Guinness Affair Rocks Britain’s Financial ‘Club’ : Scandal May Bring an End to Gentlemanly Self-Regulation

Life has not been easy in London’s financial community since last October’s “Big Bang” signaled a new, rough-and-tumble era of deregulation.

During the first week of trading, computer breakdowns cast doubts over the London Stock Exchange’s new electronic dealing system and sent fits of panic through the square mile of London’s business center known as the City.

No sooner were the computer bugs eliminated than a rash of highly publicized insider trading scandals jarred dealers and raised questions about the effectiveness of London’s gentlemanly system of self-regulation in the more cutthroat atmosphere of deregulation.

But these traumas pale in comparison to the damage inflicted by the scandal now swirling around Arthur Guinness & Sons PLC, the British beverage and retailing company, and its bitterly fought $3.9-billion battle for control of a prestigious Scotch whisky producer, Distillers Co. Ltd., early last year.

Revelations that senior Guinness executives and their financial advisers from the City’s most respected banking and securities institutions had engaged in a highly questionable, and possibly illegal, operation to boost the value of Guinness stock at the height of the takeover fight have rocked Europe’s largest, most important financial market.

Embarrassed Government

The scandal has also embarrassed Prime Minister Margaret Thatcher’s government, which has championed self-regulation, and has unleashed powerful new pressures for more stringent controls of the City’s markets.

Last Friday, the Panel on Takeovers and Mergers, which oversees the conduct of acquisitions on the London market, announced that those controlling more than 1% of a company involved in a takeover bid must disclose any dealings during the takeover period. The move is a significant tightening from the previous 5% minimum.

At the same time, the Stock Exchange declared that it would automatically investigate sharp, unexplained movements of share price in any company involved in a hostile takeover bid.

Many believe that stiffer measures could follow as a result of the scandal.

“If practitioners do not respect the system, we shall have little choice but to replace it with one incorporating statutory powers of enforcement and statutory sanctions,” warned the governor of the Bank of England, Robin Leigh-Pemberton, in a recent speech to Scottish bankers.

The so-called Guinness Affair has already been called the biggest scandal in a generation and, as new revelations tumble out daily, the prospect of criminal prosecutions becomes increasingly likely.

So far, the Guinness Affair has:

- Led to a dramatic series of resignations, including those of the high-flying Guinness chairman, Ernest Saunders; Christopher Reeves, the chief executive of a leading London investment bank, Morgan Grenfell; Lord Spens, head of corporate finance at the Henry Ansbacher investment bank, and Sir Jack Lyons, a key adviser to the British arm of the Boston-based management consultant Bain & Co.

- Triggered a stiff warning from the Bank of England to about 25 of the City’s biggest investment banks telling them to review their corporate finance controls and putting senior executives on notice that they will be held responsible for wrongdoings.

- Dampened City enthusiasm for the large-scale takeovers that have helped to keep London a strong bull market during the past two years. Last month, for example, the industrial conglomerate BTR quietly dropped its $1.8-billion bid for Pilkington Bros., a glass manufacturer.

- Caused the Thatcher government to sharpen its stance on regulatory controls in order to counter accusations that its soft policies have allowed the City to go crooked.

“This is a watershed in the way mergers are conducted,” predicted Michael Marks, managing director of Smith New Court International, a London securities house. “The City will have to tighten the rules.”

Added Sir Martin Jacomb, chairman of Barclays de Zoete Wedd, the investment banking arm of Barclays Bank: “The Guinness Affair shows that one must recognize (that) the trend to professionalism has taken a more decisive turn. The regulatory structure will have to respond to that.”

The origins of the scandal are traced to a $2.4-billion hostile bid made in December, 1985, by the food retailer Argyll Group for Distillers, the producer of Johnnie Walker, Black & White and Dewars scotches.

Dismissing Argyll as a canned-peas-and-potato pusher that knew nothing of the whisky business, Distillers sought out Guinness as a white knight. Saunders, the Guinness chairman, quickly organized a bid of $3.5 billion, and one of the most bitterly contested battles in recent City history was under way.

For Saunders, a highly successful manager who had transformed Guinness from a struggling company into an aggressive market leader during his five years as chairman, the chance to win Distillers seemed the grandest prize of all, a catch that would more than double the size of Guinness’ existing empire.

Assembled ‘War Cabinet’

He assembled a “war cabinet” that included corporate finance wizard Oliver Roux on loan from Bain & Co., and Thomas Ward from the Washington law firm of Ward Lazarus, Grow & Cihlar.

His outside team read like a “who’s who” of City takeover specialists. The Morgan Grenfell investment bank, for example, last year handled acquisitions valued at $20 billion, more than any other British bank, while stockbroker Cazenove & Co., was considered a pillar of City respectability.

As is customary in British takeovers, the currency of the Guinness offer was its own shares. In the final hectic weeks of the struggle, the sharply rising Guinness stock price helped to boost the value of its offer just enough for Distillers’ shareholders to prefer it over the Argyll offer, allowing the takeover to succeed.

Although Argyll had complained about the conspicuous jump in Guinness stock, it was only when the Department of Trade and Industry began its own investigation early last December that details began to spill out.

These details pointed to a massive Guinness operation to find buyers for several million shares at above-market prices. As an incentive, there were sweeteners, reportedly including offers to make up any losses suffered by purchasers if they had to sell at a lower price following the takeover.

It is illegal in Britain for a company to purchase its own shares or to grant financial inducements to others to purchase them. Stock market manipulation is also a criminal offense.

Chairman Was Fired

As the government’s investigation progressed, Saunders first stepped aside voluntarily, then was fired by the Guinness board when accountants found nearly $40 million in unexplained invoices for “advice and services.”

Those close to the investigation believe that a sizable amount of this money may have been used to compensate those who bought Guinness stock during the takeover.

A string of other resignations has followed among those involved in the operation.

While the pedigrees of the individuals and institutions linked to the scandal are partly responsible for the affair’s devastating impact, other circumstances have conspired to make it a major political issue.

Although the Guinness-Distillers merger was completed four months before deregulation, the revelations of wrongdoing follow prolonged media attention to the high salaries and quick fortunes that the “Big Bang” could bring fast-moving City financiers.

With Thatcher having to face a general election some time in the next 17 months, the opposition Labor Party has seized upon the scandal, claiming that her government has let cunning City businessmen prosper while allowing factories in the depressed industrial north to close, throwing honest, hard-working men and women into a national pool of unemployed already exceeding 3 million.

Labor’s shadow chancellor of the exchequer, Roy Hattersley, recently dismissed the City as “the least reputable sector” of the British economy and pledged that a Labor government would implement statutory controls over its dealings.

In a parliamentary debate on Jan. 18, Labor’s spokesman for industrial affairs, John Smith, hammered at the same theme to the cheers of his party colleagues.

System Failed

“The system existing to protect the public has failed miserably,” Smith charged.

Pushed onto the defensive, Thatcher’s trade and industry secretary, Paul Channon, promised an urgent, comprehensive review of the present informal rules governing corporate takeovers and repeated the threat made earlier in the week by Leigh-Pemberton, the Bank of England governor, that if the present system continues to be abused, the government will have little choice but to implement legally binding controls.

To demonstrate a hardening attitude toward the City, Thatcher’s government recently moved to increase the maximum jail sentence for insider trading to seven years from two.

The scandal is especially galling to Thatcher because it has come as her government has tried to encourage greater individual participation in the London stock market, historically dominated by institutional traders.

It has also not helped that Channon, a key Cabinet minister in dealing with the financial community, is a member of the Guinness family, which owns about 4% of the beleaguered company.

The present Panel on Takeovers and Mergers reflects the philosophy of a gentler age, when the occasional frown from a group of respected City figures was enough to keep the institutional players from flouting a takeover code drawn up and agreed to among themselves.

Viewed as an Asset

Many now argue that, far from being a constraint, a rebuke from the panel is viewed by some as an asset in a more competitive market where aggressive winners gather more business than gentlemanly losers.

The panel’s powers are basically limited to exposing unethical action in the course of a takeover. It also relies largely on good will and honesty for its information.

For example, when Argyll formally complained during the latter stages of its battle for Distillers that Guinness stock was mysteriously rising, it had little option but to accept at face value the assurances from the Guinness camp that there were no improprieties.

The panel’s inability to deal with a market that no longer views its rules as sacred has raised questions about its future. The Financial Times asked in a recent edition: “Is the Takeover Panel doomed?”

The affair has also focused attention on the adequacy of other regulatory bodies recently established to monitor the deregulated markets.

Meanwhile, as the Department of Trade and Industry’s investigation extends its probing, the feeling among those following the Guinness scandal is that the list of corporate casualties is almost certain to grow.

Both Channon and Chancellor of the Exchequer Nigel Lawson, anxious to prove the government’s resolve, have promised quick prosecution if the investigation uncovers evidence of criminal wrongdoing.

“Any information suggesting criminal activity will, of course, be passed promptly to the appropriate authorities,” Lawson said at a parliamentary debate earlier last month.