Investors misled over split caps

The committee found evidence of malpractice

MPs have delivered a scathing report into the management of split cap investment trusts.

The Treasury Select Committee says many split cap products were touted to investors as safe when in fact they were extremely risky.

Several split cap trusts have gone under in the past 18 months, wiping out millions of pounds of investors' money.

WHAT ARE SPLIT CAPS?

Investment trusts are basically companies which invest in other companies.

Normal shares offer both income - through a dividend - and capital growth, through the rise in the share price.

But split cap trusts split the income from any capital growth by issuing two types of share.

Investors who take capital shares give up their right to income in exchange for getting the lion's share of the capital growth.

By taking income shares, investors give up their right to capital growth in exchange for taking most of the income. That reduces the risk to their capital.

Capital investors are gambling on the share price, and risk losing heavily if it falls.

Income investors will be hurt by cuts in dividends by the companies the trust invests in.

It later emerged that some of these trusts had invested heavily in each other, weakening their financial position.

"This is a scandal - of that there is no doubt," says the committee's chair, John McFall.

Tarnished

"The sad thing is that the whole investment industry is tarnished and as a result of that people's confidence in saving is dented."

Up to 50,000 people bought shares in the trusts after being told they were "low risk".

Many of them lost more than 90% of their investment.

The fund managers had been putting money in each others' trusts, so that if one trust rose in value, the others would as well.

But this also meant the risks were much higher - if the share price of one trust collapsed, others would, too.

The reputation of the whole industry is at stake here.

John McFall MP
Committee chair

About 50 split cap trusts - one-third of the total - were suspended from dealing on the stock market, with a number of trusts cutting dividends to stay afloat. Several have declared themselves insolvent.

The report says some of the managers running these trusts have been involved in serious malpractice.

"We have been left in little doubt that there is substance in the suggestions that there was some form of 'magic circle' operating in a manner harmful to the interests of shareholders," it says.

Trundle on

Mr McFall comments: "My committee's report is calling for the industry to attempt to restore its reputation by offering compensation upfront and quickly.

"We cannot wait for the legal processes to trundle on for two, three, four or five years.

"There are compensation issues but we also have the financial ombudsman service for people to write in and seek redress.

"We are convinced that many people will be entitled to this because £687m has been lost as a result of this debacle."

The committee also criticised the Financial Services Authority for being less pro-active than it might have been in responding to the "developing dangers" of split cap trusts.

Timetable

But as well as carrying out an inquiry into what went wrong, it is recommended that the FSA also oversees the investment trust sector in future.

"They should provide a timetable for the inquiry that they are undertaking, they should report quickly and if their powers are inadequate then the Treasury must help them," says Mr McFall.

He also hopes that those within the "magic circle" will be brought to book.

"They must be rooted out because the reputation of the whole industry is at stake here," he adds.