Styperson POPE

Strategy & Compliance for Investment Firms


Marketing Funds: Promoting Unregulated Collective Investment Schemes

This is a long one but it’s a very complicated and misunderstood area… print it off, have a coffee, and take a deep breath…

The Financial Services and Markets Act (FSMA) imposes a restriction on unregulated collective investment schemes being marketed to the public but it also creates three sets of exemptions, each of which has its advantages and disadvantages.  (These all define to whom the fund can be promoted and by who, there are separate rules about the documents which must be used – click here for more information on when a prospectus is required.)

1. The Financial Promotions Order defines how an unauthorised firm can promote a scheme using unapproved documents.  Essentially, it allows promotion to some institutional investors and to Certified Sophisticated Investors (and, depending on the scheme’s investments, occasionally to self-certified high net worth or sophisticated investors).

Advantages to this approach are that:

  • Fees tend to be lower because,
    • the document used does not need to meet the FSA’s requirements for financial promotions, and
    • no FSA authorised firm has to take responsibility for the document.

Disadvantages are that:

  • an unauthorised (and therefore probably less expert firm) takes all of the responsibility,
  • the documents do still need to meet certain FSMA and common law requirements,
  • schemes can only be promoted to institutional and certified sophisticated investors,
  • the person making the communication has to establish that the investor is certified before making any promotion, and
  • authorised firms (eg IFAs) may not be able to pass on the promotion.

2. The Promotion of Collective Investment Scheme (Exemptions) Order contains one of the sets of exemptions to Section 238 of FSMA which restricts how an authorised firm can promote a Collective Investment Scheme. The exemptions here are very similar (but not identical) to those under the Financial Promotions Order (above).

Advantages are that:

  • an authorised firm is involved, giving comfort to partners in the fund by taking on some of the responsibility;
  • investors will feel more comforted knowing that a UK-based, FSA-authorised body is involved in the communication; and
  • the document does not have to meet the full requirements of the FSA’s financial promotion rules;
  • an authorised firm can approve the promotion to be made by unauthorised persons (but there’s little point because the promotion would be limited to the same people the unauthorised person cold promote it to anyway under the Financial Promotions Order).

Disadvantages are that:

  • fees will be higher because the firm will have to ‘verify’ the contents of the promotional material – they have a responsibility to investors to ensure that it is fair clear and not misleading;
  • schemes can still only be promoted to institutions and certified sophisticated investors;
  • the person making the communication still has to establish that the investor is certified before making any promotion; and
  • even some authorised firms (eg IFAs) can not pass on the promotion – eg if it would constitute MiFID business for them.

3. The FSA’s rules provide the final route for promotion. These define eight categories of investor to whom a scheme can be promoted without breaching the restriction in FSMA. Some of these are very specific exemptions for unusual types of schemes (like Church Funds and Lloyds underwriters) but two in particular are of more use.

Advantages of utilising these rules are that:

  • the scheme can be promoted to other groups of investors, including
    • persons assessed as suitable by an authorised firm (probably their IFA),
    • persons who have undergone an adequate assessment of their knowledge, experience and expertise by an authorised firm;
  • the scheme can be promoted in such a way as to reduce as far as possible the risk of someone making an investment who does not fit an exemption (this will mean controlling the promotion, dissuading ineligible persons from applying, and checking that applicants are eligible but unlike the other routes above, this does not need to be done ahead of making initial contact with an investor);
  • an authorised firm will take responsibility for the document; and
  • an authorised firm can approve the document for distribution by unauthorised persons.

Disadvantages of this approach are that:

  • the document will need to be more thorough, meeting all of the FSA’s requirements for financial promotions;
  • fees will be higher because the document will need to be verified by the authorised firm; and
  • an authorised firm will need to have processes and procedures in place to ensure that ineligible applicants are not permitted to participate in the scheme.

As you can see, each approach has its ‘pros and cons’ and each route is therefore suitable for certain types of schemes.

Routes 1 and 2 are most suitable for institutional schemes (ie funds where all of the investors are investment professionals, authorised firms, or high net worth companies and unincorporated associations).

If you are thinking of pursuing either of these routes and the fund is looking for investment from individuals then make sure that you or your distribution network already know a good number of Certified Sophisticated Investors (be careful to ask the right question and get the right answer because Self-Certified Sophisticated Investors, probably won’t count and certificates that do not cover unregulated collective investment schemes are useless to you).

If in any doubt, we recommend that you pick a sample of your target audience, say 20 investors, and (without telling them anything about the fund), ask them if they have a certificate and if they do, to fax it over to you.We can take a quick look at these and make sure that they are the right kind.Once you know what percentage of your target audience has these certificates then you’ll know how restricted you’ll be in promoting your fund.

Route 3 is likely to be more expensive because the authorised firm (probably the operator of the scheme) is going to be more involved – they will verify the document (as indeed they will for route 2 and you will for route 1), they will ensure it meets the FSA’s higher standards, they will approve it for distribution by you, and they will have in place process and procedures designed to stop ineligible investors from participating.

On the other hand, this route will allow more effective promotion of the scheme on the basis that investors will be protected by the assessments carried out by authorised firms (be they the operator or an IFA). If you want to promote the scheme to individuals who don’t already hold a Certificate of Sophistication covering unregulated collective investment schemes, these protections will need to be in place.

Above, I said the fact that “the document will need to be more thorough, meeting all of the FSA’s requirements for financial promotions” was a disadvantage. It might equally be seen as an advantage, both for the investor, who is better informed and therefore better protected, and for the promoter who can draw the attention of their distribution network to the involvement of an authorised firm.

StypersonPOPE can help you to determine the most effective route to employ in promoting a scheme. If you would like to discuss scheme promotion, please do contact Simon Webber,StypersonPOPE’s Managing Director, either by telephone or e-mail.


Investor Certificates: Sophisticated Investors & High Net Worth Individuals

Some communications about financial services (particularly those by unathorised firms or those related to funds) are restricted to ‘certified’ investors.  It’s important not to mix these up with an investor’s categorisation as Retail or Professional or whether they are a Qualified Investor – these are three quite separate regimes of classification.

The differences between the certificates are subtle but vital to understand. For instance, just taking sophisticated investors, there are three different types of certificate depending on what the promotion is about and who is making it – it’s possible that a single investor might hold all three and yet still not count as a ‘Certified Sophisticated Investor’ in respect of any particular investment.

Financial Promotions Order Certificates include:

  • Certified Sophisticated (signed by an authorised firm)*
  • Self-certified Sophisticated**
  • Self-certified High Net Worth**

* Only in respect of the investments the certificate lists
** Only in respect of debentures and shares in unlisted securities

Promotion of Collective Investment Scheme (Exemptions) Order Certificates cover the same categories but have slightly different content.

When relying on certificates, the promoter must ensure that the investor holds the relevant certificate before making any promotion. We recommend that they see a copy of the certificate either by post, fax or scan. This can be difficult in practice but it is the only route available to firms under these regimes.

To establish whether your target audience is likely to have the required certificates, we recommend that you pick a sample, say 20 investors, and (without telling them anything about the investment), ask them if they have a certificate and if they do, to fax it over to you.

StypersonPOPE can take a quick look at the certificates you receive and determine which ones you can rely on.

Once you know what percentage of your target audience has these certificates then you’ll know how restricted you’ll be in promoting your investment opportunity. If it proves to be unworkable, there are alternative routes available which circumvent the need for certificates entirely.

In any case, StypersonPOPE can help you to determine which certificates are appropriate and what percentage of your target audience holds them. If you would like to discuss scheme promotion, please do contact Simon Webber, StypersonPOPE’s Managing Director, either by telephone or e-mail.


Prospectus Exemptions… myths & misunderstandings

We see a lot of clients who really want to avoid having to prepare a prospectus.  Sometimes, I’m not sure all the effort is worthwhile and it may be better to take another look at the costs and time involved in putting a prospectus together if it makes the marketing easier – generally, it’s not as bad as you’d think.  Nonetheless, this article is about the exemptions, or rather about some of the imaginary exemptions we’ve heard of recently.  Our basic guide to the real exemptions can be found by clicking here.

“If working within the limit of 99 people, can’t Sophisticated Investors be excluded from the total?”

No.  It’s true that certain investors can be excluded but the only kind of private individuals who can be excluded are ‘Qualified Investors’.  These must be registered with the FSA and meeting the criteria  for sophistication is not helpful in meeting the requirements to be qualified investors (which are much closer to the criteria for an elective professional investor under MiFID).

“If relying on the minimum investment of €50k, is it OK to quote this in the literature but actually accept less than this?”

Again, no.  Generally speaking, saying one thing and doing another is a recipe for upsetting investors and getting sued.  Apart from this, the relevant rule states that “a person does not contravene section 85(1) if… the minimum consideration which may be paid by any person for transferable securities acquired by him pursuant to the offer is at least 50,000 euros”.  I suppose if you have a really good lawyer, you could get into a debate about the meanings of “may” and “pursuant” but I think we all know what the rule intends and I wouldn’t want one of my clients to be in the dock while the case law is being made. 

“Is it true that the prospectus rules don’t apply to funds which are unregulated collective investment schemes?”

Sorry, yet again, no.  The rules apply to most ‘transferable securities’ including shares in companies and units in partnerships (how most funds are structured).  It is true that there is a list of exempt investment types and that this list includes open ended funds but most smaller, unlisted or unregulated funds won’t qualify as open ended (even if they think they do).  They can, however, use one of the other exemptions.  It is worth noting that any fund listed on the LSE’s Specialist Fund Market must prepare a prospectus even if it otherwise falls into one of the exemptions.

With experience of the prospectus directive within both corporate finance and fund establishment, StypersonPOPE can help you plan which exemptions to use. For an initial discussion, please call or e-mail Simon Webber, StypersonPOPE‘s Managing Director.


FSA Client Categories

Client categorisation is an area where many people (including FSA authorised firms) are still confused.  To be fair to them, it has changed a few times and there are several complications and clashing concepts. 

For instance, it’s common to confuse concepts like ‘High Net Worth Individual‘ and ‘Sophisticated Investor‘ with client categorisation as retail, professional or eligible counterparty.  In fact they are nothing to do with one another – many investors are both High Net Worth and Sophisticated but still retail investors.

Client categorisation is particularly important when an authorised firm does not have the permissions to deal with retail investors.  If client categorisation isn’t handled properly, the firm can end up on the wrong side of the law.

All authorised firms must categorise their clients, so to start at the beginning; who is the client?  A client is any person to whom the firm provides, or may potentially provide,  a service in the course of carrying out a regulated activity.  Even if services aren’t provided to them, a person to whom a firm communicates, or for whom a firm approves, a financial promotion is also a client (but a different kind of client and slightly different rules apply).

How a client is initially categorised depends on what sort of entity they are.  Starting at the top and working down…

Eligible counterparties include investment firms, insurance companies, authorised collective investment schemes, pension funds, governments, central banks and supranational institutions (like the World Bank and IMF). 

Professional clients include many of these same entities because eligible counterparties are only counted as such in respect of eligible counterparty business, the rest of the time, they are professional clients.  This category also includes large businesses (how large depends on the services provided), trusts with asssets of more than €10m, and pension funds with more than 50 members.

Retail clients are everybody else – most SMEs and all individuals will be retail clients.

However, a retail client can ask to be treated as an ‘elective’ professional client.  This means that they will be less well protected by the FSA’s rules and so authorised firms are required to ensure that such people qualify to make the change.  The criteria for that qualification again depend on what kind of service is being provided.

For non-MiFID business,  the firm must assess the expertise, experience and knowledge of the client to ensure that they are capable of making investment decisions and understanding the risks involved.  Firms must have in place procedures and training to ensure such an assessment is adequate and must keep appropriate records.  There must also be an exchange of correspondence between the client and the firm in order to effect the change.

For MiFID business, as well as the above, the client must be able to satisfy two of the following quantitative tests:

  • they have carried out an average of 40 significant transactions on the relevant market in the last year;
  • they have a cash and financial instrument portfolio of over €500,000;
  • they have worked in the financial sector for at least one year in a professional position which requires knowledge of the transactions or services envisaged.

For many types of regulated activity, the first of these quantitative tests is highly unlikely to be met by even the most active investor.  If so, for an authorised firm carrying out MiFID business that does not have permission to take on retail clients, the only individuals they can work with are essentially financial services professionals with portfolios over €500,000… and there just aren’t as many hedge fund managers as there once were!

Retail clients who choose to recategorise as professional always have the right to return to being retail clients.  Indeed, all professional clients and eligible counterparties have the right to downgrade their categorisations and increase their potections.

As well as in relation to the provision of regulated services, client categorisation is important to financial promotions where communications which are likely to be received by retail clients must meet higher standards than others.   If a promotion is approved so that it can be circulated by unauthorised firms, the approval must be limited to the client categories for which it is written.  It is an offence under FSMA for a communication approved for professional clients to be distributed to retail clients.

If you are at all unclear about client categorisation, StypersonPOPEcan prepare a clear and straightforward procedure for you to follow.  Please contact Simon Webber for an initial discussion on 07710 260 717 or sw@strategic-compliance.co.uk.   


FSA Sophisticated Investor and High Net Worth Individual Certificates

Some communications about financial services are restricted to ‘certified’ investors. The differences between the certificates are subtle but vital to understand. For instance, just taking sophisticated investors, there are three different types of certificate depending on what the promotion is about and who is making it – it’s possible that a single investor might hold all three and yet still not count as a ‘Certified Sophisticated Investor’ in respect of any particular investment.

Financial Promotions Order Certificates include:

  • Certified Sopisticated*
  • Self-certified Sophisticated**

  • Self-certified High Net Worth**

* Only in respect of the investments the certificate lists
** Only in respect of debentures and shares in unlisted securities

Promotion of Collective Investment Scheme (Exemptions) Order Certificates include:

  • Certified Sopisticated*

  • Self-certified Sophisticated**

  • Self-certified High Net Worth** 

* Only if the listed investments include ‘units in a collective investment scheme’
** Only in respect of schemes investing in debentures or shares in unlisted securities.

When relying on certificates, the promoter must ensure that the investor holds the relevant certificate before making any promotion. We recommend that they see a copy of the certificate either by post, fax or scan. This can be difficult in practice but it is the only route available to firms under these regimes.

To establish whether your target audience is likely to have the required certificates, we recommend that you pick a sample, say 20 investors, and (without telling them anything about the investment), ask them if they have a certificate and if they do, to fax it over to you.

StypersonPOPE can take a quick look at the certificates you receive and determine which ones you can rely on.

Once you know what percentage of your target audience has these certificates then you’ll know how restricted you’ll be in promoting your fund. If it proves to be unworkable, there are alternative routes available but they will likely require more involvement by an authorised firm.

In any case, StypersonPOPE can help you to determine which certificates are appropriate and what percentage of your target audience holds them. If you would like to discuss scheme promotion, please do contact Simon Webber, StypersonPOPE‘s Managing Director, either by telephone or e-mail.

 


Three routes to promote an Unregulated Collective Investment Scheme

The Financial Services and Markets Act (FSMA) imposes a restriction on unregulated collective investment schemes being marketed to the public but it also creates three sets of exemptions, each of which has its advantages and disadvantages…

1. The Financial Promotions Order defines how an unauthorised firm can promote a scheme using unapproved documents.  Essentially, it allows promotion to some institutional investors and to Certified Sophisticated Investors (and, depending on the scheme’s investments, occasionally to self-certified high net worth or sophisticated investors).

Advantages to this approach are that:

  • Fees tend to be lower because,
    • the document used does not need to meet the FSA’s requirements for financial promotions, and
    • no FSA authorised firm has to take responsibility for the document.

Disadvantages are that:

  • an unauthorised (and therefore probably less expert firm) takes all of the responsibility,
  • the documents do still need to meet certain FSMA and common law requirements,
  • schemes can only be promoted to institutional and certified sophisticated investors,
  • the person making the communication has to establish that the investor is certified before making any promotion, and
  • authorised firms (eg IFAs) may not be able to pass on the promotion.

2. The Promotion of Collective Investment Scheme (Exemptions) Order contains one of the sets of exemptions to Section 238 of FSMA which restricts how an authorised firm can promote a Collective Investment Scheme. The exemptions here are very similar (but not identical) to those under the Financial Promotions Order (above).
 

Advantages are that:

  • an authorised firm is involved, giving comfort to partners in the fund by taking on some of the responsibility;
  • investors will feel more comforted knowing that a UK-based, FSA-authorised body is involved in the communication; and

  • the document does not have to meet the full requirements of the FSA’s financial promotion rules;

  • an authorised firm can approve the promotion to be made by unauthorised persons (but there’s little point because the promotion would be limited to the same people the unauthorised person cold promote it to anyway under the Financial Promotions Order).

 Disadvantages are that:

  •  fees will be higher because the firm will have to ‘verify’ the contents of the promotional material – they have a responsibility to investors to ensure that it is fair clear and not misleading;
  • schemes can still only be promoted to institutions and certified sophisticated investors;

  • the person making the communication still has to establish that the investor is certified before making any promotion; and

  • even some authorised firms (eg IFAs) can not pass on the promotion – eg if it would constitute MiFID business for them.

3. The FSA’s rules provide the final route for promotion. These define eight categories of investor to whom a scheme can be promoted without breaching the restriction in FSMA. Some of these are very specific exemptions for unusual types of schemes (like Church Funds and Lloyds underwriters) but two in particular are of more use.
 

Advantages of utilising these rules are that:

  • the scheme can be promoted to other groups of investors, including

    • persons assessed as suitable by an authorised firm (probably their IFA),

    • persons who have undergone an adequate assessment of their knowledge, experience and expertise by an authorised firm;

  • the scheme can be promoted in such a way as to reduce as far as possible the risk of someone making an investment who does not fit an exemption (this will mean controlling the promotion, dissuading ineligible persons from applying, and checking that applicants are eligible but unlike the other routes above, this does not need to be done ahead of making initial contact with an investor);

  • an authorised firm will take responsibility for the document; and

  • an authorised firm can approve the document for distribution by unauthorised persons.

Disadvantages of this approach are that:

  • the document will need to be more thorough, meeting all of the FSA’s requirements for financial promotions;

  • fees will be higher because the document will need to be verified by the authorised firm; and

  • an authorised firm will need to have processes and procedures in place to ensure that ineligible applicants are not permitted to participate in the scheme.

As you can see, each approach has its ‘pros and cons’ and each route is therefore suitable for certain types of schemes.

Routes 1 and 2 are most suitable for institutional schemes (ie funds where all of the investors are investment professionals, authorised firms, or high net worth companies and unincorporated associations).

If you are thinking of pursuing either of these routes and the fund is looking for investment from individuals then make sure that you or your distribution network already know a good number of Certified Sophisticated Investors (be careful to ask the right question and get the right answer because Self-Certified Sophisticated Investors, probably won’t count and certificates that do not cover unregulated collective investment schemes are useless to you).

If in any doubt, we recommend that you pick a sample of your target audience, say 20 investors, and (without telling them anything about the fund), ask them if they have a certificate and if they do, to fax it over to you. We can take a quick look at these and make sure that they are the right kind. Once you know what percentage of your target audience has these certificates then you’ll know how restricted you’ll be in promoting your fund.

Route 3 is likely to be more expensive because the authorised firm (probably the operator of the scheme) is going to be more involved – they will verify the document (as indeed they will for route 2 and you will for route 1), they will ensure it meets the FSA’s higher standards, they will approve it for distribution by you, and they will have in place process and procedures designed to stop ineligible investors from participating.

On the other hand, this route will allow more effective promotion of the scheme on the basis that investors will be protected by the assessments carried out by authorised firms (be they the operator or an IFA). If you want to promote the scheme to individuals who don’t already hold a Certificate of Sophistication covering unregulated collective investment schemes, these protections will need to be in place.

Above, I said the fact that “the document will need to be more thorough, meeting all of the FSA’s requirements for financial promotions” was a disadvantage. It might equally be seen as an advantage, both for the investor, who is better informed and therefore better protected, and for the promoter who can draw the attention of their distribution network to the involvement of an authorised firm.

StypersonPOPE can help you to determine the most effective route to employ in promoting a scheme. If you would like to discuss scheme promotion, please do contact Simon Webber, StypersonPOPE’s Managing Director, either by telephone or e-mail.
 

 

 

 


Promotion of Unregulated Collective Investment Schemes

As with most types of financial services, people who are not authorised and regulated by the FSA are very restricted in how they can promote an unregulated collective investment scheme.  Unusually even regulated firms are subject to tight restrictions.  The Financial Services and Markets Act 2000 (let’s just call it FSMA), makes it an offence for anyone to promote a scheme to the public:

“An authorised person must not communicate an invitation or inducement to participate in a collective investment scheme.”

Fortunately, for regulated firms, there are a few exemptions, one set is created by Treasury Order and the other by the FSA.

Treasury Exemptions
If an investor falls into one of the categories below, a fund can be promoted to them but the promoter must ensure that the investor falls into the category before making a promotion:

  • Investment Professionals (authorised firms and investment companies);
  • Sophisticated Investors with a certificate signed by an authorised firm covering unregulated schemes; and

  • High Net Worth Companies and Unincorporated Associations.

For some schemes that invest in unlisted securities, authorised firms can also invite High Net Worth Individuals and Sophisticated Investors to self-certify.

FSA Rules
These allow a scheme to be promoted to investors who have undergone an assessment by an authorised firm, including:

  • individuals for whom the scheme has been assessed as suitable (usually by a financial advisor); and

  • individuals for whom an assessment of experience, expertise and knowledge has been undertaken (sometimes by a financial advisor or the scheme’s Operator).

In these cases, a fund can be promoted to a potential investor on the basis that they will be prevented from investing unless they successfully complete the assessment (which may occur after the promotion has been made).

Whichever exemption the investors fall into, the documents for the scheme must meet detailed requirements laid down by FSMA, the Treasury and the FSA. These include presenting a balance of risk and reward, carrying appropriate warnings, giving sufficient information, and always being clear, fair and not misleading.  Summary documents can be used but these also have to meet the rules and must be consistent with all of the other information given to investors.

In most cases, an FSA authorised firm can approve the scheme documents and summaries for distribution by an unauthorised person but only to the relevant categories of exempt investor.  To rely on the FSA’s exemptions, careful procedures will need to be followed by the authorised firms (see our Services For Operators).

If you would like to discuss your plans to market an unregulated collective investment scheme, please contact Simon Webber, StypersonPOPE’s Managing Director, on 07710 260 717 or sw@strategic-compliance.co.uk.