Oral evidence: Privatisation of Royal Mail, HC 1221-ii

Oral evidence, 30 April 2014.

Witnesses

William Rucker, Chief Executive, Lazard & Co., Alan Custis, Managing Director, UK Equities, Lazard Asset Management Ltd, James Robertson, Managing Director, UBS Ltd, Richard Cormack, Managing Director, Co-Head of Equity Capital Markets, Goldman Sachs, Martin Donnelly, Permanent Secretary, Department for Business, Innovation and Skills, and Mark Russell, Chief Executive, Shareholder Executive, gave evidence.

Chair

Good, are we there? Apologies for being late, but information was published at 1.30 pm by the Department for Business, Innovation and Skills—your Department, Martin. Perhaps I may start by thanking everyone for coming. I declare that the financial advisers who manage my late husband’s pension pot bought shares in Royal Mail at an early stage. I don’t know if anyone else has any.

Mr Bacon

Chance would be a fine thing.

Chair

Right. We have a lot of witnesses and a lot of Members want to ask questions, so I would be grateful for direct, succinct answers. I will interrupt if I think that people are going off the question or going on for too long, otherwise we will be here all night. I would like to start on the issue of priority investors, as the list has now been published by the Department for Business, Innovation and Skills. What were the criteria which you adopted in determining who were to be the priority investors?

Martin Donnelly

I will ask Mark to walk us through the precise process in a moment but, as you know, our objective for this sale was to provide the Royal Mail with a successful entry into the private sector—

Chair

Can I ask you to answer the question, Martin? This is just what I said at the beginning. I don’t want a statement, I want to know the criteria which were used. We all know what the objective was, and there have been quite a lot of sessions on this. What were the criteria which were used to determine who were the priority investors, full stop? That is all I want the answer to.

Mark Russell

The short answer is that it was the institutions which showed the most interest in Royal Mail from a marketing campaign that went over the period of a year.

Chair

So, looking at the very interesting box in figure 17 which shows the number of institutions, we started with 94 institutions being targeted. 180 other institutions were considered to be high quality and 506 institutions received nothing, but only 16 institutions were priority investors. What were the criteria that got you down to that 16? Was that decided by you, the Department, or was it decided by the syndicate?

Mark Russell

No, we were advised by our advisers—

Chair

Who were you advised by? The syndicate, or Lazard?

Mark Russell

The syndicate, overseen by our independent advisers.

Chair

So what were the criteria which got you down from—let me do my maths—522 to 16?

Richard Cormack

Perhaps I could refer the Committee to figure 12. We started the exercise over a year ahead of the privatisation. In the period up until July 2014, we met 65 institutions, which were located in the UK and also globally. We had extensive feedback from those 65 institutions, which represented the largest institutional investors globally in the UK, the US, Canada and continental Europe. From feedback from those 65 we narrowed the list down to 24 institutions, which we pilot-fished, and the 16 came out of the 24. The 16 were those institutions that we met during the pilot-fishing process which were prepared to give us an indication of their order for day one of the book build. A number of the institutions didn’t give us that indication, and were therefore not part of the 16 which featured in that tier.

Chair

I am still unclear how the others didn’t fall into that category, but I take that as read. In the letter written to the Chair of the Business, Innovation and Skills Committee, the Secretary of State states a number of times that one of the criteria was to get in long-term, supportive investors. There are about five examples of this, including: “we are focused on the long-term success of Royal Mail… Our objective required us to have a positive share price performance supported by a high-quality, long-term investor base”. He says that again and again, referring to “a range of high quality institutions of the type that would form the core of a long-term, supportive investor base”. He also says: “This was still regarded as compatible with securing a stable, long term shareholder base”. There are about five or six references to that. Was that not a criterion when you were deciding who should be these 16 priority investors, who made £750 million on day one? Was that not a criterion that you looked at?

Mark Russell

The answer to that is, not exclusively. I think that it is worth Richard explaining the type of investors, and what we mean when we say “long” and “hedge”.

Richard Cormack

Absolutely. One of the criteria was to find institutions that believed in the Royal Mail story, and would therefore be supportive and longer-term investors. They were selected based on the feedback that they had given us. These institutions had met the company two or three times prior to the pilot-fishing exercise. Those institutions came from a range of different types of investor. There were some sovereign wealth fund investors, hedge fund investors, and what were called long-only investors. The clear majority were long-only, but there was a cross-section of investors. We thought it was important to go to a cross-section of investors so that we were not getting pricing points from just one narrow constituency.

Chair

I am trying to sort out whether it was a policy objective. My understanding before today’s evidence was that it was a policy objective. Of course, a policy objective was also to sell the company, but my understanding was that it was an important policy objective, which is why you went for priority investors, to seek out long-term commitment to the company. That was my understanding, but I am muddled. Is it a yes or a no to that?

Mark Russell

Yes. If you look at those IPOs, the mix between long and hedge is about 70:30. Our Secretary of State said he would like if possible to increase that percentage. We tried to get it to 80:20, between what we defined as long investors and hedge investors. So the answer to your question is yes. He certainly wanted a large proportion of long investors in the investor base. He never contemplated we would ever get to a situation in which it was 100%. That would be sub-optimal, partly for the reason that Richard gave, and partly because hedge funds typically buy and sell more frequently than others.

Chair

But was it in his mind that 42% of the shares would be traded in the first week?

Mark Russell

No.

Chair

Which is what happened.

Mark Russell

Which is what happened, because a number of long investors—

Chair

Long investors? They can’t be long investors if they have sold.

Mark Russell

A lot of what we call long investors will typically be buying on fundamental value. They will not be like hedge funds who will buy not just on fundamental value, but for technical reasons as well. A number of them sold because the price took off. It is as simple as that. They did not see the value any more. That is why they sold.

Chair

This is a question for you, Mr Donnelly, because you are an accounting officer and you in the end should have to take responsibility for the massive taxpayer loss. Why did you not contractually commit some of those long-term-investors to not selling their shares, in the same way as the individual post office workers are committed? Why did you not commit them contractually? Why did you not get that into the contract?

Martin Donnelly

The answer is simple: it would clearly have led to a less good deal for the taxpayer.

Chair

Did you try?

Martin Donnelly

Our very clear advice—

Chair

I am asking you a question: did you try?

Martin Donnelly

Our advice was that that would not be a way of maximising value for the taxpayer.

Chair

You are not answering the question.

Martin Donnelly

Yes, I am.

Chair

Did you seek advice from your advisers—both the syndicate and Lazard? Did you make any attempt to try and build in a contractual commitment by some of these people so that you could meet the policy objective of having long-term investment?

Martin Donnelly

We followed the advice of our advisers—

Chair

Did you try, Mr Donnelly?

Martin Donnelly

And therefore the answer is no—

Chair

You did not try.

Martin Donnelly

Because it would not have led to good value for the taxpayer.

Chair

You did not try.

Martin Donnelly

Because the advice was clear.

Chris Heaton-Harris

In a number of privatisations and company buy-outs you can ask people to stay with the company shareholding for a decent period of time. Although that was a policy objective, you did not have any such covenant or attachment to the shares. Is that because you thought, or a judgment was made, that that would drive the price of the shares down? If so, could you articulate that so that we can understand it?

Mark Russell

To answer your question, at the time of the IPO, we did not look for contractual commitments. We did not attempt to get contractual commitments, because we knew we would not get them. It is as simple as that. At a prior stage when we were looking at alternatives to the IPO—such as if we couldn’t get enough interest in an IPO could we do some sort of cornerstone investment and could we take a couple of institutions and sell a minority stake—we looked at the possibility of asking people to buy in just to take a minority stake pre-IPO. But the price that they would have paid for that—we got no commitments—would have been substantially below the price that we achieved on the IPO. So it is about liquidity. If you are told that you have got to lock up and not sell you will want a premium for that. If we had, unusually—really unusually—gone to investors at the time of IPO and said, “Could you hold?” the vast majority would have said, “Not at all; we want the ability to trade.”

Chair

What that whole argument demonstrates is that the concept of the priority investors was dead before it started in terms of maintaining it long term. Once you didn’t give them a contract, there was no way. Obviously they had a fiduciary duty to maximise their profits on behalf of their companies. So why on earth you had the concept at all, I fail to understand.

Mark Russell

And it is really important that we explain why we went to priority investors. We narrowed down the number of priority investors—or what we call the pilot-fishing investors—the people we believed were most interested in the business. We asked them at what price they would be prepared—this was before the book-building exercise—to invest in the business even if the industrial relations situation started to deteriorate. We had a figure back for that which was about £2.50. That gave us the confidence to advise Ministers, “You can now announce an intention to float”. You do not want to make that announcement if you don’t carry it through.” We wanted to be sure that even if the situation deteriorated—remember, we were in a situation where people might have come out on strike—we had a group of investors who were able to take these shares at a price so that we could cover the book. That is what they gave to us. That is why they got preference on allocation. But then once we got into book building—they had given us a figure of £2.50 or so that they said they would take if the situation deteriorated—we went out to over 500 investors and said, “Actually, what are we going to do now? What is the price we are going to charge?” That conversation with the 500 investors was instrumental in setting the price range that we went to. Then we said to the priority investors, “You are only going to get an allocation if you go right up to the amount that everybody else is prepared to pay—£3.30.” So, yes, they had preference because they gave us that confidence to commit.

Chair

And you chose to ignore right up to the end the over-subscription both from individuals and from companies. Whatever it was—£32 billion was what people were willing to buy—and in the end it was less than £2 billion. You chose to ignore that. You had no advantage of long-term priority. You got no long-term commitment and you had this massive over-subscription and you chose to put a maximum price on it.

Mark Russell

When you look at that over-subscription figure we are entirely satisfied that only a fraction of those people—

Chair

On what basis?

Mark Russell

Because some of them were bidding for amounts that were about 10% of their assets under management. They would never have been able to buy it.

Nick Smith

Mr Cormack, when you talked about the development of the priority group of 16, you said that the main criterion for choosing them was that they indicated that they would make an order. You said that they believed in the Royal Mail story. What did they tell you that made you think that they believed in the Royal Mail story?

Richard Cormack

For one thing, they gave us an order and some solid demand in the transaction. Secondly, we had extensive dialogues with each of those accounts around the investment case of the company, around the prospects of the company and, indeed, about the risks of the company. As Mark has said, there was the real threat of industrial action as we were having these discussions. The fact that these investors were willing to give us a firm indication of demand, notwithstanding the risk of industrial action, speaks to their support and, indeed, the fact that they are prepared to look at the company on a longer-term basis rather than just the short-term.

Nick Smith

So how do you explain that you thought they were believers in the Royal Mail story and were committed long term to it, and then sold the next day?

Richard Cormack

It goes back to the point that as the share price got to levels that they believed were excessive relative to value, they had a fiduciary duty to sell.

Nick Smith

So they just filled their boots?

Chris Heaton-Harris

No—

Chair

Let them answer the question, Chris. You can come in on a question afterwards.

Chris Heaton-Harris

You have already essentially—

Chair

Chris, you can come in on a question afterwards. Let everybody have their own question and answer.

Nick Smith

So what did they do after you thought they supported the Royal Mail story?

Richard Cormack

As the share price increased sharply—more sharply than I think they would have anticipated it to increase—some of them held, some of them bought and some of them sold. Those actions were based on their own view in terms of where they saw value on a medium to longer-term basis.

Nick Smith

It sounds to me as if they didn’t really support the story. They just filled their boots.

Martin Donnelly

Can I underline the point that Mark made, because it is very important? They helped us to have confidence that we could successfully launch this IPO, even if there had been industrial action. It was obviously at a lower price but that was key for taking the decision that we could go ahead. We had the advice that these investors were prepared to commit and ensure that we would have a successful IPO, which was critical to the future of the Royal Mail, its work force and the universal service obligation.

Chair

Okay. Let me move on to another set of questions. The concern is that there appeared to be massive interest in this share launch, but only a very few people benefited to an enormous extent out of it. So I have to ask you some questions around that. I would like to ask James Robertson and Richard Cormack how many of those priority investors were also your clients in the trading arm? What proportion? Out of the 16, how many are your clients in the trading arm?

James Robertson

I do not know for definite, but I would assume all of them. We are the largest equity trader in the London market, they are the largest asset managers in the London market—I would assume all of them.

Chair

And how many of the 16 hold shares in any of your companies?

James Robertson

I do not know that answer.

Richard Cormack

In terms of holding shares in Goldman Sachs? I do not know the answer.

Stephen Barclay

It would not really be shares, it would be trading volumes. Perhaps the question might be: how many of the investors are significant clients?

Richard Cormack

I do not have the information around the trading activity of different institutions. As a matter of policy, that is information that I do not have, so it does not influence decisions that we make on allocation.

Stephen Barclay

But obviously Goldman and UBS are major players in prime brokerage. The fees would be much higher from traded volumes than they would actually be from the IPO, wouldn’t they?

Richard Cormack

First, I do not have that information. Secondly, our client in this IPO was the Government. We were paid by the Government to execute the IPO.

Stephen Barclay

Sure, but it could be widely seen as a soft sell. What I am driving at is the existence of a conflict. Of course, you will have a conflicts policy. I know that you will say you adhere to that conflicts policy, but you must accept that there is a potential conflict between priority investors who trade high volumes through your firms, particularly if the share price is lower and trades up. There is going to be more trading volume and therefore more fee income for your firms as a group. You would accept that conflict?

Richard Cormack

We have a policy in place to manage any conflicts between the public side of the wall and—

Stephen Barclay

Of course you have a conflicts policy. How much in fines as a group have you paid in the last two years for regulatory breaches?

Richard Cormack

I do not know the answer to that question.

Stephen Barclay

It is significant as a group, is it not?

Richard Cormack

I do not have the answer to the question. It will be on our regulatory filings.

Stephen Barclay

So in other words, you have conflicts, but the conflicts policies are not always managed. You therefore would not know what the volume of business would be from the priority investors through a firm like Goldman’s trader volumes?

Richard Cormack

No.

Stephen Barclay

Would you be able to give us a note on that?

Richard Cormack

As I said, that is not information that I have access to. I would have to go back to ask.

Stephen Barclay

Right. But the firm might be able to. What would be interesting to see is what profit priority investors made and what the trading volumes with a firm like Goldman were over 12 months, set against what the IPO profits would be.

Richard Cormack

There was never any consideration around that in the selection of the investors and the allocation of the shares—

Stephen Barclay

Of course. If you were to give consideration to that, it would be a regulatory breach. But you must accept the existence of a potential conflict if, as a firm, you are making much bigger profits from trading volumes through your prime brokerage. You must accept that; that is what your conflicts policy is there to address.

Richard Cormack

We accept the existence of potential conflicts, which is why we have that policy.

Chair

Can I ask something of Lazard? We have now had the list of priority investors published, and Lazard’s investment arm was one of the priority investors.

Alan Custis

That is correct.

Chair

First of all, what proportion of the 13 million shares went to you? What page is it?

Matthew Rees

Paragraph 3.9 on page 28.

Alan Custis

We got 6 million shares.

Chair

Mr Rucker, even if we were to accept that the Chinese wall rules were adhered to, does it seem appropriate to you? You were there in a different position to the banking syndicate. You were there to provide completely, utterly and totally independent advice—technical advice and expertise—to Government on this privatisation. Do you really think that it is appropriate that, in those circumstances, another arm of your company, however Chinese-wally you made it, picked up nearly half the shares that went directly to clients of those with an interest there? Do you think that that is appropriate?

William Rucker

We were hired in February 2013. The conversations that had been taking place with the 65 potential investors dated back to the start of 2012. When we were hired, we were unaware that Lazard Asset Management had had any discussion at all with Royal Mail. When we became aware—having been hired—that Lazard Asset Management was on a list of investors that Royal Mail was talking to through Goldman Sachs, UBS and others, we made it quite clear, as did ShEx, that we should have no input whatsoever into any discussion about allocations for LAM. I think the NAO Report makes that clear. The Chinese wall is complete and utter. We have had no contact throughout. We deliberately exempted ourselves from any discussion about any allocation for Lazard Asset Management.

Chair

But the benefit that the Government were trying to obtain from having you as the independent adviser to Government was to ensure that there was absolutely no conflict of interest, which inevitably arises as a suspicion in the way that the financial institutions are managed. That was the entire benefit. You diluted that benefit, without a doubt, by having that situation where nearly half the shares that went directly to the syndicate or the adviser went to you. You diluted that and undermined the confidence that, certainly, I feel that you were providing fully independent advice. It is just inappropriate. Can you not see that?

William Rucker

Look, I think it is a question of perception and what actually happened. At no point did we play any part whatsoever in any discussion about Lazard Asset Management. Their involvement predated our—

Chair

I understand that, but at the heart of the structure that the Government established to try to protect the taxpayer’s interest was that you were there to give advice separate from the syndicate, who clearly have trading arms on which, as Stephen Barclay said, they make much more money by trading, whether their share goes up or down, than you do. You were there to do that, and yet for whatever reason you, as an organisation, allowed an arm of your organisation to benefit hugely. I assume you sold in the first week, because before I got the Secretary of State’s letter and before we were allowed to publish it, you were not on my list because you were not registered as a shareholder with Royal Mail; presumably that was because you sold in the first week. Did you?

Alan Custis

As has been mentioned earlier, we were involved with the Royal Mail back in 2011.

Chair

Did you sell in the first week, Mr Custis?

Alan Custis

We had a price target, and—

Chair

Did you sell in the first week?

Alan Custis

The share price went beyond the price target, so yes, we did sell on behalf of our clients—on behalf of the clients of Lazard.

Chair

That is why you weren’t on the list. I have to say this. I don’t know what you think, Mr Donnelly, but you employed Lazard specifically to ensure independent advice—that was the whole purpose. I am afraid, at the end, the buck stops with you as accounting officer.

Chris Heaton-Harris

Are you accusing him of doing something wrong?

Chair

No, I am not saying that. Listen carefully to my question, Chris.

Chris Heaton-Harris

I was listening very carefully to it.

Chair

I want Mr Donnelly to respond.

Martin Donnelly

This is a very serious issue. The NAO Report covers it accurately in paragraph 3.10. We wanted, on behalf of the taxpayer, to give ourselves the best available list of independent advisers. We did not want Lazard to self-censor off that list, on the basis that sufficient regulatory controls were in place—you discussed this in some depth on Monday, I think—to safeguard the taxpayers’ interest. I am personally satisfied that that was the case.

Mr Jackson

It is important that we put this in context. The Leader of the Opposition made unfounded allegations during Prime Minister’s questions, which have not been helpful to the deliberations of this Committee in coming to a reasonable judgment on the situation. Just going back, there was a reference to industrial relations and the possibility of industrial action. Was that the only issue that affected the culture in respect of the pricing of the shares or were there other issues that led to a consensus on the price, both in the Department and with your professional advisers? Was media coverage an issue? My colleagues have already said that people are wise after the event, and before, people were not talking about the share price—in fact, across the spectrum, it was quite the opposite.

Martin Donnelly

That is a very important point. From my perspective as accounting officer, I relied on our excellent ShEx team, and of course on the advice, but I also stayed close to what commentators across the media were saying. From the period through from the spring, you would have to say that the comments were somewhere between cautious and lukewarm. In fact, they became rather more cautious as it became clear that there would not be an industrial relations settlement of the wages issue before the sale. One important newspaper said in September that there was “an alarming list of risks”, including a strike, so the sale would “not be for the faint-hearted”. I think it was the Lex column that said, even in early October, “At the low end of the price range, Royal Mail shares have some appeal. At the upper end, investors have other options.” We were consistently getting that message. It was part of the wider environment. Mark, you may want to say a bit about the change in perception through July and August as the industrial relations issue became more apparent.

Chair

Ironically, I have to say to you that it was not July and August; it was October. You may try to push it back, but look at the charts in the NAO Report: they are all about the movement both in demand for the shares—I am trying to find the right ones—and in the valuations of the syndicate banks. Those movements are all in October and were way above what you eventually put the shares on the market for. I will ask Lazard one more question, and then I am going to come to Austin. The other interesting thing with Lazard is that if you look at the valuation chart—please guide me, Matthew, where is the valuation chart?

Matthew Rees

Figure 9, page 30.

Chair

Looking at the valuation chart, Lazard’s asset management arm buys a whole load of shares, sells them in a week and makes a killing. I don’t know how much money you made out of it, but it was a heck of a lot. We can work it out, actually. You sold £6 million in the first week, did you?

Alan Custis

For Lazard’s clients, which are pensioners, unit trusts and others. On behalf of our clients, we made approximately £8 million.

Chair

£8 million. But if you look at—

Chris Heaton-Harris

Is there anything wrong with that? You said it in a very accusing tone, and I just wondered.

Chair

To be absolutely honest Chris, I am here on behalf of the public, trying to look after the public interest.

Chris Heaton-Harris

Why did you buy the shares?

Chair

This is nothing to do with partisanship—it is the public interest. The public interest is that, in that first week, three quarters of a billion pounds of taxpayers’ money went down the pan. Three quarters of a billion pounds is a lot of money. I am going to pursue this, without any politics in it, because it is a public interest issue.

Chris Heaton-Harris

But why did you do it?

Chair

Pardon? It is a public interest issue. Can I go back to figure 9? I am not trying to play politics with this. It is a public interest issue. Lazard, in figure 9, was among those that had the very lowest valuation.

William Rucker

To be clear, that isn’t anything to do with Lazard Asset Management. This is the Lazard advisory business, which is completely separate from the asset management activities. This was an independent valuation, which we came up with on behalf of ShEx and the Government.

Chair

Why were you so low?

William Rucker

Our valuation had some different assumptions from other people’s. We had some more bearish assumptions about the threat of industrial relations and the consequences of that, so when you are taking these valuations it is important to realise that they’re not entirely comparable. Everybody had slightly different assumptions. We were more bearish on the industrial relations aspect, and all those assumptions were laid out clearly for the benefit of our clients.

Guto Bebb

You sold the shares because obviously you hit your target price. What was the share price at which you sold? Are you willing to disclose that?

Alan Custis

Yes, approximately. There was a range of prices because it was conducted over a period of 48 hours, but it was roughly £4.70 a share.

Guto Bebb

And with the price today at £5.29, do you feel that you should have hung on? Do you think that your reflection of the price was correct?

Alan Custis

No, we have a very clear process, where through extensive contact with the company we generated a price target of £3.95 per share, and therefore we were happy to participate in the IPO at £3.30. When the share price went materially above that target price, we felt that there wasn’t sufficient value in it for our clients, so we took the decision to sell.

Guto Bebb

Which was roughly at a 15% premium?

Alan Custis

Yes.

Amyas Morse

I wonder if I could ask a question of Lazard, regarding when you found out that your asset management arm was involved. Did you consider withdrawing as advisers at that time? I am not saying that you should have done. I am just asking as a matter of fact whether you had a discussion with the Department at that time about whether that was manageable.

William Rucker

We did discuss it with the Department, and we made it clear that we could take no part in any discussion regarding allocations to Lazard Asset Management.

Chair

But you were there. You just don’t see it, but I have to say that you were there, your position was—

Amyas Morse

I just wanted to ask a little bit about this, I wasn’t really trying to take you any further than just to elicit those facts. Was one of the reasons why the conclusion was that you shouldn’t withdraw that there was judged to be a lack of other potential advisers who could fill that role? Was that a factor?

William Rucker

I think that is a question for Mark—

Mark Russell

It goes to the heart of whether we were satisfied that there was regulatory compliance and, absolutely, we were satisfied.

Amyas Morse

So you did conclude that, first, there weren’t other advisers available and, secondly, you were satisfied that there was good regulatory compliance around this?

Mark Russell

I think the last first. We didn’t even go to whether we needed to find another adviser. We were satisfied.

Martin Donnelly

We had already approached seven advisers at the start for the competition, which Lazard won.

Mr Bacon

I would like to return to this subject after we’ve voted. Sitting suspended for a Division in the House. On resuming—

Chair

Two missing, one on each side, so that is fair.

Mr Bacon

May I ask you, Mr Donnelly, how you define independence in terms of independent advice?

Martin Donnelly

I would expect our advisers to give us professional, direct and sincere counsel on the various issues on which we have to make a judgment, and to ensure that our evidence base was as rigorous as it could be in the circumstances.

Austin Mitchell

You didn’t mention honest.

Mr Bacon

Hang on a sec. Professional, direct, sincere and with an evidence base. Those are your definitions of independence?

Martin Donnelly

Those are what come to mind as the core criteria.

Mr Bacon

Professional, direct, sincere and with an evidence base. You did not mention conflict of interest. To me that would be the first criterion of independence—not merely that the regulations would work, that you were satisfied that they would work, and that the Chinese walls would work, but that there was no possibility of conflict of interest because it could not exist architecturally. That would be my first definition of independence, but you did not even mention it. You mentioned four other things.

Martin Donnelly

No, because if I may come back on that I would take that as a precondition for anyone giving us advice.

Mr Bacon

Not necessarily.

Martin Donnelly

If I had doubts about that, they would not become advisers.

Mr Bacon

Not necessarily at all. There are many, many advisers in the world. Many of them are lawyers and many are economists, who are not disinterested and it is certainly not a precondition. One is often looking for interested rather than disinterested advice, particularly if you want a certain outcome, so that does not necessarily follow. I return to my question. It was not: what is it that is so obvious that you need not even state it? It was: what do you consider the basis of independence?

Martin Donnelly

One of the relevant factors, in addition to those I have mentioned, is the incentivisation structure. If you incentivise advisers for a particular outcome, you can expect at the margin a preference in that direction. Therefore, we were careful not to incentivise, in this case Lazard, in a way that might skew the advice in a form unhelpful to the taxpayer, whereas we had the banks incentivised to maximise proceeds.

Mr Bacon

So in addition to professionalism, being direct and sincere in your advice and having an evidence base, you have added incentives.

Martin Donnelly

Having the correct incentive structure to support those, yes.

Mr Bacon

The correct incentives. I am still not clear about what that has to do with independence. If anything, you might create the correct incentives if you want people to perform in a particular way for you—in other words, not to give you independent advice but to perform as you, the client, wish them to perform. It is not obvious that incentives are necessarily the highest on the list. It seems to me that the basis—I am sorry that you have not mentioned it—the most obvious criterion of independence is that you are disinterested. That would be the first point—the starting point. Mr Custis, you bought 6 million shares. You were doing a job. At Lazard Asset Management, your job is to buy cheap and to sell dear, and you did that. You don’t hold any now. You cleared out.

Alan Custis

That is correct.

Chair

Okay. So, Mr Donnelly, Lazard Asset Management did its job. It bought cheap and it sold dear. It had a target value and the shares went significantly over the target value so it decided, quite reasonably—it was doing its job—that the shares no longer represented value and it was a good time to exit, which is exactly what it did. The issue that then arises is: was your adviser acting completely independently, or did it have an interest at financial group level in the success of one of its subsidiaries—Lazard Asset Management? It plainly did. It had a substantial group interest in the success of one of its subsidiaries and indeed the subsidiary performed well. It produced a profit for Lazard Asset Management’s clients. So what then arises is whether your adviser was really independent. Could it have been truly independent when it was not disinterested as a group? You are saying, “Yes, yes, yes, but there were rules in place”, and that you were completely satisfied. You said a minute ago that the rules ensured that nothing could really go wrong. I have not misinterpreted what you have said; I have reflected, in a précis form, accurately what your view is. Is that right?

Martin Donnelly

The rules are, as you say, clearly—

Mr Bacon

Have I précised accurately, or more or less accurately, what you have said?

Martin Donnelly

There are legal issues, and there is also a judgment to be made about the integrity of the—

Mr Bacon

Have I précised accurately, or more or less accurately, your view?

Martin Donnelly

Yes. I was just adding a judgment about the integrity of individuals and organisations.

Mr Bacon

I am just looking for the word “yes”, thank you. Mr Rucker, you are from Lazard & Co., the advisory business which was advising BIS—that is right, isn’t it?

William Rucker

Correct.

Mr Bacon

I will just read out some sentences from this book: “Lazard has lost the almost unique position that the three houses”—Lazard UK, Lazard Frères and Lazard New York—“occupied in the 1980s. It no longer comes near the top of the league tables in either New York, Paris or London. Financial advice has become dominated by the likes of Goldman Sachs, Morgan Stanley and Merrill Lynch—and the creatures of the big money banks, such as Warburg”—of course, it got taken over, although they all did, didn’t they?—“Morgan Grenfell and Kleinwort, owned respectively by UBS, Deutsche and Dresdner. But this will change. Money is a corrupting influence on advice. One-stop financial shopping is the current fashion, but it will not last. The internet bubble has already revealed the lack of quality control being exercised by the big investment banks”—Mr Barclay referred earlier to the fact that a number of banks involved in this had been the subject of fines for regulatory breaches, and I think I am right that both Goldman and UBS topped the tables for fines for regulatory breaches—“and it is only a question of time before a mighty scandal demonstrates the inherent flimsiness of their so-called ‘Chinese walls’. There will be an irresistible demand to separate again the integrity of advice from distribution and investment analysis. Moreover, so substantial are the overheads of the big investment banks, and so spoilt and greedy are their key ‘rainmakers’, that rather than deny these people their inflated expectations, they will overtrade to sustain bonuses and profits. Trading, trading, trading—that way lies disaster, mark my words.” Mr Rucker, do you know who wrote that?

William Rucker

It is a junior ex-colleague from Lazard back in the 1980s—

Mr Bacon

It is who, sorry?

William Rucker

It is a colleague from Lazard back in the 1980s—

Mr Bacon

Yes, it was John Nott, who was a Cabinet Minister. He was the chairman of Lazard. He was not a junior colleague; he was the chairman of your business.

William Rucker

Sorry, I thought you were referring to a different book. Yes, I am familiar with John.

Mr Bacon

I am just wondering whether you agree with that?

William Rucker

I would say a number of things. First, we have no trading activities—

Mr Bacon

I know that you do not.

William Rucker

Yes. It may be clear to you, but not everyone knows that in this room.

Mr Bacon

I thought that the point of John Nott’s paragraph there was that Lazard was standing back from the fray to some extent, because it understood, in a way that many other investment banks did not, the importance of the integrity of advice.

William Rucker

Yes, and that model remains intact. We have no trading activities. I think you mentioned our position as reduced. In my experience, and I have been at Lazard now for 27 years, these things come and go—right now, we are high up the league tables—and those other aspects. If you take the independent financial advice in relation to IPOs, in the UK I think we have done over half of IPOs in which people have used independent advisers—to give you some impression of where we stand in the league tables. The key conflict that John Nott refers to is the conflict between distribution, sales and trading, and advice. We have no distribution, sales and trading at all. We have two businesses: one is Lazard Asset Management, which manages about £190 billion in assets; and it is entirely separate from our advisory business. The businesses are entirely ring-fenced, as the NAO vindicated. We have no conflict; we have crossed no Chinese walls; and we had at no point during the Royal Mail flotation any influence whatever over the allocation to Lazard Asset Management.

Mr Bacon

Mr Barclay wants to come in and I want to hear what he has to say as well, but I agree with you that John Nott was referring to the risks from sales and trading and the creation of big integrated investment houses that did all of these activities and that floated into a financial supermarket, then making money out of sales and trading volumes. Lazard stood back from that. But it must be the case, if you have as part of your group a fund-management arm—

William Rucker

As we did then.

Mr Bacon

Indeed. It must be the case, as you have a fund-management arm, that there is still the possibility of a conflict of interest—you acknowledge this yourself, which is why you have conflict policies—even on the asset-management side, as opposed to the high-volume sales and trading side. Surely the most obvious way to manage this is, if you are going to be an adviser and to maintain what John Nott calls the integrity of the advice, to say to a potential client, such as the Department for Business, “We will happily be your adviser, but in order to make it crystal clear that there is no possibility of a conflict, and that we not only want to be clean, but to be seen to be clean—as virtuous as Caesar’s wife, as it were—we will advise you, but our group will not be involved in anything to do with investment in anything we are advising on.” That is essentially the heart of what he is saying here.

William Rucker

No, I think he is talking about distribution of sales and trading versus advice; that is what he refers to. We have always had an asset management business. If we had influenced, in any way, what Lazard Asset Management was doing here, I think we would have some issue to discuss. But at no point did we have any influence whatsoever in what they did.

Chair

You keep saying influence. Can I just ask: as the adviser to Government, you saw and signed off the list of investors, didn’t you?

William Rucker

We did not sign off on the list. We were aware of the list. This list started—

Chair

And you knew that your asset management arm was on the list?

William Rucker

Yes, we did, but we did not comment at all—

Mr Bacon

Did you see the final allocation?

William Rucker

Yes, and we did not comment on any allocation—

Chair

But you knew they were on the list?

William Rucker

Yes. We were made aware, when we were hired, that the company had been talking to Lazard Asset Management since, I thought, the start of 2012, but from what Alan has now said, it was 2011.

Mr Bacon

Of the priority investors, which one got the largest allocation?

William Rucker

I don’t have that detail to hand.

Mr Bacon

Mr Donnelly, you should know the answer to this.

Martin Donnelly

I would look to Mark and the ShEx team; I am not sure whether we have that to hand.

Mr Bacon

I would have thought that that was basic information—who got what.

Mark Russell

The largest was Threadneedle.

Mr Bacon

If you ranked the priority investors in order, who came where? Who was second?

James Robertson

Would you like me to jump in? Lazard Asset Management was the second bottom.

Mr Bacon

So they were 15th. So Threadneedle was first. Can you just run through them? Who was second, third, fourth, in order?

Mark Russell

Sorry. Threadneedle was No. 3. It was: Capital Research; BlackRock; Threadneedle; GIC; Lansdowne Partners; Fidelity; ADIA; KIO; Schroders; Standard Life; Artisan; Och Ziff; Henderson; Soros; Wellington; JP Morgan; Lazard—have I got them all there?

Mr Bacon

I wasn’t counting.

Mark Russell

There is also Third Point.

Mr Bacon

Can you send us a note with what you just said, but also put next to it—we know that Mr Custis has 6 million shares—who got what at issue on flotation? Can you do that?

Chair

Mr Donnelly, yes or no?

Martin Donnelly

I am pausing only because I may need to check on the commercial confidentiality.

Chair

Well, they are all out there now, thank goodness. Otherwise we would have put them out this afternoon anyway, because we have them by other means.

Martin Donnelly

The names are, but the allocation was not. We will come back to you—

Mr Bacon

I am curious. This phrase “commercial confidentiality” gets used a lot and, of course, in commerce, there are things that are commercially confidential. But what we are talking about here is public assets that were sold to a group of priority investors, who had, as it were, special access to the purchase in a way that others did not. They were able to buy at a special price—

Mark Russell

No, not at a special price.

Mr Bacon

I am sorry; forgive me. What I mean by a special price is the price at flotation. I am not saying that they were paying a different price from everyone else, but they had the opportunity to buy at that price, which many others who might like to have bought did not. It is common that investors bid and then either get scaled down or don’t get any. When I say “special access”, I mean special access to buy at a price, in a way that others did not.

Mark Russell

And they were all scaled down; you understand that.

Mr Bacon

Yes. So this is a privileged group in a way. When this privileged group is buying assets at a special price that they have access to in a way that others do not—and they are public assets—there is a public interest in knowing who they are. I am not quite sure what is suggested: that somehow their appetite to buy something when they think there is a very high chance that they will be able to, especially when there are lots of index funds that have to own it, so they will be piling in later because they could not get any of the initial allocation, so they will be pretty sure that the price will go up and that they can bail out if they want to, like Mr Custis did; are we seriously saying that that appetite to participate in this privileged opportunity to buy something cheap and then sell it, which is after all Mr Custis’s job, would somehow be diminished if people knew who Mr Custis was? Mr Custis has come here this afternoon. He has told us quite openly who is, who he works for and that he bought 6 million shares. He has done his job. What I am trying to get at is where the commercial confidentiality is in this. Mr and Mrs Taxpayer, our constituents, surely have the right to know that information.

Mark Russell

I think what you are saying is that you think the public interest trumps a general duty of confidentiality. I think our Secretary of State agrees with that.

Mr Bacon

Okay. Mr Donnelly, why can’t we have a note that has not only the ranking in the way that our colleague from the Shareholder Executive just said, but also what the allocation was? That would seem quite reasonable, wouldn’t it?

Martin Donnelly

It does and I understand the point you are making. The public interest test is the one that led the Secretary of State to make the names public. All I need to do is—

Mr Bacon

Check with him, which is fair enough.

Martin Donnelly

Yes, and also that there are no—

Chair

Late in the day.

Mr Bacon

Can I be clear that you will check with, as it were, your masters and, assuming it is okay, you will send us a list including the allocation?

Martin Donnelly

Just to repeat what I said and, assuming that there are no legal issues we are unaware of, yes.

Chair

Thank you. I am going to go to Stephen but I wanted to ask how many shares you asked for.

Alan Custis

Approximately 45 million.

Chair

And you got 6 million.

Mr Bacon

Did you ask for 45 because you knew that you would be scaled back in a big way?

Alan Custis

No.

Mr Bacon

You wanted 45?

Alan Custis

Forty-five million was reflective of the position that we would put of a company of that size into the funds where it was appropriate. So we got 13% roughly of what we put in for.

Stephen Barclay

I think what we are seeking to clarify is figure 20 on page 48. It actually lists the shareholdings but without the names. Given that the names have now been disclosed, the logic would follow that the names would be attached to figure 20. I think that is what Mr Bacon is seeking. Mr Rucker, I was a little confused, because a moment ago you said, “We have no conflict.” Surely, the position is that you have a conflict but you are managing it. Would that be correct?

William Rucker

I said the description of an independent adviser is normally one who is free from a conflict between their advisory business and any sales and trading activity. We do not have a sales and trading activity. The only potential conflict is the one that you are all highlighting, which is Lazard Asset Management. That is an entirely separate ring-fenced business where we have no contact. There are complete Chinese walls between the two.

Stephen Barclay

But you would accept that there is a reputational relationship, and that reputational damage from the asset management arm would affect the brand of Lazard as a whole?

William Rucker

They are branded Lazard Asset Management and we are branded Lazard.

Stephen Barclay

Yes, but the name Lazard.

William Rucker

Is common to both.

Stephen Barclay

I accept that there is complex policy and that these things are ring-fenced, but you would say that there is the potential for contagion from one to the other reputationally.

William Rucker

We are linked by a common brand. We are owned by the same parent company ultimately.

Stephen Barclay

Indeed. If you are advising the Government independently and you were to feel hypothetically that the offer was low, you would be criticising part of your own group, because you would know that the asset management arm was one of the parties suggesting that low price. That is correct, isn’t it?

William Rucker

We were unaware of what the Lazard Asset Management view was throughout and I remain unaware to this day what Lazard Asset Management’s view is on the Royal Mail.

Chair

But you saw the list, Mr Rucker.

William Rucker

I was aware that they were a buyer at 330p.

Chair

You were aware.

Stephen Barclay

If you have got a number of firms saying that the value of this company is X and one of those firms has a relationship with yourselves, if you say that X is low, you are criticising the firm that has a relationship with you.

William Rucker

That would not in any shape or form come into our thinking when we are looking at the book and deciding prices. I think the checks can speak to that. At no point did we say, “Hang on a minute; we think that Lazard Asset Management will not buy at this price.” Quite the contrary. We never had any contact whatsoever, or even any discussion about Lazard Asset Management in the context of this.

Stephen Barclay

I did not suggest that you had a discussion.

William Rucker

Our advice was never tainted by that.

Stephen Barclay

What value did you place on the company’s tax losses and when was that value placed?

William Rucker

I would have to refer to my notes.

Stephen Barclay

It is a potentially significant sum. I think it is in the region of £3.1 billion of losses, which would be worth in the region of £500 million. We are not talking about small change. What I am trying to establish is whether the figure is correct that the potential tax holiday would equate to £500 million. In other words, this is a company that is likely to have to pay very little corporation tax, which obviously is a very significant factor for price. You are the independent adviser.

William Rucker

Yes, and when we valued the company we took into account all of the financial characteristics of the business including, ultimately, the cash flows of the business. The cash flows of the business reflect the tax position of the company.

Stephen Barclay

So when did you attach the values in terms of tax losses?

William Rucker

The values are implicit in our valuations because our valuations took account of the future cash generation of the business. That cash generation reflects the tax-paying or non-paying position of the company.

Stephen Barclay

So that will have been set at the date the prospectus was put out?

William Rucker

Sorry, that is in our valuation statistics: the figures you see in the NAO Report with our numbers in there will reflect that position.

Stephen Barclay

Likewise, on the property side, the Report refers on page 31, paragraph 3.16, to equity research carried out by UBS which describes surplus property as “hidden value worth £330 million to £830 million”. Is it your evidence that that equity research from UBS was wrong?

James Robertson

Shall I take this?

Stephen Barclay

I would like Mr Rucker to answer first and we will obviously come to you, Mr Robertson, in due course.

William Rucker

There is a range of opinions on what the likely outcome could be from surplus properties. UBS’s top end of the range was above most other people’s expectations. But we had independent valuations of the property that you will be familiar with from the prospectus and this was discussed at some length. Most people’s cash flows took into account potential proceeds from future surplus property generation. Indeed, when we looked at the appropriate level of gearing in the business at the time it was floated, we took into account equally what proceeds could be realised through the property portfolio. That was part of the dynamic to try to establish what was the consistent cash generation the business could sustain that would enable it to continue to pay a dividend and grow earnings in the business. Rather than seeing these valuations as a mistake, they should be viewed in the round, just as tax losses, surplus property and so on.

Stephen Barclay

So you think they were over-egging it, they were overvaluing it? When they talk of hidden value—

William Rucker

This is a very indeterminate sum because it depends on the property market, the future proceeds, planning permission—a host of things. It is extremely difficult to say that the value should be X. UBS came up with a range of values based on a range of outcomes.

Stephen Barclay

The impression, Mr Robertson, is that you are telling your investors one thing but advising the Government, as a soft seller, something else.

James Robertson

Our research analyst is independent from us as an adviser. He comes up with his own views on the value of the company.

Stephen Barclay

So their independence meant they were wrong?

James Robertson

If they want to be wrong they are independent from us. We cannot correct them. We can only point them towards the disclosure that we made with respect to that surplus property and point out that that seemed a very optimistic number.

Stephen Barclay

Notwithstanding what is happening in property prices, for example, the Vauxhall site and the potential value of a prime London site?

James Robertson

At the time, that was why he wrote that particular part of his research report. He was the only person to talk about the surplus property and put those sorts of valuations on it. The other research analysts took the guidance that they had been given by the company of around £100 million worth of surplus property over the next three years.

Chair

I am really interested in this. The UBS valuation was £830 million. You valued the surplus property at £200 million. Can we, Mr Donnelly, see a copy of the full valuation report?

Martin Donnelly

I might ask Mark about the status of the report then come back to the wider point.

Chair

Again, there is a public interest because it was your decision to put it in rather than to take it out and give benefit to the taxpayer. UBS might have been over the top, but there is a big difference between £200 million and £830 million, and I agree with Stephen about London property prices. We need to see the valuation report to protect the public interest.

Mark Russell

As you know, the NAO has seen it. It is not our valuation.

Chair

It saw a redacted version; I want to see the full original version.

Mark Russell

We have not seen the full original version.

Chair

So who has got it?

Mark Russell

It is the company’s valuation; it is not our valuation.

Mr Bacon

So Royal Mail owns the valuation.

Mark Russell

Yes. They commissioned it.

Mr Bacon

Just remind me: until it was sold, who owned Royal Mail?

Mark Russell

A few months ago, we did.

Mr Bacon

Yes. Just checking.

Chair

The valuation was done when it was in public ownership.

Mark Russell

It was, yes.

Chair

So, Mr Donnelly, can we see it?

Martin Donnelly

On the point that Mark makes—I know it sounds a bureaucratic one, but it is an important one—my understanding is that this was a report done by Royal Mail for Royal Mail management and directors.

Chair

When it was in public ownership, Mr Donnelly.

Mr Bacon

The Shareholder Executive exists to protect and manage the public interest in companies that have a public shareholding, doesn’t it?

Martin Donnelly

Yes, and the company was responsible, of course, for what went into the prospectus.

Mr Bacon

Is it right, Mr Rees, that what the NAO saw was a redacted version of this valuation report?

Matthew Rees

That is correct.

Mr Bacon

Why? Why, Mr Donnelly, did the NAO, which audits the security and intelligence services for heaven’s sake—it doesn’t necessarily publish it, of course, but it sees it—see a redacted version?

Mark Russell

May I say what redacted means? The figures that we saw were the net values of the property. Those figures were disclosed, and we can ask the company if you can have those figures. The basis of these valuations was that they started with assumptions that in 10, 13 or 15 years’ time, if we have x number of flats or whatever, we might get a gross value—it will be many, many times. Then they deduct from that those various assumptions, and you can put in all sorts of assumptions. I think that what Royal Mail will argue is that those assumptions are commercially sensitive. You can make all sorts of assumptions as to what the total gross value should be. As a shareholder, we should be interested in the net value, and that is the figure—

Mr Bacon

I think, Mr Russell, it would be possible for any expert in the world of property to make a series of assumptions and to come up with a range of valuations—many do that for a living all the time—once you know what the portfolio is, where it is, which parts of London it is in, how many acres there are and so on, which are the things that were available. I am struggling to understand why this information should have been kept from the National Audit Office. How is it to do its job when it is getting redacted information?

Mark Russell

My response, as I gave it to you before, is that it was given the net value—the value of the asset itself.

Mr Bacon

Based on a whole series of assumptions that may be heroic or may be very conservative, but the point is that they are based on assumptions. To do its job, the National Audit Office needs to see the underlying working.

Mark Russell

We can ask the company.

Stephen Barclay

Just to be clear, did the Department see the full report before the IPO?

Mark Russell

No, we didn’t. We saw a redacted version.

Stephen Barclay

So you are setting the price on property—with yourself as the client paying for the report—without seeing the full report?

Mark Russell

To be clear, these valuations—

Stephen Barclay

Is that a yes?

Mark Russell

It is a yes.

Nick Smith

Why did you not ask for the report, given that the property portfolio could be worth up to £800 million?

Mark Russell

Because our focus was actually on what the cash proceeds of selling this property would be in the medium term. That was where our focus was, and on the due diligence that was done on the business before that.

Stephen Barclay

It was a short-term arrangement for the investors.

Mark Russell

It was short to medium.

Stephen Barclay

Short to medium in what they get in yield, so if you dispose of the property after that point, in your view that was not relevant.

Mark Russell

Remember these developments are fairly speculative and fairly undeveloped. These valuations make all sorts of assumptions about planning permission and access. There are lots of assumptions.

Stephen Barclay

But the Vauxhall site is in the middle of a local enterprise zone.