Split-cap managers face heavy fines

City watchdog says most financial institutions are bearing up well

Sir Howard Davies, the chairman of the Financial Services Authority, indicated yesterday that the City regulator is moving towards handing out heavy fines to certain split capital investment trusts for "absurd" promises that left thousands of investors losing all of their money.

Speaking at the FSA's annual meeting, Sir Howard lashed out at the split capital sector, saying it was a "striking example" of financial institutions which have not behaved prudently, leaving them vulnerable to the current downturn in the markets.

Sir Howard said: "This is an unhappy episode, where exaggerated and in some cases absurd claims about the security of particular investments have misled some investors into believing they were putting their funds into relatively safe vehicles."

The FSA has been scrutinising split caps since last September and is thought to be in the final stages of preparing enforcement proceedings against managers it believes issued misleading marketing material.

The authority is also pursuing allegations that there was widespread mis-selling of split caps by financial advisers and others. The third prong of its investigation is into whether certain managers agreed to invest in each other's trusts in an attempt to keep the price artificially high.

Under its new enforcement powers, the regulator can impose unlimited fines on companies. Those being targeted for their management of split caps are likely to appeal, which means that no fines will actually have to be paid before the beginning of next year if their appeals fail.

The financial ombudsman is considering the cases of around 280 investors who have complained about split caps and will be at the stage of ordering compensation in some cases in a couple of months.

Just as Sir Howard launched his attack on split caps, another one announced it was engulfed in debt and suspended its shares. Aberdeen High Income Trust said it was in talks with its banks in an attempt to avoid forced closure of the trust and breaking up its assets.

Turning to other sectors under pressure from the continued drop in equity values, Sir Howard acknowledged that some life assurers have been selling shares recently in an effort to shore up their reserves.

But he insisted that the life assurance industry was meeting its minimum solvency requirements. He said a further relaxation of the resilience test to monitor solvency could not be ruled out, but confirmed that the FSA was not talking to insurers about doing so at the moment.

Sir Howard repeated his reservations about life companies using future profits as assets, which they have been doing increasingly in the past year as their investments, mainly in equities, have fallen.

The City's most powerful regulator said that apart from split caps, most financial institutions were bearing up well to the tumultuous state of the market. Banks were singled out for particular praise for being able to remain strongly capitalised and profitable due to sensible lending and investment decisions.

Given the robustness of most companies, Sir Howard observed that it was "a little bit strange" that the FTSE 100 has fallen 40 per cent from its peak two and a half years ago, while the Dow Jones is only down 27 per cent from its high point.

"We have not had anything like the scale of difficulties that the US has had. It seems that the winds coming across the Atlantic have got stronger the further east they have gone," Sir Howard said.

He added that public fears of a repeat of Enron in Britain were "overdone", but added that it could happen here, which was why the Treasury, FSA and others had to consider carefully whether change was required to the regulatory regime.