are you saying that you are finding a difference, perhaps even a contradiction, between promotional material used to promote these funds and the prospectuses that lie behind them?
  34. (Mr Alexander) Yes; unequivocally, yes. This is largely the case for those that bought directly from the funds, that the marketing material simply did not match the reality of the prospectuses. Had they put on the marketing the warnings that were contained in some of the prospectuses they would not have sold them.

  35. Because when we had our inquiry into this in July we saw some promotional material, and we had phrases such as "safe as houses," "more safety features than a Volvo," and, in the case of BFS, an interesting statement that these are products that, I quote, "tend to come into their own when stock markets are flat or falling." Are you finding out that the companies promoting these financial products were persisting with this kind of promotional description at the same time as they were building into their prospectuses the warnings that we have seen in the case of Guernsey?
  36. (Mr Alexander) Yes.

  37. And for how long were they continuing to promote with one language, at the front, and warn with a different language, at the back?
  38. (Mr Alexander) The promotion went on right up until the summer of 2001, when the thing started to unwind; clear, unequivocal, low risk, very little risk, when, if you may call it, the professional documentation was pointing to a higher risk level. And it was this mismatch of prospectuses as against marketing material that is the cause of concern, because, after all, the public, particularly the smaller investor, is only ever going to receive the marketing material, the application form to put their money into an ISA, they are not going to go and read any underlying documentation; most people in the City did not understand it, why should they.

  39. Do you think that companies will not have a defence, when they say, "Ah, but it was in the small print, and, caveat emptor, you should all read it before you buy a product"?
  40. (Mr Alexander) We are extremely confident there are good cases against all those involved. We are ready to go now, we intend to be issuing proceedings very shortly, and it is our intention then to seek pre-action discovery. What we have found today has been based on a trawl of hundreds and hundreds of files, I have actually read every single file, because I felt only by doing it you can get a proper impression of what people were told; people were told a great deal of things on the telephone, people were sent an awful lot of marketing material. Yes, we have seen all of it; we have seen some horrendous stuff, talking about the same as building society accounts, the same as National Savings Certificates. People were interested in one thing, and one thing only, and that was selling; and I think people sometimes forget that people who are selling these products are salesmen, and people somehow think it is in the financial sector it is any different. These are salesmen, the public are not being protected and there needs to be a serious look at the whole question of the way these things are marketed. Because had anybody bothered to actually look at the differences, as we have now done, between the prospectuses, on the one hand, and the marketing material, on the other hand, perhaps a lot of people would not have invested.

  41. Are you satisfied that the FSA was aware of the difference between the prospectuses and the marketing material?
  42. (Mr Alexander) I have got no idea. I have got no idea. Following this, it is our intention, actually, specifically, to ask some searching questions of the FSA, as no doubt you will, actually to find out what went on, because, clearly, there are these issues now, which had not emerged earlier, as to their state of knowledge, what they did or what they did not do.

  43. During the course of the things you have said to us this morning already, you have pointed the finger of blame at the FSA, at directors and auditors; who do you think is primarily responsible?
  44. (Mr Alexander) I think they all are. In terms of the ultimate, ultimate responsibility, it must be the directors; in terms of responsibility in law, I think, clearly, the auditors and the advisers to the people who used IFAs are liable. As far as the FSA are concerned, clearly, there needs to be urgent investigation into their role. I think there is culpability everywhere, I do not think anybody has come out of this, involved in this, at all well, and I think the sooner that this is cleared up... Because I think the other point I would like to make is, what we are finding is, the public's confidence in the financial sector has been severely damaged again by another case, and at a time when the markets are looking for reassurance; so this has not helped confidence in the market.

    Dr Palmer

  45. I understand that split capital trusts in this particular form would not be possible in other financial markets, that it is only in Britain that it is possible. We are sometimes a bit smug about the City, and say, "Well, the world is trying to catch up with us." Do you think this is one case where we have got it wrong and we need to look again at what types of trusts are allowed to operate?
  46. (Mr Alexander) I think that this is a case where people were put off their guard by the fact that it was another product that came out of the City. I saw a letter yesterday from an IFA to a client, and his recommendation to invest was based on two things, zeros are low risk, and, "simply," he said, "Aberdeen know what they are doing." That was his advice, based on that. And it seems to me that what has happened is that, once people have built up a reputation in the City, they are able to sell these products on the back of their reputation of what they have done. People clearly have not looked into things as carefully as they should, and, I think, in terms of selling to the public, there needs to be a much clearer and a much tighter form of regulation so that this thing does not happen again. Unfortunately, it always seems to; but I think this case is really a good chance for the industry and yourselves to look at the whole way this thing is sold, to really try to tighten up so that it does not happen again.

  47. Yes; but what you are saying then, if I understand you correctly there, I do not want to put words into your mouth, is that you do not feel that it is wrong that this type of split capital trust is marketed in Britain, even though it could not be marketed in other countries, you merely feel that a better standard of advice is needed?
  48. (Mr Alexander) Yes. If somebody wanted to market a product that was a high risk derivative, which is probably what this is, and the label on the bottle said, "Warning: this is a high risk derivative, only suitable for private investors," it is a free market, you invest at your peril. What we have got here is a situation where you had a high risk derivative being marketed to people as a low risk place for their pensions. So I think it is not so much the fact that you should not be able to market them, I think the important thing is that the message on the bottle has to be clear, not with any small print, but clear, unequivocal, so that this thing does not happen again.

  49. Do you consider that there is a justification for fees being levied on both stocks and debt, even in the case of cross holdings, if it is properly explained to the clients?
  50. (Mr Alexander) Yes; if it is properly explained. I think I am merely pointing out the fact that these people were earning a great deal of money, and, certainly, when I explain this to some of my clients, they had not an appreciation that the management fees, which were, again, a small line at the bottom, had such an effect on the equity of the fund early on. So I think it is a case of proper explanation, but, I think, more importantly, making sure that products that are only really aimed at the professional investor should stay there, and should not be marketed to the public, who simply could not, do not and could not ever understand them.

  51. Do you actually think that any sane independent financial adviser would advise investing in a trust where, effectively, the management fee is 10 per cent?
  52. (Mr Alexander) No; and, in fact, there are some IFAs who have instructed us because they did not recommend, they actually said, "We looked at it and we don't think this is any good." Their clients then went to another IFA, who did very little work, and sort of went ahead. So I think some people looked at it, some people said that this was high risk, not everybody but some people did it. And so I think it was a question, to a large degree, of the Emperor's new clothes; everybody said, "This is a wonderful thing, isn't it a wonderful thing," without looking beyond merely this veneer, and once it was stripped away everybody then said "Oh, dear."

    Mr Cousins

  53. Mr Alexander, you have just said that there is a free market, and values go up as well as down, and money gets lost. Now this is not America; this is not America, where, if somebody loses money, the FBI bundles somebody in handcuffs into a car in front of the television cameras, this is Britain we are talking about, we do things differently. Now I want to know what your real target is here, because you have attacked the advisers, you have implied regulatory failure and you have raised issues of corporate governance which can only be dealt with in company law; now I want to know what your real target is here?
  54. (Mr Alexander) The real target is to recover people's losses.

  55. Who from?
  56. (Mr Alexander) I will go through the list. First of all, if you had an independent financial adviser or stockbroker who was negligent in his advice to you, because everybody has to fill out a form that says what sort of risk profile you want to take, if you said "low risk" and you were put into these split capital trusts that were not low risk, you have a perfectly good case in negligence against the adviser, and the insurers of the adviser are already dealing with the matter in some cases. So if it is a case against the adviser then there is a case in negligence; if there is a case that you bought directly and there was false, misleading marketing material then you have a case against those responsible for putting out the marketing material. There has to be a duty of care; someone has to have broken it. If there was a failure by the regulator towards the end of this period where he failed to act upon information then the law is clearly laid down by the House of Lords that there is a possibility of looking at it. We do not know whether there is sufficient insurance in the market to cover this, we do not know whether the fund managers have sufficient assets; so at the present moment we are looking at ways to see who may be responsible. I agree with you, just because somebody has lost money in the market does not mean there is a court case, absolutely right, there has to be a clear breach of some settled principle of law and negligence, and we feel that this is done, leading counsel is finalising the proceedings and they will be issued in the High Court very shortly.

  57. Well, Mr Alexander, here we go again. You are advocating a course of action; when I asked you "Who from?", the sort of answer you have given is that you want to go to the fund managers and you want to go to the advisers, and you want to go to the insurers and reinsurers, who may stand behind the advisers on professional liability. How long is all of this going to take; a lot of these guys are bust already?
  58. (Mr Alexander) It may not take very long at all. Some of the cases may be suitable for summary judgment; cases may be over very, very quickly. There is no point in pursuing people that have no money; we are not trying to punish anybody, we are only trying to focus on where there has been a legal duty that has been broken and there is a real chance of collecting money. Some of the people that have lost money are in their late eighties, early nineties; they cannot afford to wait. I have got people, elderly couples, who are going to be forced to sell their homes because they have lost their income; they cannot afford to wait. So, therefore, it is not a matter of "Let's go to law," it is a matter of, these people have got a real grievance; only those cases that are worth bringing will be brought, and only against those people that have clearly broken their duty of care, and where there is a real prospect of success.

  59. Are you going after the regulators as well, for compensation?
  60. (Mr Alexander) Not at this stage, no.

  61. Despite what you said in your opening presentation to this Committee, which clearly implied you were going after the regulators?
  62. (Mr Alexander) Under the procedure now laid down, the first step in any dispute is to deal with pre-action discovery and pre-action letters; so the first step following this evidence is to draft a letter, which will be done this week, to the regulator, asking him to explain his behaviour and to disclose various documentation. If, on the basis of that pre-action protocol, which is something that is now laid down, there are unsatisfactory answers, then, if the clients decide to do it, there will be an action for misfeasance; but you cannot just simply issue proceedings, you have your suspicions, you raise it in correspondence and then you go forward from there.

  63. Another thing. I want to be clear, in your paper to this Committee, what you are actually saying about the press. For example, let me give you a quote from the Daily Mail, 30 June 1999: "the risk on this is pretty low," talking about split capital trusts, "a good idea for risk-averse investors, for school fees planning and those approaching retirement." Now you are not suggesting that there was anything wrong in the Daily Mail saying that in 1999?
  64. (Mr Alexander) No, I am not. In any event, newspapers themselves, it is established, you cannot bring an action against a newspaper for tipping things. I think it is fair to say that it may well be that a lot of the press also got it wrong; there were exceptions. If you go through the records now, you will find that certainly the Financial Times, right back in 1997, when these trusts came out, actually were probably the only people warning about a high risk of investment and collapse. What I think happened was that there was a huge amount of marketing done by these companies; some of the documents that you have seen, where it quoted "as safe as houses," came from supplements in publications such as Bloomberg Money, which were, if you like, put together by these funds. I think there was a tremendous amount of very aggressive marketing by these funds, the journalists wrote about it, and, it is quite right, zeros were a good investment for school fees, certain types of zeros, not all of them. And I think the failure here by those that wrote about them in glowing terms, by the advisers who advise, was simply not to discriminate between the structural differences between the good ones and the bad ones; that is the only mistake, it was just that it did not get beyond that superficial look at it.

    Mr Ruffley

  65. You have given the FSA a bit of a kicking, have you not; you talk about misfeasance, recklessness, and, as I think James Cousins just pointed out, you seem to be rowing back on that a bit. We have to have cool heads here, you cannot start throwing these allegations against the FSA without some evidence. Now let me just explore this. You presented to us, only just this morning, these faxed documents; one is a draft prospectus, Framlington Global Financial and Income, 24 August 2001, which I think you are suggesting contains a paragraph that the Guernsey regulator put in, which warns about the problems associated with cross shareholding. And then the second document, 23 February 2001, a similar draft, BC Income and Growth Fund Ltd, where there is a form of wording, as I understand it, that warns about the problems associated with high gearing, rather than specifically cross shareholding. Now you present these two documents to us as evidence that it should have put the FSA here on notice, because the Guernsey regulator is insisting on these things in these prospectuses. What I want to know is, at what stage were similar forms of words appearing in UK prospectuses for which the FSA was the Listing Authority; 24 August 2001 and the February one? What is the problem; this form of wording and these warnings were in prospectuses, were they not?
  66. (Mr Alexander) No. The key bit here, which does not appear in the UK prospectuses, and it is not the part about the cross holdings, it is the part about "This may be considered to give rise to a systemic risk should there be failures within the sector." That is the key part.

  67. Yes; but it refers to cross holdings?
  68. (Mr Alexander) Exactly; it refers to cross holdings. There were other parts, in some of the UK prospectuses, that relate to cross holdings and to gearing. But what this deals with, and this is the very important part of it, - - -

  69. This is cross holding, not gearing; the other one, the second one, is gearing, not cross holding?
  70. (Mr Alexander) Yes.

  71. Fine; we know that.
  72. (Mr Alexander) Yes. What we are complaining about is the following, that the Guernsey regulator, and as I am advised by the BBC, who have actually spoken to him, and we are now trying to see him, presented these documents to the regulator; in our view, it should have put the regulator on notice about the risk, about the systemic risk and a likely collapse in the market-place. And the concern is, therefore, why, when they got this severe risk in relation to a collapse in the system, stronger steps were not taken to protect the public; it is not the fact that the previous ones did not have it in them, and I am not even complaining about the fact why did it take the Guernsey regulator to spot it when the FSA did not spot it. But, having been given a specific document that shows that another regulator considered this to be a real risk, which would mean that large numbers of people would lose a great deal of money, that no action was taken, because a lot of people put money in, in May, June, July, even August, even September 2001, people were still being sold this on the basis of low risk.

  73. Just to be absolutely clear, those months that you have just mentioned, you are saying that the UK listing authority, the FSA, did not ensure any comparable wording, whether it related to gearing, whether it related to cross shareholding, or indeed both, that did not appear in any UK prospectus at all?
  74. (Mr Alexander) Correct; at all.

  75. And that is the subject of your charge?
  76. (Mr Alexander) Yes. So it relates to that group of people, and it is a large amount of money, that would have bought towards the end of the period, when, frankly, this could have been prevented.

  77. They are the same people; in terms of the Listing Authority, the FSA are now the Listing Authority, as I understand it, the same people have been transferred over, so substantially we are talking about the same people. One final question. You are going to be in a litigator's heaven, are you not, by the sound of it? One specific thing, you are going to go after IFAs, you are going to go after auditors - that will be nice, and expensive - and then you talk about directors; one specific question, Mr Alexander. Cross shareholdings, the last time I looked, was not a hanging offence, not a criminal offence, desperately unwise and depressing for very many people who have suffered as a result, but not an offence. You have talked about collusion, you have said these guys knew what they were doing, you have said it was not a mistake. Just so I am clear about this, because collusive behaviour is referred to in the press and it sounds fairly serious stuff, can you just describe to us what cause of action is disclosed by these cross shareholdings, it is very unwise, but it is civil, it is not criminal; what is the cause of action that you are putting down, in relation to the cross shareholding?
  78. (Mr Alexander) Let me make it absolutely clear, there is nothing wrong, in principle, with having cross holdings, there is nothing wrong with people sitting on each other's boards, it happens all the time; where it goes wrong is in two areas. First of all, in terms of the directors themselves, as to the independence of their decision-making process when they agree to invest in specific trusts, so there may be a breach of fiduciary duty to their shareholders. In terms of the companies generally, it is nothing to do with the cross holdings, it is nothing to do with the cross directorships, it is everything to do with the marketing material. So, therefore, it is not what they did, it is how they did it; in other words, had they gone about it, in our view, in a way that clearly and accurately described the risks involved then people could have taken a better or more informed decision. So it is not what they did, it is how they went about it that is the important thing.

  79. So the answer to the question is that the cause of action is breach of fiduciary duty?
  80. (Mr Alexander) Breach of fiduciary duty and misrepresentation.

    Mr Tyrie

  81. I have two questions. The first relates to your very first remarks. You said that the FSA may have behaved recklessly. By failing to act once they had received the Guernsey regulator's wording about systemic risk, they were acting grossly negligently, and therefore, this means that they may not be fit and proper people to run an investigation. Is that correct?
  82. (Mr Alexander) Yes.

  83. Do you think that the fact that the FSA is immune from action for gross negligence is something which should be reviewed, in this context?
  84. (Mr Alexander) I have got two answers to this. First of all, in relation to gross negligence, we would have to go on misfeasance, where there is no immunity for misfeasance. What I would tell you though, because it is a matter that has concerned us in two other cases - - -

  85. May I just clarify, where you are saying misfeasance, what you are talking about is bad faith?
  86. (Mr Alexander) No; misfeasance. And, in fact, if I just may, in essence, recklessness, which is part of it, and if I just may quote from Lord Hope, in the Three Rivers case: "Recklessness is demonstrated when it is shown that the public officer was aware of a serious risk of loss, due to an act or omission on his part which was unlawful, but chose deliberately to disregard the risk." So what we are saying is that he was aware that, by failing to notify, by failing to act in accordance with his job, there was a likelihood of serious risk; that is recklessness. In terms of the immunity of the regulator himself, we have two other matters which are likely to come before the courts soon, relating to the whole question of immunity. Under European law there is no immunity; we are apparently the only country in Europe that has sought to provide immunity to the regulator. And, therefore, it is a matter of some considerable interest, where you have got companies selling products across Europe, particularly, where the home regulator is the regulator in charge, that, somehow, by coming to buy a product in the UK, on the face of it, it would seem that you do not have quite as much protection as if you were to buy the same product from a company in France. So I think there is a matter of whether or not our laws are currently in harmony with the rest of Europe, particularly in relation to the regulator's position.

  87. In your view, should the FSA be immune to action for gross negligence?
  88. (Mr Alexander) No.

  89. My second question is on compensation. Do you think that the level of compensation should take account of the general market sentiment and conditions; or do you think it should relate only to the sum invested?
  90. (Mr Alexander) One of the questions that we ask clients on their questionnaire is, "If you had not invested in this, what would you have invested in?" Because, quite clearly, it is not as simple as saying, "Well, I've lost 100, I want 100 plus interest;" everybody's case is different. But it is clear that most people have said, because that was what they were looking for, low risk, they would have looked for another low risk investment. But I think it is quite fair to say that you have to look at each case, you have to accept the market has gone down, you have to accept all of that, when it comes to compensation, it is not just a matter of simply saying, "I've lost this, I want that." There is a calculation to be made also based on the state of the market and what people would have invested in.


  91. Just a quick last question from me. You mentioned, at the beginning of your evidence, that Aberdeen Asset Management features disproportionately in the losses that your clients have experienced. Are all Aberdeen zeros flawed, and, if not, what is the distinguishing feature between the successful Aberdeen splits and the unsuccessful?
  92. (Mr Alexander) Not all Aberdeen products are flawed. The distinguishing features go back to the very fundamentals of the differences between the good and the bad, and that is whether or not the money was invested in other companies and had high levels of gearing; if those two elements are not there then you will be able to see it. And there has been published statistics which actually show the differences between the various zeros, and it has been broken down in relation to the percentage of debt they have in them and the amount of cross holdings; and it is quite clear to see, in terms of the performance, the greater the debt, the greater the cross holdings, the greater the loss, effectively. And you can go all the way up to the top. And I think the very first case that I ever got, which was really before the scandal started, was a chap who had seven different zeros, he bought them through a stockbroker, the market had gone down, five of them were perfectly good, five of them had lost 1 per cent, 2 per cent, two of them had lost 40 per cent. And he could not understand how it was possible that, seven things, that on a piece of paper looked the same, five of them had gone down, a small loss, which was acceptable, and two had crashed so dramatically. And that was, if you like, the clue to the first way to investigate it, how was it possible that you could have things that looked the same yet performed so differently, and I think that was a very good starting-point.

  93. So you are saying then that the nature of some zeros was changed by (a) the high level of debt, (b) the extent of the cross holdings, and (c) the management fees charges, etc?
  94. (Mr Alexander) The management fees obviously took a great deal of money out of it, and, yes, of course; but I would not say the management fees was the defining reason that things failed, I think it is more the fact the high levels of debt, combined with the cross holdings, and the system risk, because once, obviously, one went it then started having the knock-on effect that obviously had been picked up.

    Chairman: You have given us a comprehensive tour this morning, Mr Alexander; in fact, you have taken us round the houses. But, as I mentioned at the beginning of our inquiry, we are interested in this (a) from the consumer's point of view, and (b) from the industry's point of view. So thank you very much for your contributions at that level.

    Memoranda submitted by Financial Services Authority

    and Financial Services Ombudsman

    Examination of Witnesses

    MR JOHN TINER, Managing Director, Consumers' Investments and Insurance Directorate, Financial Services Authority; and MR WALTER MERRICKS, Chief Ombudsman, Financial Ombudsman Service; examined.


  95. Good morning, Mr Tiner, welcome, and Mr Merricks. For the shorthand-writer, could you formally introduce yourselves, please?
  96. (Mr Tiner) Yes. John Tiner, Managing Director, Financial Services Authority.

    (Mr Merricks) Walter Merricks. Chief Ombudsman of the Financial Ombudsman Service.

  97. Mr Tiner, you were given an unexpected prominence in the evidence of the former witness, so I will probably start on that particular issue. First of all though could I thank you and Sir Howard for your response to my letter of 26 September, with your letter of 10 October, enclosing a memorandum, which we hope to make public, on your inquiries. On receiving information regarding the Guernsey regulator, we did surf the web, and I have got a copy of a letter to the Guernsey Press and Star, from Peter Moffatt, where he states specifically that it would not be right to portray the discussions which took place with the FSA, as the Commission's own views were developing, as a warning. So could you give us an insight into that particular aspect?
  98. (Mr Tiner) We have seen that letter as well, Chairman, and it seems to us that there has been some confusion here, firstly on behalf of The Independent, which first ran this story some months ago, and secondly by the previous witness at this hearing. It seems that the Guernsey authority has been in discussions with a Mr Hugh Aldous, of the AITC, concerning his concerns about cross holdings and the systemic implications of that, and that he does not recall specific conversations with the FSA, but we had a range of conversations, as we normally do, with other regulators. So it seems to me that his letter to the Guernsey Press and Star seems to suggest, from his point of view, that there was no such warning, of any kind.

  99. On this issue, you have launched a formal enforcement, and I know, from the letter you sent me, that you cannot give us precise details of who is involved in that, but I would like to ask a number of general questions relating to that. First of all, how many authorised investment managers are under investigation on the grounds of alleged collusion?
  100. (Mr Tiner) Well, Chairman, what I would like to say there is that we have a small number under investigation. I think, in my last appearance here, I responded to a question from Mr Ruffley about how many might be subject, at that point, when we were discussing that in July, to possible collusion investigations, and I think I need to point out to the Committee, there is a difference in the status of our investigations we were conducting in July, when I came here, and the status of the investigations we are carrying out today, which is under our formal enforcement powers, and I think I referred then to it being perhaps a handful. And what I would like to do today is suggest that it is a handful, the number of firms that are subject to enforcement investigation. But I think I should also say that our strategy here for the collusion investigation will most likely develop as we learn more, as we dig deeper into the transactions and as we take evidence from the witnesses. So I would not like to put a precise number on it today, because I would anticipate that during the course of the investigation it might change.

  101. Could you give us an indication of the classes of authorised investment managers under investigation?
  102. (Mr Tiner) They are fund managers.

  103. In my letter to you, I did mention that to find concrete proof of misselling or collusive behaviour could be very difficult, and Sir Howard replied in the same terms, and did add that you may find enforcement cases being heavily contested, and that could affect the timescale of your inquiry. Could you give us a flavour of how you see an inquiry progressing, in terms of timescale?
  104. (Mr Tiner) Of course, the investigation has not just kicked off, as I say, our enforcement people have been involved with our investment firms' supervisors for some months already, and we have a chart, which has got the visual impact of this one on the wall but has got rather more on it; and, I am afraid, as a regulator, as an investigator, it is not good enough for us just to say it will be too complex, we have got to look at all angles, and it is much more complex than that. I would say therefore that there is an awful lot of data, thousands of transactions to get through. The process is that we will analyse all of that, we will interview witnesses, we will take evidence, and then we will form judgements, preliminary judgements, which we will put to the firms, and then, following their response, prepare, if we think it is appropriate, a submission to our independent Regulatory Decisions Committee. The firms concerned, or the individuals concerned, then have rights to appeal to the Financial Services Tribunal, and the latter part of that process could take many months.

  105. Okay; well, if you can keep us informed as it goes along, we will be quite happy. As I mentioned earlier in our proceedings, we are looking at this both from the consumer and the entire industry-wide element.
  106. (Mr Tiner) Yes.

    Mr Plaskitt

  107. When you were before us back in July, Mr Tiner, you, in evidence, referred to splits, certain types of splits, as, and you described them, a contagious cocktail of high gearing and high cross holdings. When did splits of that nature first begin to appear in the market?
  108. (Mr Tiner) I think that there was a flurry of issues during the late nineties and the early part of this century, and that most of these splits that had those characteristics were probably being launched around that time, but there were a few that were earlier than that.

  109. So late nineties and into 2000?
  110. (Mr Tiner) Yes.

  111. And the FSA was fully aware of the existence of these products?
  112. (Mr Tiner) Well, of course, the FSA does not regulate investment trusts; we do not regulate investment trusts, and therefore we do not regulate split capital investment trusts. Our responsibility is towards the activities of fund managers, and they saw as their clients the investment trusts themselves, as institutional clients, and not the clients of the investment trusts. So what we did do, however, in February 2001, was issue a warning to advisers, to make sure that they were properly explaining the risks of split capital investment trusts to their clients.

  113. But you were aware of the marketing material being used to promote these contagious cocktails, were you not?
  114. (Mr Tiner) I would say that, prior to that, we were aware that we were not as deeply interested, I would say, in this particular activity, because they were unregulated products, as we might have been had they been a packaged unit trust product, which clearly falls within the direct scope of product regulation.

  115. But you use strong language to describe these things, contagious cocktails, was how you described them, and now you are saying that they were not of significant interest to you to do anything about them; is that right?
  116. (Mr Tiner) What I am saying is that we did not regulate them, we did not regulate the structure of these trusts; and what has emerged is that they have, over time, built up gearing, built up cross holdings, some of this was quite recent activity during the middle and end of 2001, as a number of trusts were restructured, and it is mainly from that point onwards that we have become particularly concerned. The earlier trusts, clearly, we are interested to know how they were marketed and how they were described, and I think some of our work has suggested that a number of advisers did do their homework and did see them as being, at times, too risky, because they understood this contagious cocktail that I described last time.

  117. Something has happened to make it important enough for you now to be heading up this really big inquiry, and yet, when we go back to the earlier stage, when it started to emerge, you seem to be rather standing back from it all. So what has happened to take you from sort of observer, because you said you were not the regulator, to now being intimately involved in investigations; something has happened along the line, and what was that?
  118. (Mr Tiner) What has happened is, quite severe detriment to consumers.

  119. I am sorry to interrupt, but, exactly, severe detriment to consumers, but surely that would have been apparent as soon as products emerged which you were able to describe as a contagious cocktail, yet in the early stages you were not doing anything about it?
  120. (Mr Tiner) No, but we did not regulate the products, and we still do not regulate the products.

  121. And you still do not, but now you are really involved with this?
  122. (Mr Tiner) But we do regulate the activities of the fund managers, and therefore it is the activities of the fund managers and of the advisers and of the stockbrokers here that is of interest to us, because of the detriment that has been created for their clients.

  123. Does not that leave the consumer rather unprotected, if it has to evolve to that stage before you are going to get involved?
  124. (Mr Tiner) No, I do not think so. I think that, since then, since, whenever it was, the late nineties, when a number of these were launched, the powers of the FSA have changed quite a bit, and we now have a much more, for example, active team looking at financial promotions. So I think that regulation has sort of helped resolve some of the issues that might have been around at that time.

  125. It seems to me that there was no-one around to jump on this when they first emerged and clearly were a problem, and you yourself identified they had a problem, nobody seemed to be getting stuck in to protect consumers; is that correct?
  126. (Mr Tiner) There may have been a gap in regulation.

    Mr Ruffley

  127. Could I just pursue this, because I think you should have the opportunity to respond to some pretty serious charges made by Mr Alexander. He seems to think that these draft wordings that were put in by the Guernsey regulator into the two draft prospectuses I referred to earlier, he seems to make out they were a kind of smoking gun, that the Guernsey regulator kind of put you on notice, in some sense, and that you should have done something about it. Could you just explain to me what your response is to that charge, because from what he said, in those months in 2001, going up as far as September 2001, there was no warning in prospectuses about gearing or about cross shareholding, indeed about both, and the systemic risk; where does the FSA fit in, in terms of ensuring that kind of wording is in prospectuses, or procuring that that is done? What I want to try to understand is, did you do anything wrong, is his charge valid?
  128. (Mr Tiner) Yes; well, I think it is all very well for the sort of ambulance-chasing lawyers to come to these occasions and make these sorts of allegations, frankly.

  129. It is why I want to give you the opportunity to reply.
  130. (Mr Tiner) And I am looking forward to receiving a letter from Mr Alexander so we can explain to him exactly what did happen.

  131. But what about the smoking gun, because he was getting very excited.........
  132. (Mr Tiner) I was slightly confused by what he said, actually, because he said that the prospectuses were fine but the promotional material was not, and then he said the prospectuses were not fine. So I am confused. I am not quite sure what he was quite trying to get over to you. All I would say is that the so-called warnings, as he described them, were not regarded as warnings by the Guernsey authorities, they were not, whatever was received, and I am afraid it was before I arrived and I have not looked into what was received, if anything, regarded as warnings by us. However, through the UK Listing Authority, which was not part of the FSA at the time, we have to approve all prospectuses, and we have done a trawl of past prospectuses and we think the disclosures about cross holdings, or the ability, within the investment mandate given to the managers, to invest in other trusts was clearly disclosed.

  133. And systemic risk, because cross shareholding in and of itself is not something that needs to be talked about, it is cross shareholding leading to systemic risk?
  134. (Mr Tiner) Not all cross holdings lead to systemic risk, and fund of funds have been around for a very long time, and they have not always created a sort of market contagion. And so I think our view has been that those disclosures, according to those individual investment mandates, were satisfactory; but we do not, I think, regard that whatever the Guernsey regulator said to us, and, as I say, he denies actually having given anything to us, as he says to the press in Guernsey, as a warning.

  135. I tend to share your view about Mr Alexander; he may be Class Law but he has not been a class act, because I think he has confused the issue. If I could just finally ask, on this prospectus point, the FSA had what responsibility in relation to prospectuses?
  136. (Mr Tiner) The UK Listing Authority - - -

  137. Which you were not, at the time?
  138. (Mr Tiner) Which we were not at the time.

  139. But did you have any overarching responsibility, not directly as a Listing Authority, because you were not until this year, but in your general remit as the regulator for financial services? I just want to understand this, because a lot turns on it. We are going to go after you, as a result of this, and I do not know how strong this is, I am less convinced by the minute?
  140. (Mr Tiner) My understanding is that only from 1 December last year were the UK Listing Authority, the UK Listing Authority became part of the Financial Services and Markets Act, and therefore the responsibility of the FSA; before that, I am not aware that there was a contracting out kind of obligation from the previous regime to the FSA, there might have been, I will have to check it and come back to you, I am afraid.

  141. Could you check and write to us on that, for clarification. Because I have to say that, the Financial Services Authority, it is important that the whole of the country has confidence in it, and I do not think it helps anyone if some pretty serious charges are levelled against your organisation without you having the opportunity to clarify it, because the whole sector, financial services, suffer, beyond the split capital trusts, if your integrity and competence is impugned. So I thank you for your answers, but if you could put in writing, specifically, on further consideration, answers to the questions that I posed about what you knew, when you knew it, and also what responsibilities, if any, you had, because I think this is quite a serious matter to clear up?
  142. (Mr Tiner) Indeed. I will do that very quickly.

    Mr Beard

  143. Mr Tiner, where do you see the risk arising in these split capital trusts; is it because there is something inherent in the concept of the trust, or is it because of the conduct of certain people in the way they run them?
  144. (Mr Tiner) I think that the sort of, as has been described previously, old-style, split capital investment trusts, where there were three classes of shares, and they sort of came in order, in terms of getting their money out and getting their return out, so there was a lower risk element, a medium risk element and a higher risk element, if you like, were a part of the investment landscape for some time, and they performed over many years, over decades. This evolution of cross holdings, and particularly to a very high degree, some of them over 70 per cent of the portfolio invested on the splits, together with gearing, has meant that, if these were created during the bull markets of the late nineties, if the markets went up very sharply the investors stood to make an awful lot of money, and if the markets fell sharply the investors stood to lose an awful lot of money, and that is what has happened. And, as the markets have weakened, I am afraid that the loss of the investors has become exponential, and in some cases people who might have invested 50,000 are now left with a few hundred.

  145. Which of your predecessor voluntary regulating bodies was responsible for supervising this, or regulating it?
  146. (Mr Tiner) It was split in different places. IMRO, the Investment Management Regulatory Organisation, were responsible for regulating the fund managers; the PIA, Personal Investments Authority, were responsible for regulating the advisers; the Securities and Futures Authority were responsible for regulating the brokers; investment trusts were not regulated at all, other than at the point of the prospectus, which was the UK Listing Authority. Of course, that has now all come together, since 1 December, into the FSA.

  147. And what did any of those bodies, or you, when you took your powers, on 1 December, if it is appropriate, what did you do to warn consumers of the inherent risk that you foresaw, you or your predecessors?
  148. (Mr Tiner) Certainly from the time that we got our full powers, in N2, on 1 December last year, we have been fairly constantly warning consumers, through our website and through speeches and through any other mechanism that gets through to the media, about the risk of these.

  149. But the horse had bolted by then; so what happened?
  150. (Mr Tiner) Prior to that, I think the first public statement that we made about it, as I am aware, was February, March 2001, where we warned advisers to make sure they properly disclosed the risk to their clients.

  151. You mention, in the supplementary note that you gave us, you say here, that "the investment trust company was not required to obtain authorisation...and because the prospectus and listing particulars for the trust were excluded from the investment advertising regime which operated under the previous legislation - as they continue to be under the new financial promotion regime." In other words, you are not able to inspect the prospectus before any of these trusts are formed; is that the case?
  152. (Mr Tiner) Not as a financial promotion, we are not, but as a prospectus, under the Listing Rules, like any other prospectus, whether it is issued by British Airways, or Vodaphone, whoever, then we are; but it does not constitute a financial promotion.

  153. So what does paragraph 19 of your note mean then, in that case?
  154. (Mr Tiner) What it means is that, at the point of the prospectus, the prospectus effectively stands on its own; if there is any subsequent marketing material published by any authorised firm then that is subject to the Financial Promotions Order and subject to regulation, but the prospectus itself is not.

  155. So that they can put out whatever they please, in the prospectus, and no-one could adjudicate it?
  156. (Mr Tiner) No; no, they have to comply with the Listing Rules, in other words, the rules that govern what listed companies need to say about inviting applications for buying their shares. There are certain requirements and there are things like, in this area, describe the investment policy, the investment strategy, of the trust, and they do that, and that is where, in some cases, this cross holdings thing has been revealed. But they are not looked at as financial promotions, in the sense that they are sort of sales documents, if you like.

  157. There has been a lot of criticism about the marketing material issued by both brokers and managers; do you look at this before it has actually been widely available to the public, or do you only react to complaints when it has been published?
  158. (Mr Tiner) A bit of both. We cannot, obviously, look at every single piece of financial marketing literature that is out there in the market-place, we would have a multiple of the people we have now if we were to look at, pre-clear, every single advert or promotional literature, marketing document, or whatever, and we do not do that. What we do do is, we look at a sample of financial promotions before they are launched, and we discuss with firms about how they need to improve them, if we think they are potentially misleading. We then review marketing literature that is out there in the market-place and sometimes we ask for that to be withdrawn, if we think it is misleading. But what we cannot do is look at every single piece of marketing literature.

  159. So, in summary, Mr Tiner, out of this episode of the split capital trusts and all that is going on, what have you learned that has changed your practices in the FSA?
  160. (Mr Tiner) I think that we have learned that, firstly, complexity often results in risk; however the analysts might tell you about it being a low risk, complexity often equals higher risk. So I think that in our surveillance now of financial promotions we are increasingly concerned about complexity. Secondly, we are increasingly concerned to look at promises that look just too good on the surface, and we have a number of current inquiries, rather than enforcement investigations, undergoing there about some high risk products which just look too good to be true. And so I think that, out of this affair and out of generally what we have learned from what we have seen in financial marketing literature, we have just increased our resources dedicated to this particular activity.

    Mr Mudie

  161. The way I see what you say though is, investment trusts were not regulated so you cannot be blamed, but you are now looking at fund managers. I presume you were responsible for fund managers before?
  162. (Mr Tiner) Yes, IMRO were responsible for fund managers.

  163. So, the fund managers, you are now saying you are looking at fund managers; it was your job to look at fund managers before. So, whether investment trusts were regulated or unregulated, you had a responsibility for fund managers, which you do not seem to have picked up; now you seem to have only picked this up when a lot of people have lost money. Is that going to be a pattern of behaviour for the FSA; quite seriously? You have just said something which I think is good advice when it is showing returns too good to be true, it deserves looking at, does it not, not from an investment point of view, from a regulatory point of view? Now why was this not picked up before?
  164. (Mr Tiner) I cannot tell you exactly why it was not picked up before; this is going back some years.

  165. Are you looking into why it was not picked up before?
  166. (Mr Tiner) No. I think we are looking at what lessons we learn from this recent debacle in the split capital investment trust sector, and making sure that, given the powers we have today, which are greater than the powers that existed then, particularly in relation to financial promotions, we have got our resources doing the right thing. And so, for example, looking at products like precipice bonds, and so on, that appear to just make promises which look too good, that we are on the case. And I think that, going forward, and I hope that, going back over the last year or so, since the FSA has had its own personality, if you like, legal personality, we have been doing that.

  167. You sound like Mr Alexander there, if you will excuse me. I just asked a very quiet thing and you seemed to be confirming it, but you deny it. If you are going to learn the lessons, you have to look at why it was not picked up, and I just ask you, are you looking to why this was not picked up by the organisation sooner?
  168. (Mr Tiner) I think the problem is that the regime was so totally different then to now. It is like comparing apples and pears, in a way; we could look at it but I am not sure it would actually help us inform our sort of activities in the future, because the regime is so totally different.

  169. But, Mr Tiner, just looking at it from the investors' point of view, who have lost a lot of money, some in desperate circumstances, they look to you; now the way the situation is moving is you are now acting when they have lost their money. They look to you, as a regulator, to ensure that they are investing that money in a relatively safe, transparent situation; now clearly that was not so. And so I would be angry, if I was an investor, looking at you, as a regulator?
  170. (Mr Tiner) Again, I am sort of here focused more on making sure that we do do our job today; and what you say is absolutely correct, that our job is to make sure that consumers, who are the significantly weaker party in any buy/sell situation between an adviser or a fund manager and themselves, are given the proper warnings, and that is what we are trying to achieve today. I think your point about can we look back and, quote, "learn the lessons" and make sure we have not missed anything, is a fair point; and, as I say, I think the regime is very, very different today, so we need to treat that with caution, but perhaps we should do it.

  171. But you can understand why we are looking at you, because we are your regulator, if you wish. But just on the paper we have been given, I take it that there is going to be a delay, understandable, in the second part of your investigation, but where are you with the first part, because, whatever Mr Alexander said, that was one that actually touched nerves, the promotional and marketing, and that seems to me to be an easier one to bottom? When do you anticipate bringing something on that first part of your investigation?
  172. (Mr Tiner) It should be easier to bottom, it is a more self-contained kind of investigation than the very widespread kind of collusion investigation; and we are progressing very well since we began this formal process in May, and I would hope that we will bring a case before our Regulatory Decisions Committee around the turn of the year.

    Mr Tyrie

  173. I think most of us are agreed that splits were a good idea in their original form but that they ended up abused through high gearing and cross holdings. Do you happen to know what has happened to the good end of the splits market, as a consequence of the bad end of the market being exposed?
  174. (Mr Tiner) Yes. I think the market values of the so-called good end of the market have suffered collateral damage from the bad end of the market, but the structures of these trusts at the good end of the market are such that, if people are holding them to maturity, which most people do, because they are saving for a particularly defined outgoing, the good ones should be expected to deliver on what they said they would do.

  175. I ask this because you, as an institution, published a very important document, called 'A Risk-Based Approach to Regulation' about two years ago, which lies at the heart of the way you approach these problems. This said, that there should not be zero risk, that risk is an inevitable part of a successful and flourishing financial services industry. What steps do you think you can take to rebuild confidence in the market, to the point where people will be prepared to carry on innovating to provide good products, not only in splits but more generally, because this is going to infect the whole market?
  176. (Mr Tiner) Clearly, product innovation is important, and it is important to give consumers a range of choices about what type of investment they would like to hold. Our objective here is not in any way to stifle innovation but to ensure that innovative products are properly described to the customers who want to buy them, and that does not seem to me to be an impossible mission, at all, and that is what is at the heart of risk-based regulation.

  177. Can I just explore very briefly, I think you have handled very well the allegations made by Mr Alexander, I just want to explore a hypothetical question, which you may be reluctant to answer, but let us suppose that you did get this warning from the Guernsey regulator, what would you have done with it?
  178. (Mr Tiner) Hypothetically speaking. I am not clear exactly what the warning was supposed to have been. I do not know whether we were supposed to have been sent this prospectus, or he came over and talked to us about it, I am not quite clear at all of the form of this warning.

  179. Would it not have been reckless to have sat on it?
  180. (Mr Tiner) I think that what we would have done, had we, say, been given this thing, we would talk through it, and, again, this is through the UK Listing Authority, remember, not through the financial regulators, that we would have taken it into consideration in judging whether the disclosures in UK prospectuses were adequate. That is hypothetically the sort of thing we would do, like any other information we receive, from anywhere else; we receive information all the time, and what we want to do is to plug that in to the people that are thinking about these prospectuses to make sure they are covering the ground.

    Mr Tyrie: You see, he has concluded that you should not be immune from actions for gross negligence; the immunity was granted partly because the FSA did not want to be run around the block by very large firms, like Morgan Stanley, every time you decided to look at their regulatory structure. But we are finding, in this case, to our surprise, that it is possible perhaps that your immunity may reduce the vigilance that you may have been operating with, to protect consumers; and that, if you had sat on this document, that could have, or whatever came through, might have come through, from the Guernsey regulator, that this would be considered gross negligence and that you would be immune from it. In the light of not only that point but also the point made that most other regulators around the world are not immune from gross negligence, at least they are certainly not in continental Europe, do you think this is something that needs to be looked at? Are you happy that you should be immune, that you can behave recklessly, as an organisation, and still be immune?

    Chairman: That is a hypothetical question.

    Mr Tyrie

  181. Well, that is the situation, that is the law. Just to clarify this, Chairman, not with respect specifically to this case, but in general, you are immune, you have immunity from actions in response to reckless behaviour by the FSA?
  182. (Mr Tiner) My understanding is that it is a fact, within the Financial Services and Markets Act, operating from 1 December, that we have statutory immunity. I suppose that does not cover acts of bad faith. But prior to that there was no such immunity, and, in any case, this prospectus issue was through the UK Listing Authority, as I have said a number of times, who I think were subject to different types of regulations. The question of statutory immunity is, I do not think, something for us, frankly, I think this is something for Government and policy-makers in Government to decide. There is a two-year review of the Financial Services and Markets Act starting at the end of next year, I do not know whether that will be on the agenda or not.

    Dr Palmer

  183. Just trying to summarise, the problem comes down to this, that the high gearing and high level of cross holdings substantially increased the risk of this particular type of split capital that we are talking about; the nature of the marketing, in some cases, appears to have been misleading in not showing that risk, the stuff about "the babies sleeping at night", and all that rubbish. And then there is a third point, that the fees levied on both stocks and debt actually gave a perverse incentive to the fund managers to increase the gearing and increase the cross holding, and therefore increase the risk. Would you agree with that?
  184. (Mr Tiner) It could certainly create a self interest.

  185. Do you think that in the future we should prevent, in one form of regulation or another, this incentive from being present, should we discourage fees being levied on both stocks and debt?
  186. (Mr Tiner) My feeling is, not, actually, because this is not a question of levying fees on stocks and debt, it is a question of levying fees on equity and debt, which equals stocks, and that is the sort of asset and liability side of the balance sheet. And what investment managers do, in this case, and in many cases, not very well, is to manage those assets, and the fee that they receive is for the management of those assets, and the assets they are managing is the gross number. Now we could discuss whether the level of the fee was too high, that is an issue for the market, but levying the fee on the gross assets, i.e. the actual work they are supposed to be doing, seems to be reasonable.

  187. Do you feel that, we heard in the previous evidence that it is difficult to imagine any sane independent adviser actually recommending a product with an effective fee of 10 per cent of the amount invested. if I were selling you electrical equipment and I said, "There's a risk it might electrocute you, I have to warn you of this, so I am putting it in bold type, but it may work perfectly well, it may be very good," it would actually be illegal for me to sell you that, however loudly I warned you about the risk? Do you not feel that there is some level of risk at which it ought not to be possible to sell financial products?
  188. (Mr Tiner) Probably, on a theoretical basis, yes; but I think that, at the very extreme of the Hedge Fund market, where there are some horrendously complex derivative structures, it is possible to explain them but only to very sophisticated investors, they are quite plainly not products for normal people, perhaps I should say, people on ordinary incomes. So I think it is possible, but your level of understanding and knowledge has got to be very, very significant, to begin with. I would not regard them as being explainable at all to the vast majority of the population.

  189. So what you are saying is that you put the entire weight on the type of explanation given to different types of investors. It is very difficult, as MPs, to legislate on this, to ensure that 86-year-old Mrs Smith does not somehow get her hands on this totally inappropriate product?
  190. (Mr Tiner) Yes; there is one core principle within the requirements for the selling process, which is called 'suitability', and it is absolutely central to every piece of advice or sales decision, it is that the product which the consumer is buying is suitable, or being sold is suitable, to their particular circumstances, and that is the core part of the regulation. And, of course, Ron Sanders got into this by designing some really quite simple products, or coming up with a suggestion that there be some quite simple products which would be readily available to the population at large, because of this complexity issue, I think, and I would agree.

    Chairman: We will resist the temptation to ask you to define "normal".

    Mr Laws

  191. Mr Tiner, I am sorry to take you back to Guernsey one last time, but I am still slightly uncertain about some of the details behind the answers you gave us earlier. The BBC's claims, in relation to warnings that were given by the Director of Investment Business on Guernsey, their claims, on this "Money Box" programme, were basically that early in 2001 this individual, Peter Moffatt, conveyed his views about his concerns in relation to these products to his opposite number at the UK's Financial Services Authority. Can you tell us who his opposite number was, and what he actually conveyed?
  192. (Mr Tiner) I am sorry, I did not hear the "Money Box" programme on Saturday, but was that the Guernsey regulator speaking himself?

  193. These were the claims that were in the programme. I assume that you have seen a transcript of the programme, or the programme itself?
  194. (Mr Tiner) I have not, I tried to get one yesterday and I could not get one; but I think that this goes back to the article in The Independent on Sunday, on 30 June, where it was suggested that the Guernsey regulator, Mr Moffatt, did contact his opposite number at the FSA about this.

  195. Who is his opposite number?
  196. (Mr Tiner) I think it would have been a Mr Aitken.

  197. And what did he say to Mr Aitken?
  198. (Mr Tiner) I do not know.


  199. I think, Mr Tiner, we have gone over this quite a bit. I think what we can do, we can clarify this by an exchange of letters, if you wish to do so, because a lot of the answers you have given us are based on information which is not available to you at the moment; am I correct in saying that?
  200. (Mr Tiner) Yes.

    Chairman: So we will have a final point and then there will be an exchange of letters.

    Mr Laws

  201. Can I say that I find it absolutely astonishing that if you are saying that this dates back to an article in a newspaper some months ago, it has been broadcast on BBC television, that, given you knew you were going to come to see us today, it is astonishing that you are so badly briefed on this. I find that absolutely amazing. And this is a very substantive allegation, this; how come you have not checked it out?
  202. (Mr Tiner) The letter from Mr Moffatt, dated 9 July 2002, as far as I am concerned, puts a line under it.

  203. It puts nothing at all under it. What it says is three things. The Commission has not criticised the FSA, we know that; it says that it regularly exchanges views with the FSA, that is frankly meaningless. It says it would not be right to portray the discussions as a warning; what would it be right to portray them as, that does not mean anything, it is open to all sorts of portrayal? And you are telling me you have not checked up with the individual who is concerned in this, you have not looked back at the correspondence. I find that absolutely astonishing.
  204. (Mr Tiner) There was not any correspondence.

  205. There was no correspondence at all?
  206. (Mr Tiner) Not that I am aware of, no.

  207. There is no correspondence between this individual and the FSA on this subject?
  208. (Mr Tiner) Not that I am aware of, no.

  209. Either at the end of 2000 or the first quarter of 2001?
  210. (Mr Tiner) Not that I am aware of.

  211. Can you confirm that for us and send us a note?
  212. (Mr Tiner) Certainly.

  213. And have you not spoken to this Mr Aitken at all to find out what his discussions were?
  214. (Mr Tiner) I have spoken to him, and he knows Peter Moffatt quite well, because they have worked on investment fund business together for many years and they have many conversations. He has no explicit recollection that there was a particular warning in this case. But I will talk to him again, in the light of this, and check it.

    Chairman: If you could write to us on that, that would be fine.

    Mr Cousins

  215. Just to tidy that up, you did say much earlier that the Guernsey regulator had spoken to the AITC about this issue?
  216. (Mr Tiner) That is my understanding, yes.

  217. Now the AITC is doing quite a significant study of the risk profile of the whole sector, and presumably they are doing it in co-operation with you?
  218. (Mr Tiner) Yes.

  219. Did the AITC not talk to you?
  220. (Mr Tiner) No; not at the time.

  221. But later?
  222. (Mr Tiner) Just, I think around the time that this surfaced in the summer.

  223. You mentioned earlier that there was a gap in regulation, and I understood you to mean, essentially, that we have an investment product here in the form of a company; now that gap in regulation is still with us, is it not?
  224. (Mr Tiner) If it is a gap. I said there might be a gap; and, if there is a gap, yes, it is still with us.

  225. And that would require it to be addressed through changes in company law; that would be one route?
  226. (Mr Tiner) Yes; probably a change in the Regulatory Activities Order, covered by the FSMA.

  227. Right; that is helpful. So there is a possible gap in regulation here. Now the other thing you mentioned was collateral damage to the whole sector; and I do not want my remarks being misconstrued as an attack on the whole sector, they are not intended in that light at all, but there is a serious risk of collateral damage to the whole sector, and indeed beyond it. You have heard this morning that all these people are going to be sued, and all the different actions that people will take, some advisers, professional indemnity insurers will act in one way, and others will act in a different way, some will try to close it down, some will resist it; there are your own inquiries, Section 47, Insider Dealing Legislation, we will have an epidemic of early onset Alzheimer's. At a time when markets are fragile, as they are now, do you not think it is much more important that somebody binds up the wounds of all of this and settles it now, in a way that everyone sees to be fair? And all these avenues being pursued, which will run on for months, years, in some cases they may even run on for decades, now that would be intolerable. Do you not think somebody has got to show the leadership to bind up the wounds of this thing and get this thing off the park, so that the people who feel very aggrieved by this get some sort of rescue?
  228. (Mr Tiner) I absolutely agree with that, Mr Cousins, that the sooner this can be brought to closure the better it will be, not just for the investment trust sector as a whole but for the whole of the savings sector, at a time when, frankly, the Government are trying to do everything they can to encourage an increase in savings, and there has been a series of events which have generally had an adverse effect on confidence over the last several years. And, here, I think that, if there is willing participation to do as you have just suggested, where the people who feel that they have been in the wrong are willing to come up with the money to put those people who have been wronged right, then I think it will be possible to draw a line under it very quickly; if they are not willing to come to the table voluntarily on that basis then it will have to be achieved through enforcement or through complaints through the Ombudsman Service. I hope we can get all of those things done as quickly as we can; but there is, as I have said here before, a process we have to go through to make sure, if it is the sort of formal route, that we are able to gather the evidence to make the case, and therefore get proper recovery for the people that have been wronged.

  229. Are you aware of any such initiative on a voluntary basis?
  230. (Mr Tiner) I am aware that there is one firm who is trying to put together a scheme for its unit holders in one particular unit trust.

  231. That is all?
  232. (Mr Tiner) That is the only one I am aware of.


  233. Could I ask Mr Merricks a couple of questions, and thank you for coming along, Mr Merricks, on the issue of compensation. Class Law has stated that there could be up to 50,000 people who have lost out as a result of the problems with splits; how many inquiries, or how many live cases, do you have at the moment, on that?
  234. (Mr Merricks) We have 1,054, as at yesterday; we are continuing to receive a number of cases every week, probably between 50 and 100 new cases for investigation every week. Perhaps I should just say to the Committee that the cases that we investigate, or complaints that we investigate, are all complaints that have already been submitted to the firm involved, because the structure of the Ombudsman Service is that we cannot become involved in anything until the firm itself has had a chance to investigate the matter. So if an investor is then dissatisfied with the answer given by the relevant firm then the investor has the chance, as I say, if they are dissatisfied, to pass the case for investigation to us and we then proceed to investigate it ourselves. We have two capacities, in a sense, we are an investigative body and we are a quasi-judicial body, we have the power both to require documentation and information from the parties, and then the ability to make binding decisions against, if necessary, money awards, against the firms involved, up to certain financial limits.

  235. To what do you attribute the discrepancy between these figures, as 50,000, on the one hand, just over 1,000, yourself?
  236. (Mr Merricks) Mr Alexander said he had about a thousand clients, I think, and it is interesting that we have a similar number. It has surprised me, actually, given the amount of concern that there has been, in the press and elsewhere, and the number of people who are known to have lost money, that we have had a relatively small number, and indeed a relatively slow take-up; most of the complaints that we have received we have received in the past, say, two, two and a half months, and we had a small trickle before that.

  237. Could it be a factor that people do not know how to complain, and maybe this public campaign helps?
  238. (Mr Merricks) I would be very surprised, because there is a great deal of publicity about how to complain. But I think that perhaps there are some people, and we have certainly seen evidence of this, who are not entirely clear who they should complain about; some people who have been advised by an adviser, that advice may or may not have been very good advice, but they are not necessarily keen to level a complaint against that adviser, because the adviser blames the fund management group, and it may be that that is where the blame should be directed. And we are certainly having to assist complainants, in explaining to them against whom it is possible for them sensibly to make a complaint, if that is what they want to do.

  239. So it is complex then, that is what you are saying?
  240. (Mr Merricks) I am afraid so.

  241. When was the first complaint about splits received, and have you disposed of any complaints?
  242. (Mr Merricks) We have not disposed of any yet; we received the first ones earlier this year, and we made a statement in our May edition of our Ombudsman News, and which goes on our website. We have not yet disposed of any complaints, either in favour of investors or in favour of firms.

  243. One of the factors that the Ombudsman may take into account, where appropriate, is, and I quote, "what he considers good industry practice at the relevant time." What does that mean?
  244. (Mr Merricks) We take into account both the legal situation, what obligations the advisers may have had, or under Regulatory Rules, but we are also able to look at what we think of as, what we believe to have been, good practice at the time; that is absolutely right.

  245. Does it mean, for example, that, if the zero dividend preference shares were generally considered "safe", this will prejudice investors' compensation claims?
  246. (Mr Merricks) Not necessarily; we have to look at what advice, if we are talking about advice, what advice was given, whether it was suitable, what level of analysis and research the adviser undertook, and those are all matters we are looking at in relation to each of the complaints we receive. And, of course, for many of the investors, zeros, if they were zeros that they had, were only part of the portfolio, and so we have to look at the suitability of the whole advice that the investor received, and what component the zeros may have been within the portfolio that they were advised to take.

  247. Maybe I could ask Mr Tiner to answer this question, along with yourself. Mr Tiner stated in the earlier evidence that you would be looking at promises that look too good on the surface, and that innovative products need to be properly described. Yesterday, again, I was surfing the net and I picked up, in one of the major papers in the UK, of September 1999, an advert for zeros, for companies, and it stated at the top, it was a "Stop, Ready, Go", "9% estimated annual growth." "Zeros are one class of share within the Split Capital investment trust sector, and offer investors steady quasi-guaranteed annual growth." "Zeros are lower risk investments similar to bonds. They are less volatile than conventional shares or other investment trusts. Analysts believe that not one has ever defaulted." ' This trust aims to deliver 9% annual growth to you, so get ready, go and contact us.' How do you view that promotional literature?
  248. (Mr Tiner) I would say that, if it is a trust without any cross holdings or gearing, there are aspects of that which would be correct.

  249. Can you possibly prove that to be the case?

(Mr Tiner) If it is of that kind then, plainly, it is misleading.

(Mr Merricks) We look both at the circumstances of the investor and of the claims that were both being made and the totality of the situation. But we do not judge solely on advertising material, we look at the individual circumstances which led to a sale; and if the advertising was the sole issue then, clearly, what you have read out, with the benefit of hindsight, looks much less attractive.

Chairman: Fine; thank you very much. Can I thank you for your attendance this morning. As I mentioned earlier on, we are looking at this both from the consumer and the industry, and we wish to see the whole industry reputation being repaired in it; so our inquiry is a very constructive inquiry, and we are very pleased that you have come along to give us your contribution. And at some stage in the next few months we will wrap that up and provide you with our evidence. Thank you very much.