Davies orders curbs on split cap trusts after savage attack by MPs

Stung by an MP's criticism that he had been "asleep on the job", Sir Howard Davies, the chairman of the Financial Services Authority (FSA) last night ordered a crackdown on the scandal-ridden split-capital investment trust industry.

Although the measures are disguised as "changes to the listing rules governing the interests of investors in investment companies", there is no doubt they are aimed at the managers of the split-capital trusts, which have lost millions of pounds for an estimated 50,000 investors who thought they were putting their money in low-risk investments.

The measures include an annual election of investment managers, a limit on the percentage of total assets that can be invested in other funds, greater clarity about the investment policy to be followed and the extent of borrowings, and public warnings about the likely risks and how they will be mitigated.

Shareholders will have to approve any material change in investment policy, instead of only in the first three years as at present.

Investment trust prospectuses or listing particulars will have to include risk warnings "in language that investors will clearly understand". There will be exceptions for funds of funds, where one fund explicitly invests in other investment trusts.

This announcement partly offset the damaging effect of Sir Howard's lengthy appearance before the Treasury Select Committee earlier in the day, when he was forced to reject suggestions that the FSA had done nothing for six months after issuing a general warning about the trusts.

Sir Howard said regulatory notes issued in March 2001 had said there could be risks with income shares in splits. These trusts are split into two classes of shares, one of which receives all the dividends and income from the investments and the other ­ known as the zero ­ enjoys all the capital growth.

But Sir Howard conceded that the FSA had failed in its warning to make a distinction between the low-risk zeros and the higher-risk income shares.

Michael Fallon, Conservative MP for Sevenoaks, challenged Sir Howard that for six months after that general warning the FSA had been "asleep on the job". Sir Howard replied: "I don't think so. I think we are doing rather a lot of things."

Split-capital trusts have been discredited after about 40 of the 120 trusts ran into difficulties due to high levels of holdings in each other, high borrowings to invest in other companies, and stock market falls.

MPs also renewed their criticisms of the FSA for failing to respond to a warning from the Guernsey regulator over the dangers of high levels of cross- holdings in each other by some of the trusts.

During a heated exchange John Tiner, the managing director of the FSA's consumer,investment and insurance directorate, denied he had misled the committee on a previous occasion by saying the FSA had not received any correspondence from the Guernsey regulator.

He said: "I gave an honest answer on the information I had, which was that we had not received correspondence."

Sir Howard said the FSA had carried out "some research" in the early part of 2001 into the potentially incestuous nature of the trusts, but said early research did not substantiate concerns about the supposed "magic circle" arrangements, in which some split-capital trusts invest in one another. Subsequent analysis had caused the FSA to take a different view.