Week 4

Day 13 - Tuesday 3rd May 2005

Page 2. This started with Hapgood for E+Y complaining about disclosure of documents by Herbert Smith acting on behalf of ELAS.

Page 3. Mumford on behalf of Ransom followed cross-examining Charles Thomson. The theory is that CT was operating a very similar scheme at Scottish Widows for dealing with GARs to ELAS's DTBP so how can CT complain about what ELAS did?

Page 24. Headdon cross-examined CT. Why are you conducting a case which might cost ELAS £70 million when your solvency margin is £104 million? CT replies to the effect that living on a knife-edge is normal at ELAS so this particular gamble is nothing new. 'We cannot be confident that we will continue to meet those requirements' , '... meeting the regulators requirements is desirable but not essential'.

i.e. Boring old farts those regulators - just ignore them. Where have we heard that before?

Page 51. The with profits guide and actual and allocated returns was discussed and CT says: "the approach was radically different from what I was accustomed to elsewhere which would start from what money was available in setting terminal bonuses rather than looking at the investment return and deciding how much of that could be allocated"

Page 52: "Not standard methodology to approach the question in this way."

So CT agrees one should look at the internal Office Valuation or Realistic Balance Sheet before allocating final bonuses. As I have repeatedly said ELAS did not do this and it is nice to have it confirmed by CT but why then did he not do the same when announcing the bonus for 2000 in early 2001? It took the arrival of Nowell to put it right.

Page 53 CT explains this: "2001 not time for calm reflection but manic activity" A bit difficult to imagine him in manic activity but was not calm reflection absolutely essential at that moment?

Page 60 Headdon who is cross-examing CT says that in early 2001 CT only had to ask for the Office Valuation - everything was available -
Headdon: " The point I am just making is that this material was around at the time, and I therefore find this insistence that things like realistic balance sheets only became available quite late on in the summer of 2001 rather curious."

I felt rather sorry for CT at that point. He had only been a fortnight at ELAS at that point and why the blazes did Headdon not give him the realistic balance sheet without being asked?

Headdon moved on to another subject at that point.

Page 62. CT appointed Peter Nowell as Appointed Actuary at end of March 2001.

Page 63: Memo from Nowell dated 9th April 2001 i.e. under a fortnight in the post: "I think we should create a realistic balance sheet".

Page 64: Nowell points out that assets are 15% below APV - aggregate policy values. CT says not important as they had already moved the MVA up from 10% to 15% in March.

Page 66ff: Nowell wrote a note on 18th May 2001 a few days before the AGM as markets fell and things got worse. He said a major adjustment was needed to policy values. This was very worrying. "It was felt that this presented a very difficult message to policyholders as it was so inconsistent with the message put out in the early part of the year and with the annual statements ... It is difficult to see that the s.425 scheme would be seen favourably in such a scenario".
The problem was that the fair way of cutting the policy values was to cut the final bonus substantially. This would mean that those longest in the fund would suffer most - the GARs and how could you do that if you were going for a compromise which asked them to give up their rights:

Page 80: "A proportional reduction in final bonus will therefore hit GAR policyholders harder" wrote CT to the Board. It might lead to more litigation as being contrary to Hyman. So the decision was taken to screw the non-GARs instead. If the non-

GARs thought they were screwed by Hyman I wonder how many realise they were screwed again in July 2001 with the blessing of the FSA of course.

Page 83. CT comments that he would have expected assets to exceed APV at end of 1999 in view of the high stock market. So he admits that in a properly smoothed fund you would expect to have a surplus at the end of a Bull run.

Page 88. So much paper! The minutes of the Board meetings disclosed in Court have been heavily redacted. Unfortunately they disclosed the draft minutes of one meeting as well and forgot to redact them. Dear me how embarrassing. No doubt the head of some trainee will roll in HS.

Page 94. The matter of the July 2001 cuts having been discussed with the Board from 18th May onwards, Treves contributes to an article in the Daily Express claiming he only knew about this on 27th June:

"When it comes to understanding events at Equitable, timing is crucial, says Treves. His lawyer's eye for detail is evident as he fetches his diary so he can accurately run through his meetings since taking charge. One of the first things he did after appointing the highly qualified board that has replaced the discredited team whose decisions helped spark the crisis was to commission a report into the true state of the business.

The review was presented to him on June 27, and it was only then, insists Treves, that he discovered just how desperate things were at Equitable. "'I was shocked. It had never crossed my mind that things were so bad. The piece of paper that most surprised me was a graph that showed over the course of 10 years the gap between the asset values and the policy values. There was an ever increasing divergence between the two. That was the piece of paper, supported by endless statistics, that did it for me'. "Without slashing the value of the policies, this enormous and unsustainable gap would never be closed. The fact that the fund is mature, with no money coming in from new business, led the board, after a series of intense meetings, to make its crucial decision, rather aptly on Friday, July 13th. "'It was then that we looked at each other and said, "We cannot go on living with this". I have to say that from the earliest meeting at which the information was made available there was very little doubt that firm action needed to be taken, and urgently. With every passing day, the situation was getting worse and worse. There was not the slightest sense in my mind or that of the board that things were going to be all right.'"

Well actually the figures were converging not diverging!

The loyal Mr Thomson, when asked by Headdon, admitted that he did not see a close parallel between his own version of things given under Oath earlier and that of Mr Treves.

Page 104: Mr Headdon suggests that all are agreed that the July 2001 cuts were made only because of the fall in the Stock Market. CT says he is not quite so sure. But what about the October 2004 meeting he said just that?
Page 110. CT's alzheimer's is getting worse with loss of short term memory: "Again, I am sorry, I do not have a recall as to what went on between March and October. And that was 2004.

Day 14 - Wednesday 4th May 2005

This was much less entertaining. Mr McGeough of Dentons who had acted for ELAS ever since 1745 or something was in the box. He had never attended Board meetings or received Board papers prior to those meetings but he had always had a very good lunch with them afterwards.
Obviously very embarrassed to be called by ELAS to give evidence against his old chums. I think the idea was that he should say that he had warned that the Hyman case could be lost and that therefore the old Board should have taken action earlier. He said he had put down a Caveat that the way of declaring bonuses did not accord with policy conditions but otherwise was not very helpful either way. Cross-examined by the defendants' Counsel he did not add much more. To Martin he said he had never heard of Bratton Seymour. He was the client partner. He had had no part in instructing Warren.

Denton's litigation partner Cindy Leslie was more helpful if slightly sybilline: "It was ridiculous to think that they would have thought or I would have thought that a case that had good prospects would necessarily win". She felt there were specific risks.

P.S. Yesterday Tuesday 17th May I dropped into Court 76 for the morning. Acres of folders as if one was in the Public Records Office. Headdon in the box being cross-examined by Milligan. Headdon is really impressive. Relaxed, urbane, highly intelligent, very careful with every answer. He not only answers the questions after some thought but adds on a short highly informative lecture to explain the issue in more detail and with great clarity. The only problem was that Milligan was asking him all the wrong questions. ELAS's case is that from 1996 the Board should have known the risks of Hyman and done something including slashing the bonuses by dramatic amounts. Headdon carefully explains that they were cutting the bonuses but they had to pay attention to PRE and not cut them too fast. Nobody suggests that 1996 was too late and they should have cut the bonus back from 1990 onwards, not because of Hyman, but because of the second black hole. One wonders quite what Milligan is up to - perhaps just passing the time of day until the case collapses. Headdon has all the answers - he gave a very detailed explanation of all the factors that need to go into making a decision about bonuses. I wonder how many noticed that the one thing he omitted was the realistic balance sheet. Milligan failed to land a single punch but was he trying? The Judge just looked on seemingly making only the rarest of notes. Headdon negligent? He certainly does not give that impression.

And by the way, once you have got the assets and the policies back in balance, all your problems have been solved. The fact that one generation has benefited from overpayments at the expense of later generations was not something that could be mentioned. Presumably most of the beneficiaries of this were GARs - so don't mention it please.

Day 15 - Thursday 5th May 2005

This was Cindy Leslie - the litigation partner in Dentons - being cross-examined by Leaver.

The background is that like Mr McGough the day before she is being called by ELAS to give the impression that she warned that the Hyman case could be lost. The Defendants want to show that she never warned them explicitly or so strongly that they should have taken precautions. This is going to be a question for the Judge to make his mind up on. She clearly said that any litigation is not certain but that the dreaded scenario 6, which is what eventually happened, was very unlikely. For me the question is when you know that there is a scenario 6 that is catastrophic can you just ignore it because it is very unlikely. Should you not take some precaution?

Page 2. Cindly Leslie (CL) agreed that it was going to be necessary to reserve for £1.5 billion win or lose Hyman. Fools will remember that the Treasury was insisting on this reserve for the GAR liabilities quite apart from Hyman. ELAS of course were hoping to get the Treasury to change its mind but that was another matter. What Hyman decided was that the £1.5 billion was going to be screwed, in large part, out of the non-GARS.

ELAS wanted to keep quiet about this because of the effect it would have on their reputation and business. However one precaution they could have taken would have been to put all new business into a new separate fund ring-fenced from the main fund. CL suggested this to Headdon and he made a similar suggestion in his contingency paper of February 1999 (page 29). But it never got any further. Perhaps Headdon would have regarded it as a sign of weakness to do this - presentation governed all.

They were certainly alive to the problem that the non-GARs could be affected by scenario 6 outcome (pages 33 to 35).

McGough and Leslie were encouraged to appear as witnesses as there is an agreement that Dentons would not be sued by ELAS (page 46).

Page 107: After the Court of Appeal all the lawyers advising ELAS were unanimous that they could still ring-fence. They seemed to have ignored the point that the court had NOT been asked to rule on ring-fencing and Waller's remarks were just obiter dicta.

Page 113. The Nash letter of 1st February 2000 was only written after very careful advice from Dentons. It was toned down as they feared that being too rude about those who were talking of £1.5 billion might sue for libel. How they squared that with the fact that they had the £1.5 billion liability anyway, as explained above, escapes me.

Page 128. Doubts about ring-fencing began to creep in March 2000 and Sumption, acting for Hyman, finally poured cold water on it by saying that he would argue against it in April 2000. By this time Elizabeth Gloster, the new QC for ELAS, had changed her mind on ring-fencing anyway but thought that they still had a better than evens chance of winning overall in the House of Lords.

Rabinowitz then took over and drew CL's attention to a letter of 15th July 1999, after the start of the Hyman hearing in the Vice-Chancellors court at first instance. It was written to Ruth Loseby in the actuarial department of ELAS and it said that her view was that if there was an adverse judgment there would be NO ring-fencing. This view was not, however, conveyed by CL to the Board which lets the Board off the hook.

It seems to me therefore that the actuarial department and Headdon were probably much more aware of the risks in Hyman but they did not pass their views on to the Board.