City Index admits spread bet with Plumber 'smelt bad'

City Index, the company at the centre of the "Plumber and Spaniard" spread-betting fiasco, admitted yesterday that a controversial wager it took on a recent flotation had "smelt bad" and had proceeded despite being queried internally.

The spread betting firm took a £6m bet from Paul Davidson, a former pipe fitter dubbed the Plumber in the Square Mile, that shares in the biotech tiddler Cyprotex would rise after flotation. Mr Davidson is also the major shareholder in Cyprotex.

City Index hedged the deal through a contract with the investment bank Dresdner Kleinwort Wasserstein, which subscribed for 80 per cent of the shares in the float to cover City Index's exposure.

The arrangement raised eyebrows in the City when it emerged this week. By generating such a large committed buyer in the float, the bet in effect guaranteed a strong debut for Cyprotex shares. The wager has also attracted interest because it was placed on Mr Davidson's behalf by his friend Nigel Howe, an employee at Cyprotex's broker Gilbert Elliot.

Michael Spencer, City Index's non-executive chairman, broke the company's silence over the affair yesterday to criticise its actions while revealing that some employees had raised doubts about the transaction. He himself learnt of the deal from this week's newspaper reports.

"I would not have taken the bet myself – it doesn't pass the smell test," he said. "But someone [here] spoke to DKW and found out it was okay with DKW's compliance department, and thought: 'If DKW thinks it's ok then that's alright.'"

He added: "There was a debate in City Index but [we] accepted too readily the fact that Davidson had taken legal advice and therefore everything was ok."

Mr Spencer will be reviewing controls within City Index to curb the size of spread bets in relation to the amount of shares being placed in a float.

Gilbert Elliot also revealed that its staff had questioned why 80 per cent of the shares in the placing were going to one institution. Julian Knight, its managing director, said senior staff had been "satisfied with the answers".

The broker has suspended Mr Howe on full pay pending an investigation into the affair. A separate probe is underway by the Financial Services Authority. No one involved in the transactions appears to have acted illegally.

DKW declined to say why its compliance department had approved the transaction with City Index. Mssrs Howe and Davidson could not be contacted for comment.

Mr Howe was reported to have claimed to have done no more than exploit a legal loophole that allowed a bet to be placed before a company is listed on the stock market.