Michael Harrison's Outlook: Governance police shoot one of their own

The FSA's little list; Inflation Report

The line of scalps in the Hermes trophy cabinet is impressive and includes, among others, the former Mirror boss David Montgomery and Sir Angus Grossart, lately but no longer head of Scottish Investment Trust. Now the corporate governance activist which serves to invest the money of the BT and Post Office pension funds has a couple more to add to its collection. Unfortunately, they have both come from within its portals.

The line of scalps in the Hermes trophy cabinet is impressive and includes, among others, the former Mirror boss David Montgomery and Sir Angus Grossart, lately but no longer head of Scottish Investment Trust. Now the corporate governance activist which serves to invest the money of the BT and Post Office pension funds has a couple more to add to its collection. Unfortunately, they have both come from within its portals.

Peter Butler and Steve Brown, two of Hermes' top directors, have been forced out after a classic boardroom bust-up over the future of the flagship funds division they run, Hermes Focus Asset Management.

The delicious irony of this will not be lost on all those businessmen who have felt the righteous lash across their backs of Messrs Butler and Brown as they rampaged through the land in their mission to clean up the British boardroom.

In the end, the falling out seems to have come down to filthy lucre and a dispute over the future ownership of HFAM, which accounts for just 3 per cent of the £46bn Hermes has under management but a rather bigger share of its profits. The two founding directors wanted a slice of the action, arguing that the fund comfortably outperformed the rest of Hermes last year and yet all they got in return was a measly £1.8m each.

Tony Watson, Hermes newish chief executive, backed no doubt by BT's pension fund trustee, saw things rather differently, pointing out the potential for conflict if one part of the business was semi-detached from the rest and run by employees who were shareholders.

As head of corporate governance at Hermes, Mr Butler above all, should have understood this. M'learned friends have been hard at work drawing up the severance terms. Meanwhile, stand by today for the obligatory statement of sweetness and light from Hermes, wishing the two men well and looking forward to HFAM's bright future under its new leadership, as if for all the world nothing untoward had ever taken place. If Hermes needs any help with the scripting, there is no shortage of victims to turn to.

The FSA's little list

Now listen up. Or, if you prefer, just List! The official newsletter of the UK Listing Authority does not constitute formal guidance. Nor should it be taken as a statement of policy from its parent organisation, the Financial Services Authority. But here's a word in your shell-like. List! wants everyone to know that the UKLA takes an extremely dim view of analysts being lent on to guarantee favourable coverage of new issues. Nothing so unsubtle as the thumbscrews. More the cold-shoulder, "freezing out" those perceived to be negative towards an IPO in favour of cuddling up to analysts who are prepared to write, shall we say, more positive research notes in return for selective information or privileged insights.

In the good old days, the issuers of new shares, particularly very big ones, virtually guaranteed themselves favourable coverage by hiring every investment bank in sight, thus ensuring that their broking arms would toe the line.

That is not so easy these days with a plethora of smaller, independent brokerages prepared to speak their minds and fund managers themselves increasingly acting as their own research analysts. In the case of the recent Virgin Mobile float, for instance, there were no fewer than 13 independent buy-side brokers offering their verdicts on the stock.

So the pressure from issuers has had to become more insidious, from the downgrading of relations with unco-operative brokers right through to the threat of legal action to suppress unfavourable coverage of upcoming share issues, not just by analysts but by financial journalists as well, on the grounds that pathfinder prospectuses are privileged documents.

This is a grey area of the law, so it is not surprising that the FSA is reluctant to jump in with both feet to make issuers subject to the same constraints under the listing rules as the research houses which follow them. At the moment, the onus is on the broker to ensure his judgement has not been clouded by an agreement to produce favourable coverage. But it is a perilously thin line between an issuer going out of its way to ensure favourable coverage and active abuse of the market.

The pumping and spinning of new issues at the height of the dot.com bubble, predominantly on Wall Street but also over here, demonstrated how easy it can be for professionals to mislead the investing public when there is a fast buck to be made. And so the FSA's strictures are understandable.

How much longer the relationship between issuers and analysts can be adequately dealt with under a regime of self-regulation is a moot point. In the meantime the FSA is relying on whistleblowers to keep it informed. All strictly confidential and on the QT.

Inflation Report

How quickly the landscape, as viewed from Threadneedle Street, seems to change. A couple of weeks ago, the worry was whether a half-point rate rise would be enough to slow the economy down. Now the issue appears to be how close we are to the peak of the interest rate cycle. Another quarter point increase before the end of the year might just do it or, at a push, one more after that.

In his admirably candid way, Mervyn King observes that it is virtually impossible to say with any confidence what is going to happen to output, inflation and therefore interest rates. The latest quarterly Inflation Report from the Bank of England rams home the Governor's message, noting that its central projections for inflation and growth have virtually no chance of actually coming to pass. House prices? Don't ask us about them. The central assumption is that they have peaked and will now gradually subside but we have been saying that for the past two years.

The crucial difference now is that the Bank is no longer making forecasts of what will happen to inflation and growth two years out based on interest rates remaining where they are but on the basis of where the futures market believes they will be. On this test, consumer price inflation hits its 2 per cent target two years out with rates just a shade above 5 per cent. That suggests one more quarter pointer, two at most. It is a virtuous circle with the Bank re-inforcing the market's view and the market feeding back into the Bank's forecasts

As the Governor cautions, he could just as easily be wrong, in which case all bets are off. But on the basis that he is not, there is a growing body of opinion which says that rates are somewhere near the top. Mortgage lenders should take note.

When the dear departed Nicholas Ridley became Secretary of State for Trade and Industry in 1989 he frightened the socks off the Permanent Secretary by asking him what the department was for. Fifteen years later, they are still trying to answer the question. Labour and the Tories seem to favour death by a thousand cuts and the Lib Dems immediate execution. David James, the Conservatives' trouble-shooter, reckons 5,000 job reductions at DTI headquarters would save the equivalent of what the Millennium Dome cost. An apt analogy perhaps for the white elephant of government departments.

m.harrison@independent.co.uk