City regulator ignored warning about strength of split capital trusts, MPs told

The Financial Services Authority was yesterday accused of "recklessness" for failing to intervene earlier in the way split capital investment trusts were run after it allegedly ignored warnings about the stricken sector from regulators in Guernsey.

Class Law, the solicitors firm which is putting together a legal case on behalf of 1,000 aggrieved investors in split caps, said it had been told that the Guernsey regulator passed documents to the FSA last year which raised the alarm about split caps.

The move came after the Guernsey regulator itself took the view in 2001 that some split caps being set up there ought to carry a warning of potential "systemic risk" due to the high level of cross holdings between split caps and because of their heavy gearing.

Stephen Alexander, a partner at Class Law, said: "In our view it should have put the regulator on notice of systemic risk and likely collapse in the marketplace."

Mr Alexander, who was speaking to the Treasury Select Committee, said that the accusations that the FSA did not act quickly enough has cast into doubt the high-profile investigation it subsequently set up into the group of fund managers which set up a large number of split caps.

"This brings into question whether the FSA can properly continue with its investigation. You cannot be a judge in your own court," Mr Alexander told the group of MPs.

Class Law, which is in the final stages of preparing its legal case over split caps, said it has written to the FSA to ask it to explain why it did not act earlier. If the FSA cannot give an adequate response, the law firm may extend its case to the regulator as well as a number of fund managers and brokers.

The remarks raised the temperature in the already fraught debate surrounding the collapse of many split caps, so called because they include different types of shares.

John Tiner, an FSA managing director and head of its insurance division, said it was easy for "ambulance chaser lawyers to make these allegations".

Mr Tiner said the FSA had spoken to its Guernsey counterpart about split caps, but added: "The so-called warnings were not described as warnings by the Guernsey authority and were not regarded as warnings by us."

Mr Tiner pointed out that the FSA did issue a statement to independent financial advisers (IFAs) in March 2001 impressing on them the need to fully understand split caps and to warn investors about their potential risks.

He said the regulator did not go further because its jurisdiction did not extend to investment trusts, of which split caps are a sub-sector. Mr Tiner observed: "There may have been a gap in regulation".

Mr Alexander said among the fund managers involved in split caps, Aberdeen Asset Management, Exeter Investment and BFS were the "principle three" which had launched a large number of the products.

He said he had also received many complaints from investors about Brewin Dolphin, a brokerage which piled many of its private clients into split caps and also earned fees acting as broker to a number of funds.

Mr Alexander said that many of the fund managers who set split caps up in the late 1990s and in 2000 regarded the trusts "as a fantastic opportunity to make huge amounts of money corporately and individually".

He pointed out that few investors realised that management fees on most splits were based on both the equity and debt in the fund. This meant it was not uncommon for a fund with 30 per cent equity and 70 per cent debt to see management fees being levied from investors at 10 per cent.