Crunch time for split-caps

Will the watchdog succeed in getting financial companies to compensate their former investors, asks Jenne Mannion

Compensation for investors whose savings plummeted when the split-capital investment trust sector collapsed in 2002 will be on the agenda next week as a two-year investigation into the so-called "magic circle" debacle draws to a close.

Estimates show more than 50,000 people lost £650m when the sector collapsed, and John Tiner, the Financial Service Authority chief executive, has summoned 21 financial institutions, including fund managers, stockbrokers and independent financial advisers, to a meeting in London on Tuesday.

After the FSA's biggest investigation, the watchdog is expected to ask the groups for plans to compensate victims, rather than enforce action. Groups involved include Aberdeen, BFS, Exeter, Gartmore, Framlington, Jupiter and Morley. Mr Tiner has promised to report the FSA findings.

Split-capital trusts have two or more classes of shares that pay different types of returns. One class of the same trust will pay a high income without capital growth, and others will pay higher growth at the end of a period, if investors forgo dividends.

The shares were sold as low-risk products that would pay a regular high income, or a pre-determined capital return at the end of a set period. But the declining stock market meant necessary hurdle rates were not met. And many split-capital trusts had shares in each other, which caused a domino effect as stock markets fell. This was exacerbated because many trusts had high borrowings.

The case against providers is based on these cross-holdings among a large number of splits, and also that splits were mis-sold as safe products at a time when they were becoming increasingly unstable and risky.

The 21 institutions accused have been subject to confidentiality clauses, so are reluctant to comment officially about the summit on Tuesday. But some of them believe the FSA has suggested voluntary compensation contributions because it was unable to collect sufficient evidence. There are suggestions that demanding compensation could lead to any evidence being tested.

But Leon Kaye, director of the solicitor Leon Kaye, which is acting for 600 clients who believe they were mis-sold split-capital trusts, says: "There is clear evidence against the industry. It is unlikely the FSA has had problems locating this."

The FSA does not have the power to demand financial groups pay compensation. Stephen Alexander, partner at the solicitor Class Law, said the FSA could impose fines, but not compensation orders. In most cases, compensation for financial products comes through the Financial Ombudsman Service.

Mr Kaye said the FSA's concept of voluntary contributions for compensation should be encouraged, but he is uncertain the firms would comply without enforcement.

Any voluntary fund would have to be more successful than the Hardship Fund established last year by the Association of Investment Trust Companies (AITC), the trade body for the investment trust industry. Although official figures have not been released, it is understood this has raised just £1m of its £10m target.

The AITC's aim was to offer emergency support to people left in financial hardship caused by failed investments in split-capital trusts. But fundproviders were reluctant to contribute in case this was seen as an admission of guilt, although awards from the fund would not be classed as compensation.

Mr Alexander, who is acting for 700 clients, said action by the FSA would not affect his clients' claims to compensation. "Any compensation organised by the FSA will be parallel to our action," he says. "We are carrying on with our cases."

Annabel Brodie-Smith, communications manager at the AITC, says her organisation had not been invited to attend the Tuesday meeting. "But we welcome the fact that this is on its way to being resolved, which is in everybody's best interest." The only area where investors have had success is through legal challenges.

Mr Alexander said Class Law had settled compensation for several recipients who bought into Aberdeen's Progressive Growth unit trust. The trust's advertisements in 2001 claimed they had "the one-year-old that lets you sleep at night", but the share price tumbled 75 per cent the year after. Investors told the FOS they had been misled. Other investors in Growth have been promised an uplift by Aberdeen's chief executive, Martin Gilbert. That comes into effect in August, 2005, at its five-year redemption date.

The recovery in the stock market over the past 12 months means Aberdeen's liability for compensation is reducing. The share was trading at 26p last week, more than half the 50p launch price in August, 2000. In October, 2002, it was 12p.

FACT FILE: SPLIT CAPITAL TRUSTS

There are 120 split-capital investment trusts, with capital split into three types of share:

* Zero dividend preference shares, or zeros, which have a maximum redemption value paid only if market performance has been good enough. No dividends are paid to holders of zeros

* Income shares, which pay dividends

* Capital shares, which pay no dividend. Their value will depend on how much money remains in the company after zeros and income shares have been redeemed and borrowings repaid