FCA 2013/46 is the reference for the feedback statement and rule amendments which the FCA has generated to follow on from the Financial Services Authority’s CP 12-19 from last autumn. That was the paper that proposed significant reduction in the scope of regulated investment firms to promote to their retail clients (a) collective investment schemes and (b) arrangements which the paper termed “non-mainstream pooled investments”. That term was left vague at the time (leading to considerable alarm in the Venture Capital Trust industry, for example). The definition has hardened now around unregulated CISs, qualified investor schemes under the FCA’s COLL Sourcebook, traded life policy schemes, and certain securitisation vehicles.
One area of commercial activity, traditionally considered to be outside of regulation altogether, is that of fractional investment. In recent years, different types of fractional scheme have been used to finance a variety of real estate developments, chiefly in the hotel and leisure resort sector. I do not propose to review the diversity of structures here. However, all have in common the need to demonstrate that they are not CISs.
Under the FSMA 2000, there are several platform conditions for the existence of a CIS. There are two alternative conditions in s 235(3), namely that the arrangements must (a) provide for the pooling of contributions and of income/profits; or (b) be managed as a whole by or on behalf of the operator. Negative both (a) and (b) and you are not a CIS. Successful fractional arrangements have been able to demonstrate (with the benefit of in-principle opinions from legal advisers) that each fraction investor acquires a dedicated part of the whole that is managed as a part by the manager, or which the investor could in theory manage himself if he wished to.
The key question which now arises is: if not a CIS, is a fractional scheme a NMPI? Given how narrowly this term has eventually been defined, I am forced to conclude that no, it is not. Specific schemes and arrangements will always need a fuller analysis. But as a general conclusion, fractions are not affected by these new rules. That means that those who promote them (and are unregulated) may continue to offer them to the investing public; moreover, IFAs and SIPP trustees and the like, who may be required to act as investment intermediaries, need not fear that in doing so they ought to have restricted access to certified high net worth investors etc.
My advice in relation to each new fractional is always to get a FCA lawyer’s in-principle opinion. (More than that, get the core documentation drafted by a FCA lawyer who understands how CISs can be deemed to exist and what is essential to avoid this happening.) My next ambition is to see if I can work with the SIPP trustee advisor firms to formulate a standard form of opinion letter that will satisfy the trustees, and not require fractional developers to seek Counsel’s opinion at significant expense on every future deal. Watch this space for further news.
On 4 June, the FCA published keenly anticipated rule amendments with respect to the sale to individual investors by FCA-regulated firms of (a) unregulated collective investment schemes and (b) certain things that look like them.
By way of background, there has been alarm in the financial services industry in recent years over the capacity to place retail investors into complex financial products that are, objectively speaking, not suitable for them. With the lapse into recession and economic malaise in the last few years, and the desertion by the banks of their normal role of providing savers with a decent rate of deposit interest, numerous schemes have sprung up offering high interest returns at considerable risk to the principal. In addition, the market has become frequented by schemes of a very alternative nature. Investors have been invited to sink money into all manner of novel asset classes (logging, ostriches, antique coins, bio-nuts, wind farms and oriental art are just a few that spring to mind). Leaving aside arrangements which are outright fraud, many that have been fairly constituted and lawfully promoted are too high risk for the routine investor. But IFAs, we are led to believe, have been using subjective discretion to classify their retail clients as “expert” and make these promotions possible.
The FSA proposal was that what it deemed to be a collective investment scheme or a “non-mainstream pooled investment” should only be capable of promotion in circumstances where the regulated firm could determine that the investor was a “certified high net worth individual”, or a “certified sophisticated investor”, or a “self-certified sophisticated investor” – these terms all stem from the Financial Promotion Order. And each of these definitions suffered from significant operational limitations.
The certified high net worth individual and self-certified sophisticated investor exemptions were developed as a means of making private equity funds and investments more accessible. As they appear in the FP Order, they are of no utility in relation to hedge funds, many real estate vehicles and all manner of exotic asset CISs.
The certified sophisticated investor exemption allowed the individual to obtain a certificate from an authorised firm, and this could attest to sophistication generally or in relation to a specific product/fund; but the firm that certifies the investor cannot then promote to him, as this was considered self-serving.
Well, these limitations will continue to dog these exemptions where unregulated persons promote investments (and, for that matter, where FCA-regulated firms rely purely on the FP Order exemptions to promote anything apart from CISs and NMPIs – which is not uncommon). But in relation to promotion by your typical IFA of a collective investment scheme or the like, the world is now much simpler. Any such arrangement can be promoted to a relevant class of certified or self-certified investor – even though the rules and guidance go on to say that e.g. mere certified high net worth may be insufficient and the IFA will have to dig deeper and keep reasoned records to justify his conclusions.
What should emerge, though it will take a little time and a bit of bravery, is a process whereby the IFA world will develop a reasonably dependable system for scoring sophistication and thereby allow for certification of sophistication to a reasonably objective standard. IFAs may be fearful of this at present; but the science is absolutely no different from the tools that they use to identify any new client’s investment experience and approach to risk.
Old FSA Consultation Paper 12-19 was among the more controversial policy presentations fashioned in 2012 by the now superseded regulator. It left to the FCA, its new successor, to collect up and make sense of a great number of responses ranging from the intense to the incensed. The declared purpose of CP 12-19 was to firmly shut out the possibility of mis-promotion by FSA/FCA-regulated firms of complex collective investment products to retail investors. The problem was that although the “collective investment scheme”, as a concept, is clear from the FSMA 2000 and the exemption order for CISs made under s 235(5) thereof, simply locking down these arrangements was insufficient. And so the FSA invented the “non-mainstream pooled investment” (or NMPI), and sought to shoe-horn into this definition all manner of other products that have a collective feel to them.
Well, to make a long story short, we now know that the NMPI classification is actually – and thankfully – going to be rather narrower and more manageable than we had all feared.
Investment trusts were always going to be outside the definition, but we now know that Venture Capital Trusts are excluded as well – to the considerable relief of a large number of firms involved in one of the most successful and least scandal-ridden segments of the retail financial services industry.
EIS portfolios (sometimes called EIS funds) are also outside the definition. These are arrangements where a manager offers to manage a portfolio of shares in EIS-qualified companies for multiple investors with identical parallel agreements. There has always been some doubt as to whether they might be collective investment schemes in any case (and a few have been set up as such, by adopting structural devices that disqualify them from an otherwise applicable exemption in the order under s 235). But the key point here is that the FCA concedes that an EIS portfolio is a service and not a product. As such (and completely logically), the EIS portfolio has been clarified by default as being no different in form from the discretionary investment management contract in general terms.
For completeness, it is now obvious that an offer of shares in almost any corporate vehicle (provided this is not an OEIC) is clearly also outside the definition. The only caveat here is that the NMPI definition will include certain sorts of “special purpose vehicle” – a term that the FCA defines as an entity used for securitisation purposes (and which also satisfies certain other conditions). So if you are offering shares in a company that is a trading or a routine investment entity, this cannot be a NMPI in normal circumstances.
The FCA rule changes are not officially in force until 1 January 2014, though the FCA has let it be known that it would wish for shadow compliance with them even now.
The position, thankfully, is largely resolved, and in the end, the restriction on promotion will apply to relatively few types of structure other than acknowledged CISs. There has been a great deal of fuss, therefore, and a significant unsteadying of the retail financial services industry, over a relatively anodyne outcome.
The Court of Appeal has ordered Dresdner (DKIB) and Commerzbank to honour DKIB's pre-merger promise of a guaranteed €400 million staff bonus pool. The promise was designed to help stabilise the workforce following a large number of defections, which had prompted the regulator to put DKIB on its watchlist.
Key Decision Points
DKIB had unilaterally varied its employees' contracts in accordance with the contractual variation terms in its own staff handbook.
The handbook stated: "changes can only be made by a member of the Human Resources Department and must be communicated to you in writing. When the change affects a group of employees, notification may be by display on notice boards or Company Intranet".
The Court of Appeal said these sentences should be read separately and, as the change affected a group of employees, it did not need to be made by HR or be in writing (although the Court decided that HR was involved). A town hall announcement to staff by DKIB's CEO of the guaranteed bonus pool broadcast live over the Company's intranet was enough to vary the employees' contracts.
The promise of a guaranteed minimum bonus pool was contractually binding, although individual employees could not say that they were each entitled to a specific amount. It was enough to give “some indication of the minimum size of the cake but not of the size of the individual slices".
Where a term is being introduced into a pre-existing contractual relationship, there will be a very strong presumption that it is intended to be legally binding.
There was no need for the employees to "accept" DKIB's offer of a guaranteed bonus pool. Requiring the employees to actively accept the offer would be a "wholly formal and unnecessary exercise" and the only sensible conclusion was that anyone who could potentially benefit from the offer would be deemed to have accepted it.
The introduction several months later of a "material adverse change" clause, which was designed to allow DKIB to reduce the size of the guaranteed bonus pool, was a breach of the implied term of trust and confidence.
This case was based on a very specific set of facts but, businesses who make promises to staff, may find the Court holds them legally bound to honour them.
The Supreme Court recently confirmed that tax advice given by non-lawyers could be covered by legal advice privilege. This does not change the law, but clarifies that if you wish to rely on the protection afforded by legal professional privilege, you need advice from a lawyer.
For more information, please see our article here.
Barry and Julie Clark (the Clarks) v In Focus Asset Management & Tax Solutions Ltd (IFAMTS)
The Clarks sought financial advice from IFAMTS following the sale of the family business including premises. The financial advice received was to borrow and invest substantial amounts in endowment policy plans. The trade in the policies was said to be "disastrous” with losses claimed in excess of £500,000.
Mr and Mrs Clark complained to the Financial Ombudsman Service (FOS) who concluded that the complaint should be upheld and that IFAMTS should pay compensation. The compensation formula ensured that the Clarks were in the same position that they would have been, if the advice had not been given. The FOS’s Decision had to be limited to the statutory maximum of £100,000. However, it did state that a court would make its own decision as to whether to award a greater amount above £100,000. FOS recommended that IFAMTS pay the full amount. IFAMTS refused. The Clarks accepted the Decision in the sum of £100,000, noting on their acceptance their right to pursue the matter through the civil courts. IFAMTS claimed that as the Clarks had accepted the FOS's final Decision, they were prevented from taking civil proceedings to recover the balance and that their caveat had no effect. The Court disagreed and concluded that the statutory scheme does not preclude complainants from claiming damages from a financial services provider for an amount in excess of the FOS's determination.
This appears a welcome clarity. Depending on the value of the claim, many complainants may prefer to use the FOS regime as first port of call. If the complainant does not agree with the outcome, it does not have to accept it. If compensation is awarded, proceedings can still be taken in court for further damages. From a practical perspective, the compensation awarded could also provide cashflow to the complainant for their litigation fees. However, a word of warning. Given this Judgment specifically disagrees with the earlier Judgment in Andrews v SBJ Benefit Consultants Ltd and these are both High Court decisions; perhaps this is not the end of the matter. If a complainant is in a similar position to the Clarks, careful tactical consideration needs to be given before lodging an acceptance of the Decision, to avoid further challenges down the line.
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Insider dealing is a top priority for UK prosecutors, with increased collaboration between the Serious Fraud Office (SFO), The Serious Organised Crime Agency (SOCA) and the Financial Services Authority in recent years.
Just last month ex-Deutsche corporate broker Martyn Dodgson was charged with conspiracy to insider deal along with three others. They currently await trial.
These charges are part of Operation Tabernula, a joint investigation between FSA and SOCA. According to FSA this is the “largest and most complex insider dealing investigation to date.”
For financial services firms, the consequences of an employee or director being accused of insider dealing can be highly damaging, destroying both client and investor trust in the firm.
For traders and tippers, the consequences can be life changing with the prospect of facing jail time, large fines and being prohibited from the financial services industry for life.
Along with a more intrusive regulator, we now have an extremely broad definition of what constitutes insider dealing. As the Einhorn/Greenlight case shows below the definition even includes unintended market abuse.
At the beginning of this year David Einhorn, the founder of hedge fund Greenlight Capital, received the second highest fine imposed on an individual for trading Punch Tavern shares on the basis of inside information.
In June 2009, Einhorn was party to a telephone call in which it was disclosed to him by a corporate broker that Punch was in the advanced stages of a substantial equity fundraising. Minutes after the call, Einhorn gave instructions to sell Greenlight’s entire holding in the company. A few days later when Punch announced a fundraising of £375m, its shares fell by almost 30%.
The FSA said that the trading helped Greenlight's funds avoid losses of over £5m. The regulator confirmed that although Einhorn's trading "was not deliberate because he did not believe that it was inside information" this did not matter as this was "not a reasonable belief".
Head of FSA enforcement Tracey McDermott commented on the lessons to be learnt from this stating: “Einhorn is an experienced professional with a high profile in the industry. We expect someone in his position to be able to identify inside information when he receives it and to act appropriately. His failure to do so is a serious breach of the expected standards of market conduct.”
When handling inside information firms should therefore be alive to the potential pitfalls and put in place measures to prevent inside dealing.
Policies and procedures
Effective policies and procedures to control the flow of inside information should be established and reviewed. These should recognise the responsibility to control access to inside information and reduce the risk of misuse of information.
Training and awareness
Adequate measures must be taken, including training programs, to help employees understand the importance of keeping information confidential and the responsibility being an insider places on them. They must also be aware of the civil and criminal consequences of improper disclosure and insider dealing.
"Need to know basis"
Reasonable steps should be taken to limit the number of those with access to inside information. Where possible a “need to know basis” policy should be adopted and only individuals that "need to know" the information should be privy to it.
Personal account dealing
Firms should monitor their employees' trading activities. Personal account dealing procedures should be established, implemented and enforced.
Suspicious transaction reporting
Firms should make suspicious transaction reports in relation to questionable trading activities. In deciding what transactions to report, the key test is that there are reasonable grounds for suspecting the transaction involves insider trading.
Given the huge reputational damage and severe regulatory and criminal consequences of insider dealing, firms should consider the above points so that they ensure they have adequate systems and controls in place to monitor not only how their employees handle inside information but also how they are actually trading.
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Earlier this year the FSA banned Tony Verrier from performing any function in relation to any regulated activity in the financial services industry. Following Mr Verrier's departure from inter dealer broker Tullett Prebon, Mr Verrier tried to poach up to 80 other brokers (on Tullett's estimation) for his new employer, BGC Brokers. It became personal; amidst a web of evidence of dinners, presentations, forward contracts and signing payments, Tullett and BGC fought over the traders. BGC won in respect of 10 of them, but Tullett came out on top. Not only did Tullett win the High Court litigation but, based on evidence heard during the case, Mr Verrier has been banned from taking any regulated role in the UK financial services sector.
For the FSA, this isn't just about poaching staff. The High Court thought it lawful for Mr Verrier to woo Tullett's brokers and get them into forward contracts with BGC. It was also not especially concerned about Mr Verrier's lawful intentions to "kill Tullett Prebon if it is the last thing I do". It wasn't keen on Mr Verrier effort's to provoke Tullett into constructively dismissing its employees, but they weren't illegal.
The illegal and dishonest conduct the Court found included using other desk heads, in breach of their duties to Tullett, to help with the mass recruitment. Mr Verrier tried to get the departing brokers to write letters of complaint which the writers thought untrue. He intended to "blow the whistle" and have them leave en masse, regardless of whether or not they had grounds to claim constructive dismissal. Mr Verrier planned their exits and BGC gave the indemnities and incentives to get the brokers out. In concluding that the commercial gain to BGC would outweigh damages and costs which the Court could award, the Court thought they "showed a cynical disregard for the law".
The FSA's concern over Mr Verrier's behaviour, however, arose out of what happened when he came to Court. The Court found that in giving evidence Mr Verrier departed "adroitly" from the truth where it was inconvenient. Disapproval varied from unconvincing evidence, through to the "inconceivable". It became apparent that Mr Verrier destroyed a key report, concealed the existence of meetings and went on his recruiting spree while subject to undertakings to Court that he would not do so. The Court labelled as a "deliberate ploy" Mr Verrier's assertion that his final blackberry had become inadvertently locked by a password he did not have. It was again inconceivable that more than eight other blackberries had gone missing over the course of a year without an improper intention. Perhaps it was mere coincidence that Mr Verrier's PA also mislaid her blackberry after she was suspended from Tullett? The Court thought not.
Should the FSA have opened an investigation before condemning Mr Verrier? In my view, no. The Court sat for 45 days and heard from more than 26 witnesses. There were nine barristers, four firms of solicitors and over 900 pages of written submissions. The FSA could ignore that, spend a fortune and reach the same conclusion. Or it could decide that the High Court was wrong. Instead it concluded, based on the damning judicial pronouncements, that Mr Verrier's conduct needed a strong and public riposte. It ruled that he was not a "fit and proper person" and duly banned him. This course of action shouldn't come as a surprise. It should be a reminder. Take care before the Court; the regulator is watching too.
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Attrill & others and Anar & others v. Dresdner Kleinwort Limited (DKIB) and Commerzbank AG
This case related to a dispute over a guaranteed bonus pool of €400 million and DKIB's refusal to pay bonuses to certain front and middle-office employees.
Stefan Jentzch, the CEO of DKIB, announced a €400 million bonus pool during a “town hall” meeting on 18 August 2008. His announcement was broadcast live on the company's intranet.
Mr Jentzch said this pool would be allocated according to individual performance. As a whole, however, it was designed to provide an incentive for staff to stay with the company. DKIB had suffered a number of defections, and the FSA had put DKIB on its Firm Watchlist as a result. It was crucial that DKIB took action, despite the fact that, in August 2008, it was making a loss.
The situation got worse following the collapse of Lehman in September 2008. In August 2008 Commerzbank AG had agreed to buy DKIB, and the sale was completed in January 2009. However, the global financial crisis had led to Commerzbank requiring two bail-outs by the German state, totalling €18.2 billion, by January 2009. Consequently, there was significant public and political pressure not to pay bonuses.
DKIB wrote to the employees confirming their provisional bonus awards on 19 December 2008. The letters also said that the awards were subject to review in the event of material adverse change, but Mr Jentzch held a further town hall meeting the same day and reassured staff that it was very unlikely DKIB would seek to rely on the clause.
Mr Jentzch was replaced as Managing Director of DKIB on 12 January 2009. DKIB subsequently relied on the material adverse change clause and slashed the discretionary bonuses by 90%. 104 employees brought claims for the balance of their promised bonuses. DKIB argued in response that the employees did not have a contractual entitlement to the money. However, the High Court held that DKIB had varied the employees' contracts in accordance with its staff handbook. The staff handbook said that any changes to the employees' terms and conditions had to be made by the HR Department and "communicated … in writing. Where the change affects a group of employees, notification may be by display on notice boards or [the] Intranet". This offer was made verbally by the CEO, who was not a member of the HR Department, and while it was broadcast over the Intranet it was not kept. Mark Hindle, the Global Head of HR for DKIB did, however, send an email on 20 October 2008 stating that "the bonus pool for the Front Office has already been communicated by Stefan Jentzch". The High Court said that, taken together, this was sufficient to vary the terms of each employee's contract in line with the provisions set out in the staff handbook.
The High Court found in favour of the employees and ordered the bank to pay €50 million in respect of the unpaid bonuses, along with the employees' substantial costs.
DKIB appealed against the decision, but the High Court refused permission to appeal. DKIB is currently applying direct to the Court of Appeal for permission to appeal against the judgment and so this may not be the final word on the subject.
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We are never short of surprises in the world of tax. Until last week I thought K2 was a mountain but now I learn it is apparently a sophisticated tax scheme used by a number of high profile wealthy individuals and condemned as morally reprehensible by the Prime Minister!
From the reports I have seen, it operates by the promoters of the arrangement setting up a company in Jersey which enters into an employment agreement with our wealthy individual (let’s say an entertainer and call him Mr Motor) and the Jersey company then hires out the services of Mr Motor to third parties. Mr Motor is paid the minimum wage of around £10,000 per annum by the Jersey company and the Jersey company makes loans to Mr Motor equal to its net annual profits. Mr Motor is receiving loans from his employer interest free, which gives rise to a taxable benefit in kind equal to 4% of the loan balance each year on which he pays (say) 40% tax. Therefore, Mr Motor is paying approximately 1.6% of the loans annually in tax, and those loans represent earnings he would otherwise have received in the UK and paid full tax and national insurance contributions on. After the loans are made, the right to receive repayment from Mr Motor is transferred to a foreign trust for Mr Motor (presumably to give comfort that Mr Motor would not be liable to repay the loans should the Jersey company ever be wound up).
So far, so good and it looks like a grand wheeze. However, does it really work? It seems to me that if HMRC wants to attack the arrangements then it could have two possible avenues immediately without having to run off to Parliament for ever more draconian powers:
- The arrangements may be susceptible to an argument that the employment with the Jersey company is in practice a sham. In many cases with tax mitigation arrangements the theory is fine but the practice has a tendency to fall down. If someone wishes to hire Mr Motor for an event, do they speak to representatives of the Jersey company or do they speak to Mr Motor’s agent? Does the Jersey company even have any employees in Jersey for a potential hirer to speak to? If HMRC could show that, so far as Mr Motor’s career is concerned, everything is carrying on as before but simply with hirers sending the fees to Jersey then HMRC just might have an argument.
- Far more dangerous for Mr Motor are the powers HMRC have had for some years now under legislation known as the “transfer of assets abroad” provisions. This applies where a UK resident taxpayer makes arrangements such that a person resident abroad receives income which would otherwise be taxable in the UK and the UK resident taxpayer receives capital sums (defined to include loans) representing that income without paying tax on the full amount of income. Sound familiar? If applied by HMRC, the result of these provisions is that the UK resident taxpayer is taxed on the amount of income diverted to the offshore person.
The only question is why HMRC is not already using the above arguments, which have been available to them for years. All in all, if I were Mr Motor I would be slightly worried.
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