Purchase of zeros on the basis
35. The real issue is with the sale of zeros on the
basis of some form of advice or encouragementthe FSA's
third and fourth categories. These would often be individual investors
who could not be expected to have understood all the details of
financial products and whom it is the job of government and legislators
to seek to protect.
36. Mr Piers Currie (Aberdeen's Marketing Director,
Investment Trusts) told us that in the documentation for their
share schemes, in respect of investments in zeros, "We
did not describe it as low risk exclusively" and that the
accompanying materialwhich investors would be required
to readdescribed the characteristics of the zeros concerned.
The 'Key Features' document for the Aberdeen Investment Trust
Share Plan (July 1999) stated for example that "We
advise anyone contemplating the purchase of a split capital trust
to take independent professional advice". The 'Risk Factors'
section noted that "The
substantial use of gearing by some Trusts, usually in the form
of bank borrowings ... means that changes in the value of the
investment portfolio of the company can be expected to result
in exaggerated movements in the [Net Asset Value] which are potentially
unfavourable as well as favourable"; in respect of zeros
the section states "The
repayment of zeros is not guaranteed and is dependent on the issuing
investment trust having sufficient assets at wind-up date".
The July 2000 version states that "An
Investment Trust which 'gears' may well have a more volatile share
price than one which does not".
In respect of zeros, the July 2000 version states that ZDPs "have
a pre-determined redemption value ... This final redemption is
not guaranteed, and will not be repaid in full if the investment
trust, on liquidation of its portfolio, has insufficient assets.
They however rank first in priority on a trust's assets after
bank borrowings, and are therefore deemed less risky than other
share classes". Similar statements feature in the June 2001
version of the Share Plan Key Features document, though the added
statement appears "Shareholders
should be aware that if any trust at wind-up does not have sufficient
assets to repay ... [any] prior entitlements such as bank borrowings,
then they will not receive any capital back at the winding up
37. But such formal warnings, whether in respect
of Aberdeen or other fund managers, are not the whole story. A
significant part of the problem was that a whole climate of opinion
appeared to have developed
that zeros had never failed and were therefore low risk.
This impression permeated the general coverage of the subject
and meant that what may have been technically correct statements
about risk in the formal documents did not have a great impact
compared to what investors were being told in the wider context.
There is a string of quotations from press coverage and advertisements
A newspaper advertisement in September 1999 described zeros as
"lower risk investments
similar to bonds" which offer "quasi-guaranteed
Mr Currie, of Aberdeen, was quoted in the Glasgow Herald on 11
February 1999 as stating that investment in the Enhanced Zero
Trust was "a no-brainer.
It is a banking decision really. You are able to borrow cheap,
invest high.", implying that there was no significant risk
of not getting the envisaged return.
Mr Fishwick was quoted by Reuters in connection with zeros as
extolling their reliability "even
in the most volatile of equity markets. Their prices do not fall
back sharply even when equities are in decline".
Aberdeen's Progressive Growth Unit Trust notoriously promoted
its investment in zeros in 2001 with the message "The
one year old who lets you sleep at night".
The AITC itself was suggesting to investors in August 2001 that
zeros "might prove
to be the best choice" for someone seeking "only
a minimal amount of risk".
All five of these statements have proved to be false. We consider
that Aberdeen's promotion material and statements, in particular,
were recklessly misleading.
38. Mr Alexander supported the idea that there had
been negligence among advisers and that the most common failing
was "that they failed
to understand the structural differences between those split capital
trusts that were sound and/or of relatively low risk and those
... that were highly geared and with cross-holdings ... that were
clearly of much higher risk. In many cases, it is quite clear
that the advisers merely relied upon a leaflet or marketing documents
from the fund managers rather than reading the prospectuses, which
would in most cases have shown the risks involved";
similarly, "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 to put their money into an ISA, they
are not going to go and read any underlying documentation".
He cited evidence from an Aberdeen statement to the Financial
Times in 1997 that the newer splits were only suitable for the
professional investor or someone with an adviser, suggesting that
Aberdeen knew then that there were risks and should not have been
marketing them to the public.
Advisers continued straight through the events of September 11th
2001 to take the attitude that zeros were "a
good thing, and they never focus on the fact that these particular
zeros were not the same as those they had previously looked at".
39. The risks of zeros were noted by Cazenoves for
example in their January 2001 Annual Review noted "The
wider issue is whether there is systemic risk to the whole split
sector resulting from the poor performance of some of the recently
launched funds ... Sophisticated investors know that splits create
high income through the use of 'smoke and mirrors' and high charges
to capital account. We suspect that most private clients and IFAs
40. One of the firms against which Mr Alexander said
there were particular complaints was Brewin Dolphin. Brewin Dolphin
told us that zeros "had
been widely sold by advisers, through fund managers' advertising
campaigns, and have been generally recommended in the press"
but that it was not their practice to distribute fund managers'
marketing material to any private investor.
They said that they advised over 80,000 private investors and
that for some of these they had recommended zero shares, but that
"Each and every one
of our clients's portfolios is different and each has been invested
to achieve the client's objectives ... With all the information
we had at the time we believe we gave sound advice to our clients".
When questioned whether the advice being given about zeros changed
in the late 1990s as splits began to change character, Mrs Bowden
for Brewin Dolphin said "I
do not think there was a huge shift in perception at the time
... Across the industry I think the market professionals as a
whole did not see a huge shift ...".
41. It seems clear to us that those primarily
responsible for the development of the 'newer' splitsthe
board members themselves, some trust fund managers and some sponsoring
brokersdid not take the steps they could and should have
taken to bring the true nature of the risks in zeros to the attention
of the wider investment community. We deplore the fact that many
investors in the 'newer' zeros were not adequately warned by trust
fund managers of the risk to their investment, especially as the
managers subsequently increased that risk by substantially increasing
42. We accept that not all individual investors
in zeros over the last five or more years are automatically entitled
to compensation, even if their investment was made using some
form of adviser or intermediary. The circumstances of each case
must be examinedinitially by the adviser or company concerned
but if necessary by the Financial Ombudsman Servicebut
we are in little doubt that there is a wide range of cases in
which it will be found that compensation is justified. In
some cases it may appear that the promotional material contained
phrases and statements which appear to convey adequate warnings
of the risks involved. But these statementseven assuming
that in themselves they accurately describe the extent of riskare
not the full story. The statements of risk in the promotional
material must be assessed in the wider context of the way in which
clients were led to believe that zeros were, overall, a safe investment.
The greater was the general belief among inexpert investors that
investments were 'low risk' when they were not, the greater was
the onus on those advising themor on those designing the
products and promoting them through advisersto make clear
what the risks were. It was insufficient for the warnings to be
little more than small print. Of course, the level of compensation
must take into account the fact that any alternative investments
had the investors not invested in zerosmight also
not have fared very well.
43. In many cases an independent financial adviser
or broker would have been involved. In coming to a view as to
whether fault lies with the adviser or with the firms supplying
the information to the adviser, the question which needs to be
addressed is whether the adviser could have been expected to have
spotted the real nature of the 'newer' splits. Mr Alexander, arguing
that all the players in the field held some responsibility for
what had happened, suggested in respect of IFAs that some had
simply relied on their previous confidence in splits and in managers
such as Aberdeen rather than examining the underlying information
properly. He noted
also that some advisers had looked at investing in some of the
splits and had rejected them as desirable investments.
He felt therefore that there were grounds for negligence claims
against advisers who had recommended these products to clients
who had asked for low risk products, and against any brokers who
had sold products directly to clients where the clients had received
misleading marketing material.
44. The Association of Private Client Investment
Managers and Stockbrokers (APCIMS) and individual professionals
have cited to us instances where disclosure from the boards and
fund managers to investment advisers about investment portfolios
etc may have been incomplete or misleading.
Mr Godfrey, when asked whether professional investment advisers
should have spotted the risk, replied "I
doubt whether most professional investment advisers would have
had the competence or experience or level of knowledge to have
dug into this and found that which the product manufacturers themselves
did not find."
Future developments and financial
45. Brewin Dolphin told us that they had "put
in place a dedicated team to examine complaints" from their
clients. We note
that Aberdeen accepted that, in the case of its Aberdeen Progressive
Growth Unit Trust, some compensation was appropriate.
Mr Gilbert told us "...
we marketed that as a low risk product ... and while we can look
at the marketing literature we produced for the unit trust and
legally it stands up ... we have taken the view that we are not
happy with the performance of that fund. Therefore we are proposing
and are still committed to an uplift package for all the people
who have bought ... not just those who have bought directly from
us, but everyone who has bought."
When challenged in October 2002, following press reports that
Aberdeen might be reconsidering their proposed 'uplift package',
Mr Gilbert stated that the story was "absolutely
January 2003 Aberdeen told us that their "commitment
to the ... uplift package remains unchangedwe continue
to work towards its finalisation".
46. What has happened has caused harm not only to
the splits directly affected but to the whole splits sector and
possibly to the whole investment trust sector. The damage could
be even wider still, reducing confidence in the whole savings
process. It is important that confidence is restored and this
will not be achievednor will justice be delivered to those
who have suffered lossesif the issue of compensation is
fought at length through the courts.
We look to the various firms involvedtrust fund managers
and sponsoring brokersto be as positive and accommodating
as possible in their approach to compensating investors who may
have been mis-sold investments based on zeros in new-style splits.
We note that some steps have already been taken by the companies
involved. It may be in the interests of the investment trust industry
to go beyond what they might regard as their legal obligations.
Given the delays which some investors may inevitably face in obtaining
redress through the formal mechanisms already in train, one possibility
would be for the investment trust industry speedily to establish
a compensation fund for small investors who have suffered losses
from zeros; sums paid from the fund could in part be recovered
from the firms responsible if and when a compensation liability
Measures such as this could go a long way to restore the reputation
of the industry. This is an issue to which we will continue to
pay attention and to which we may wish to return if there is evidence
that firms involved are not responding as they should.
47. In practice, many cases are now coming before
the Financial Ombudsman Service (FOS) and are being resolved.
A case can only be dealt with by the Ombudsman once the complainant
has already raised the matter with the company concerned and failed
to receive satisfaction. As at 22 October 2002, the Ombudsman
(Mr Walter Merricks) had received 1054 complaints.
At that time, he suggested that the reason he had not received
a greater number of cases, given the wide publicity surrounding
the issue, may have been that people were uncertain whom to complain
against: people were not clear whether their complaint lay against
their financial adviser, or against a fund manager, or someone
else. He indicated that they were 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 wish to do".
Since then, the number of cases has risen to 2097, with cases
continuing to come in at a rate of 50-100 per week.
The Ombudsman came to preliminary findings on some of the cases
in December 2002, but has not yet come to final conclusions.
48. The FSA told us in July 2002 that enforcement
investigations by them into the promotional and marketing material
issued by authorised firms were under way. In October 2002 we
were told that these inquiries were continuing,
and that it was hoped it would be possible to bring the first
cases on possibly misleading marketing material before the Authority's
Regulatory Decisions Committee around the end of 2002.
We understand that in fact the first cases are now expected to
reach this stage in the near future. It is important that both
the Financial Ombudsman Service and the FSA complete their zeros
mis-selling investigations quickly.
49. It is not fully clear to us how these parallel
sets of inquiries relate to each other. The FSA explained in a
note to us that while its "investigations
cover the conduct and behaviour of the firm generally", the
FOS's inquiries "will
be limited to considering only those complaints it has received
from customers ... In particular, it is limited to considering
each case on its own merits"; the FSA therefore did "not
see a significant amount of duplication between the FSA's current
investigation ... and the FOS's inquiries".
It explained that it was able to make material available to the
FOS in certain circumstances under a Memorandum of Understanding.
50. While we accept that the two bodies are performing
different roles, we can nevertheless see areas of difficulty.
First, the two bodies might in practice form different judgements
as to what constitutes an appropriate risk warning on what are
basically the same facts, albeit one is generalised and one is
specific. Secondly, in dealing with the large number of complaints
in a related field, the FOS has-quite properlygrouped together
similar cases. In adjudicating on these he is in practice likely
to set down general principles as to expected behaviour, and in
doing so there is the possibility of overlap or conflict with
the role of the FSA. APCIMS noted that the "FSA
and the regulatory bodies which it superseded always refused to
provide a definition of risk" and expressed concern that
the FOS would be making decisions on risk "without
having a regulatory definition of risk [with] the clear consequence
that there is potential for defining risk by hindsight".
Thirdly, their inquiries are pursued on different timescales,
so that clarity of outcome is lacking. As APCIMS have noted "The
Ombudsman timetable and the FSA's timetable are mismatched. The
FSA's investigation on the marketing material is unlikely to be
published until summer 2003. The Ombudsman is under pressure to
decide much earlier on the cases that have been referred to [him]".
It could be problematic, for example, if the FSA were to find
that a company had in effect been guilty of mis-selling, whereas
the FOS had already found in favour of the company in the individual
cases referred to him. There is a need for greater clarity
as to the relationship between the different inquiries being carried
out by the FSA and the Financial Services Ombudsman into the problems
of mis-selling in relation to splits. We recommend that the FSA
publishes a fuller statement, as a matter of urgency, explaining
how the apparent conflicts between the FSA's inquiries and those
of the Ombudsman can be reconciled. These problems are compounded
by the fact that the FSA is also pursuing inquiries (as we discuss
below) into even more serious allegations of misconduct which
go beyond simple mis-selling.
51. We note that much greater information about splits
than was typically the case in the past, including crucially their
levels of bank borrowing and of investments in other splits, is
now regularly placed in the public domain. This is due in part
to the work of the AITC, as part of the sector's efforts to restore
confidence, though they are dependant on cooperation from all
the companies concerned.
Details of this work are given in the AITC's written evidence.
Aberdeen themselves have also taken steps to place more information
in the public domain regularly.
The FSA has been supporting these initiatives.
We commend the steps, albeit belated, taken by the investment
trust industry to improve the level of information publicly available
about splits' affairs, including borrowings and holdings, and
the frankness of the evidence given by Mr Godfrey of the AITC
in explaining the shortcomings of the splits sector.
44 Ev 136, para 18ff Back
Dr Adams noted that there "was a rise in the number of unit
trusts investing in ZDPs" in 2001 and 2002, citing also
unit trusts managed by Exeter, Framlington and Gartmore [Appendix
Though we received evidence from Mr R Plummer arguing that the
warnings should not have been accepted by the FSA (as the UK Listing
Authority) as adequate, and Mr P Challens noted one case where
the risk warnings in the original prospectus were not repeated
in the formal offer letter for a subsequent issue of shares [memoranda
not printed]. Back
Q 266; see also Q 820 [AITC.]. Back
Q 317 Back
Q 386ff; see also documentation for Aberdeen's Enhanced Zero
Trust, Ev 205. Back
It also contains an entry in respect of the effects of management
charges, stating "Certain trusts deduct part of their management
charge from capital, which increase distributable income, at the
expense of capital, which will either be eroded or future growth
constrained ." Back
Though our attention was drawn to an analysis from Smith New Court
as early as 1992 which cast doubt on the adequacy of the traditional
ways in which the safety of zeros were measured (see Appendix
3 [Dr Adams]). Back
It is important to note that the same analysis does not apply
to non-zero share classes in splits which were, as noted earlier,
always recognised as involving higher risk (see for example Q
For a selection of such quotations, see Ev 207. Back
Q 375 Back
Q 482ff. Back
See Q 490ff. Back
Appendix 3 [Dr Adams] Back
Q 817 ff. and Ev 207 Back
Ev 126, para 3; Q 266 Back
Q 270 Back
Q 260 Back
Q 266 Back
Investment Trust Companies Annual Review, 10 January 2001. Back
Ev 175, para 9 Back
Ev 175, para 11 Back
Qq 686-687 Back
Qq 273-274 Back
Q 277 Back
Q 279 Back
Appendix 2, para 3.1; see also evidence from Mr P Challens [Memorandum
not printed]. Back
Q 791; see also Q 847 ff. Back
Ev 175, para 12 Back
Aberdeen saw this as being in addition to any obligation it might
be found to have to compensate anyone who had been mis-sold a
zero (Q 531). Back
Q 395 Back
Q 537 Back
Information supplied by Aberdeen (24 January 2003) Back
Q 365 [FSA] Back
The level of losses refunded might be weighted to reflect overall
market falls. Back
Q 368 Back
Q 370 Back
Figures as at 23 Jan 2003 (see Appendix 6) Back
Ev 134, para 1 Back
Q 337 Back
Appendix 5 Back
Appendix 2, paras 6.4-6.5 Back
Appendix 2, paras 6.1-6.3 Back
Ev 190 ff. Back
Aberdeen sponsor the monthly Split Capital Closed End Funds
Monitor, prepared by Fundamental Data Ltd. Back
Q 200 Back