Do You Sincerely Want To Be Rich? (30 page)

    Hutchinson, a friendly, bouncy man, first came into contact with IOS when he was working for one of the City's more blue-blooded firms of brokers, Laing & Cruickshank. This firm made a speciality of unit and investment trusts, and Arthur Lipper called one day to exchange ideas on the possibility of creating a trust which invested in other unit trusts, as in the original conception of the Fund of Funds. He was put onto Hely-Hutchinson who had done the firm's latest survey. Hely-Hutchinson was interested and went to Geneva where he was told he would get a guaranteed amount of business for working with IOS. But the partners of Laing & Cruickshank decided they did not want to get that closely involved, and Hely-Hutchinson had to make up his mind: Laing & Cruickshank, or IOS?

    He chose IOS, and after some months he found another City broking firm willing to accept him as a partner and do IOS business. The firm was called G. S. Herbert.

    The problem, in the spring of 1967, was to find the most suitably located body to place IOS fund orders with Arthur Lipper in New York. It had to be someone outside the us and it had to be someone who could be seen to be independent of IOS. Hely-Hutchinson in London was the most sensible solution. At the Savoy on April 16 he was asked if he could have the operation set up by the end of May.

    With the noble co-operation of the British Post Office he made it. It was one of the gpo's biggest jobs: telex lines and machines were installed so that the London office would be in constant and direct contact with New York and Geneva. The gpo sprang to its task with enthusiasm, and the new London office in Old Jewry was ready even before those at the other end. But the plan met with a last minute hitch: the officials of the London Stock Exchange decided they did not want G. S. Herbert, a member firm, to place the orders with Lipper directly. A further intermediary had to be found; IOS luckily already had an association with another City firm, the London & Dominion Trust run by Clinton Redgrove, a specialist in South African investment. It was agreed that one room of the offices, the one with the telex machines in, would have a plate nailed to the door saying London & Dominion Trust, so that the orders were actually placed in its name.

    When the day of settlement came IOS was ready. The legal domicile of the FOF proprietary funds was shifted to Canada, but the managers stayed in New York, and their other us bases. They no longer placed orders, but made 'investment suggestions'. These were collated by Arthur Lipper and telexed through to the London & Dominion office in Old Jewry. From there they were passed on to Geneva for confirmation; once confirmed the clerks in the London & Dominion office would turn the suggestion into an order and pass it through an interconnecting window to the next door office which had an Arthur Lipper label on the door. The London office of Arthur Lipper would then transmit the order to the New York office for execution. Hely-Hutchinson had an office the other side of London & Dominion Trust from which he supervised the operation. It was expensive, but Arthur Lipper's commissions were adequate to cover it and the sec order was thwarted. A 'suggestion' could be turned into an 'order' within 45 seconds.

    When the offshore madness reached its peak in 1969, London became the favourite base of a number of the wilder of IOS’s competitors. Britain's laws, like those of many an offshore haven, are tolerant of those who want to use her facilities as long as her investors and her resources are left alone. But when, in early 1967, IOS showed how useful that tolerance could be, the company was no stranger to London. For, unique among offshore firms, IOS had four years before found a way to avoid both the uk securities laws and exchange control laws. It was an operation conducted with the same audacity as those in far flung countries in South America, Africa and the Middle East, but with a much higher degree of sophistication. Britain was the first European country IOS set out systematically to convert to the cult of equity investment.

    The St Augustine of this mission was a small, prematurely grey former lieutenant of the usaf called Roy Kirkdorffer. He had been stationed in England before he left the air force to join IOS, in 1959, in France. He returned to London in October 1962 and took offices in Dover Street in the West End. Let the IOS bulletin take up the story: 'Five hundred miles away, in Geneva, Switzerland, two men are leading a small team working late into the night on a new, as yet un-named concept of insurance linked to equity growth. Their names are Dick Hammerman and Barry Schwartz.'

    Hammerman was one of the few early IOS recruits with a professional financial background. He had worked for a us insurance company and was a chartered life underwriter. He was brought in to set up an insurance company for IOS which he formed in Luxembourg in early 1962 and called the International Life Insurance company. The Fund of Funds itself was launched just as Kirkdorffer was arriving in London. But before he and his salesmen could get to work on the British investors, Hammerman and Schwartz had two major obstacles to overcome.

    These were,
first,
that in Britain no fund, or unit trust authorized under British law, may be sold by salesmen: and,
second,
that no one in Britain can make non-sterling investments without incurring a heavy extra expense. British investors who want dollar shares must first buy 'investment dollars'. These can only be created by the sale of foreign shares by other British residents. They are traded at a substantial premium above the official exchange rate, because demand normally outruns supply.

    Such obstacles should have been daunting indeed to any company whose business was selling dollar investments by door-to-door or cold telephone call methods. But IOS engaged the services of Freshfields, one of the most prestigious firms of London solicitors, who also act for the Bank of England. Together, they came up with an ingenious solution to both problems by using the special status which insurance companies enjoy in British law. Ed Cowett said later: 'We had very imaginative and very sound legal advice in Britain through Freshnelds. I must give them full credit.'

    Getting round the salesmen's problem was easy enough. Although British law does not allow salesmen to sell shares, it does allow them to sell life insurance policies, and this is how traditionally they are sold by most leading insurance companies.

    In Britain, as in many places, the concept of taking precautions against untimely death is inextricably entangled with the concept of making investments for use in life. Often most of the money paid into insurance policies is used for investment, with only a small part covering the 'life risks'. So IOS dressed up the Fund of Funds as an insurance policy, and called it the Dover Plan. The name, drawn simply from the street off Piccadilly in which Kirkdorffer had his offices, was nevertheless another inspired association of ideas, conjuring up the White Cliffs of Dover, security and essential Britishness. A picture of the White Cliffs was used on the front cover of one annual report.

    Getting round the investment dollar premium required much subtler perception of the legal and financial status of insurance companies in Britain. No individual in Britain is allowed to take out a life insurance policy with a company abroad. But London is a world centre for insurance, and earns a considerable income for the balance of payments out of it. Transfers of money between insurance companies in and outside the country are therefore not restricted. Any insurance company in Britain is allowed to 're-insure' its risks with a company abroad, even if that company is its parent. Normally, the payment sent abroad on any individual life insurance policy would be small - commensurate with the small slice of the policy payments actually used for life risks, IOS had other ideas.

    In April 1963, as Kirkdorffer's sales force was ready to swing into action, ili Luxembourg spawned a British subsidiary. For two and a half years after that, ili (uk) sent virtually the whole of the premiums paid to it out to ili in Luxembourg as 're-insurance'. There the bulk of it was invested in the Fund of Funds, i.e. in dollar securities, without the prohibitive extra cost of, investment dollars.' (Part of the premium required to cover the death risk was actually placed in London for reinsurance with an independent company.)

    Thus, with the best of legal advice, the intention of the British exchange control rules was frustrated. That was remarkable enough in itself: the insurance policy which enabled the money to be collected was no less cunning.

    Its special qualities have much to do with the relationship in Britain between life protection and investment, which has always been particularly close because of the tax reliefs granted on life insurance payments.

    Until the early Sixties, the mam way of investing through buying a life insurance policy - in instalments or otherwise -was the 'with-profits endowment policy'. The death benefit under such a policy is small in comparison with the premium taken by the insurance company, which is mostly invested in stocks, shares and properties. The company pays bonuses to the investor out of the income from the capital gains made with the money. Each policy runs for a set period of years, at the end of which the insurance company guarantees to pay back a certain minimum sum.

    The fact that they must always have reserves adequate to meet such guarantees makes life companies of this sort inherently conservative in their attitude to bonus payments. During the Sixties, with the growth of stock market prices, the bonuses paid out on with-profits endowment policies began to lag far behind the growth and income of the underlying investments. This opened up the life companies to the competition of unit trusts, the equivalent of us mutual funds, which began to grow rapidly even though they could not use direct sales methods.

    By the time Kirkdorffer reached London, a new breed of policy had been evolved, called 'equity-linked'. Usually, this had no guaranteed maturity payment, and its value at any moment was determined by the value of the underlying shares -usually, in fact, shares of a unit trust - bought with the premiums.

    The lack of a guaranteed end payment naturally required special safeguards. On a with-profits endowment policy, the insurance company shares in the income and capital gains of the money under its control, taking a slice for its profits and leaving the rest for distribution to the customers in bonuses. It may fail to pay bonuses, but the guaranteed maturity value cannot be touched.

    In normal 'equity-linked' policies, there is a different safeguard: the proportion of premiums that the company can take for profits and expenses is laid down in advance and written into the contract. Otherwise, it is clearly possible for the company to use up all the money in profits and expenses, leaving the policy holder with nothing.

    The Dover Plan was drawn up and sold for some time with no such safeguard. There was no guaranteed maturity value on the policy. It was laid down that ili should take a percentage of each premium payment, before investing it in what is called the 'Equity Unit Account'. But the size of the percentage was not laid down, and the wording of the document was so vague that it is hard to understand how it got the approval of ili's legal advisers. All it said was that the company would invest 'that part of each premium paid under this Policy which after deduction of expenses including investment costs is to be applied towards Equity Units'. More plainly, any of your money that we don't keep for ourselves, we will invest for you.

    For two and a half years the Dover Plan salesmen had everything their way. Equity linked policies were still a novelty and few questioned the fact that the Dover Policy did not specify its charges. Questioned for instance in 1964 Hammerman said that they were about 50% of the first year's premium and 10% of each year's premium for the remaining nine years of the policy. The front-end load of the investment programme had been transferred to the Dover Plan, but this did not seem unfair, when compared with the low surrender-values of a 'with-profits' policy in its early years.

    Then in the summer and autumn of 1966 markets on both sides of the Atlantic dropped sharply by some 20%. Investors generally grew restless, especially those who had recently been converted to the great equity cult. Dover Plan holders wrote in to find out the value of their investments. The replies they got frequently came as a tremendous shock. Many had just not understood the front-end load; they believed the salesman had told them they could get all their money back whenever they wanted, which, indeed, he sometimes had. But even those who had understood the front-end load on the first year's premium were a bit surprised to find that ili was loading the
second
year's premium too.

    The load was not large by comparison with the first year's deduction, but it was nearer to 15 % than to Hammerman's 10. It came as a complete surprise to some Dover Plan policy holders, and to some salesmen too. Hammerman maintained that it had always been the intention of the company to load the second year's premium, but this had hardly become widely known. In December 1966 Barry Schwartz, Hammerman's executive manager who had helped devise the Dover Plan, told a client who had decided to discontinue his policy that from the total amount of premiums received £102 5s had been deducted to cover all first year expenses including investment costs. In the subsequent years an amount of £11 14s would have been deducted each year. This clearly suggested that charges, after the first year, would be even, although in fact they were not.

    Bluntly the wording of the policy document left ili free to raise the cost of the product after the client had signed up.

    The criticism of the Dover Plan reached a peak in the winter of 1966-7. Newspapers and financial advisers were deluged with letters from company directors, retired army officers, vicars, stockbrokers, accountants, bank managers. They had been promised a 'hedge against inflation', and told that their money would probably double over ten years if they invested monthly with the Dover Plan, or treble if they took out 'prepaid' policies (i.e. invested a lump sum). Yet after two years or so, not much progress towards these promises seemed to have been made.