FSA 'sat on' early alarm over £12bn scandal

The Financial Services Authority was warned about "splits", split-capital investment trusts, long before the £12bn scandal broke late last year.

The warning came from the offshore regulator Peter Moffatt, who says he believes the FSA should have warned the UK public much earlier about splits.

Mr Moffatt, director of investment business at the Guernsey Financial Services Commission, says he had warned the UK regulators in the spring of 2001 and had also written to the Association of Investment Trust Companies' (AITC) corporate governance adviser at the end of 2000.

Private investors have lost millions due to the fall in value of the split capital funds, which were marketed as safe investments. There are also allegations of collusion by a group of funds referred to as "the magic circle" which bought stakes in each other's fund, a move that amplified the fall in values when the markets turned down.

Splits initially seemed to be the perfect solution for investors, who wanted income, growth or a predetermined fixed return as the fund issued shares tailored for each of these requirements. Many splits operated offshore for tax purposes and all are limited life, closed-ended funds.

Splits have grown rapidly over the last five years and now have assets of £12bn. The funds had often been sold as high return but at low risk. Then last year investors began reporting major losses. Some individuals who had invested £6,000 found their capital had dwindled to just £500.

One of the first to raise the alarm was stockbrokers Cazenove in July last year. The broker was concerned by the high gearing of some of the funds raised at the peak of the 1990s bull equity market and the cross-holdings of the income shares by other splits. This led to major restructurings of funds as the net asset value of the funds fell and risks were transferred to other splits by the cross-holdings.

However, before these public warnings, Mr Moffatt had changed the regulations in Guernsey in April 2001 to highlight these risks and had warned UK authorities they might need to do the same.

Mr Moffatt said: "The issue was not the gearing, which was usually spelt out, but the cross-investment in each other. I raised this issue with the AITC and the regulator and they said the splits had the capacity to diversify.

"This is not the point, it is whether they did or not in practice. The view in the regulator was that investment trusts were for institutional investors and there would not be a benefit in being more intrusive."

Last week, the FSA said it began its work on splits early last year and that the cross-holdings of each other's funds, the "magic circle", had not breached regulations.

The FSA finally raised its concerns in a report published in May 2002 raising concerns about splits. But the report was most concerned about the gearing and critics dismissed the report as nothing more than a slap on the wrist for the sector. FSA said problems existed with only a "minority" of splits.

The FSA is now conducting a major investigation into collusion between fund managers. They are also investigating the independent financial advisers who sold the splits, and the marketing literature.