THE chief City watchdog was yesterday accused of failing in its responsibility to protect investors by a Commons Treasury Select Committee report on the split capital investment trust scandal.

Although MPs stopped short of accusing the Financial Services Authority and Sir Howard Davies, the FSA chairman, of “being asleep on the job”, as at an earlier hearing, the report said the regulator was less “alert” than it should have been in identifying the dangers of split capital trusts.

The report also gave warning that investors face delays over compensation because of “apparent conflicts” between the FSA’s investigation into the firms implicated in the scandal and the scheme set up by the Financial Ombudsman Service to compensate individuals for mis-selling.

The FSA was asked “as a matter of urgency” to release a statement clarifying the relationship between the two inquiries. The MPs also demanded a timetable for the FSA inquiry and reassurance that the results of the inquiry would be published in full.

The report called on the Government to give the FSA sufficient powers to ensure that it can fully complete the investigation. It also said that investment trusts should be brought directly into the FSA’s regulatory scope.

John McFall, chairman of the committee, urged the FSA to hand out severe penalties to firms and individuals implicated in wrongdoing. He said: “We have been left in little doubt that there is substance in the suggestions there was some form of ‘magic circle’ operating in a manner harmful to shareholders.”

The report will add to the pressure on the FSA to mete out punishments for the scandal. Sir Howard and John Tiner, managing director of the FSA, were criticised for their handling of the scandal at a hearing in November.

Daniel Godfrey, director-general of the Association of Investment Trust Companies, said that he was confident the FSA would act. He said: “It would appear likely there will be some cases where individuals or firms will be found to have acted improperly, and I’m sure the FSA will act harshly.”

The report picked out Aberdeen Asset Management for particular censure, accusing it of issuing “recklessly misleading” promotional information. The fund manager said it “utterly rejects” the accusation: “At all times we met our legal and regulatory obligations in full.”

The report said that the high level of cross-investment in the industry amounted to “little more than a sophisticated form of pyramid selling”.

MPs on the committee called on the firms implicated in the scandal to “go beyond their legal obligations as regards compensation”. They called on the industry to set up a compensation fund for investors in zero dividend preference shares, with the money paid from the fund made up by firms “if and when a compensation liability is established”.

Sir Howard said: “The comments on the FSA are fair and reasonable: we will respond positively to the specific proposals. The detail will depend on the decision the Government now needs to make on the recommendation that investment trusts should become regulated products.”

What the report found

• The investment trust industry should “go beyond” its legal obligations in compensating investors
• There is evidence of a “magic circle” at the expense of shareholders that should be investigated fully
• The FSA should set out the timetable for its investigations and clarify apparent conflicts with the Financial Ombudsman Service
• Investments trusts should be brought into the direct regulatory scope of the FSA.