Introduction
Over the last few years, the regulatory regime contained in the Financial Services Act (the "Act") has become much more relevant to the world of property. This is largely due to the increasing attractiveness of investing indirectly in property, ie through a fund of some sort. Such funds are, almost invariably, collective investment schemes. A unit in a collective investment scheme is an investment, as that term is defined in the Act, and anyone who deals in or advises on such investments needs to be authorised to carry on investment business. Similarly, anyone establishing or operating a collective investment scheme will also require authorisation.
Authorisation under the Act
Anyone who carries on investment business in the United Kingdom, with certain exceptions, is required to be authorised to do so. The usual method of obtaining authorisation is to join one of the Recognised Self-Regulating Organisations ("RSROs") which are supervised by the Financial Services Authority.
In order to decide whether an organisation needs authorisation, it is necessary to decide whether or not it is carrying on investment business within the United Kingdom. This is defined in the Act as engaging in one or more of the activities which are listed in Part II of Schedule 1. The activities which are most relevant to people in the property business are the following:
- dealing in, ie buying or selling investments;
- arranging deals in investments;
- managing investments;
- advising on investments;
- establishing or operating collective investment schemes.
Investments are also defined. The three most relevant are shares, debentures and units in a collective investment scheme.
Collective Investment Schemes
It is the area of collective investment schemes which is most likely to be interesting to those people who are active in the property business, whether as professional advisers such as agents, or as principals such as property developers.
Collective investment schemes are widely defined. The definition in Section 75(1) of the Act states that a Collective Investment Scheme means "any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income." It is important to note that the underlying property of an investment scheme can be anything, including land. This has led to confusion. People think of the regulatory regime contained in the Act as involving things which are obviously investment such as shares, debentures, futures, etc. However, when dealing with land, they do not always realise that they may need advice in this area.
An area of particular difficulty relates to joint ventures. The parties to a joint venture, say, to develop land, may consider they have entered into a straightforward commercial agreement. However, inadvertently, they may have created a collective investment scheme.
An additional reason why collective investment schemes are important is the increasing popularity of limited partnerships. This is because limited partnerships are tax-transparent, ie the tax treatment of each individual partner depends on their personal circumstances and not that of the partnership and each limited partner enjoys the benefit of limited liability. Limited partnerships are usually collective investment schemes.
There are a number of exceptions to the definition of collective investment scheme which may assist. First, it is not a collective investment scheme where each of the participants carries on a business other than investment business and enters into the arrangements for commercial purposes related to that business. In many cases, this will be sufficient to exclude the collective investment scheme provisions of the Act. If two property developers enter into a joint venture to develop land, then they each carry on a business other than investment business and are entering into the arrangements for commercial purposes related to that business, namely property development. However, it has become the practice in recent years for the participants in a joint venture to use special purpose vehicles for that purpose. These are usually new companies which have not traded. Such companies do not have an existing business and therefore do not fulfil the necessary requirements. Various schemes have been suggested for overcoming this difficulty but none of these have yet been tested in the courts.
A second exception is where each of the participants is a body corporate, ie a company, which is in the same group as the operator of the scheme. This exception was designed to deal with joint ownership arrangements set up by companies within the same group, but may have a wider use. The definition of group is the normal one contained in the Companies Act 1985. Given this definition, it is possible to create a situation where the participants are all legally in the same group when, economically, they belong to separate groups.
A third exclusion is where the joint venture uses a body corporate, ie a company. Thus, if parties enter into a joint venture, but use a company as a joint venture vehicle, the collective investment scheme provisions are irrelevant.
A person establishing or operating a collective investment scheme needs to be authorised to carry on investment business under the Act. If they are not authorised, they have committed a criminal offence. Equally importantly, any agreement entered into by a person who is not authorised to carry on investment business in connection with such business, is unenforceable against the other party. The court does have a limited discretion to allow such agreements to be enforced but it would not be safe to rely on this discretion being exercised. Thus if someone were inadvertently to establish a collective investment scheme which later proved unsuccessful, there is a risk that those investors who had lost money could argue that the agreement was unenforceable and that they were entitled to recover money paid by them under the agreement. In short, investors may seek to use this technical point to recover money in an unsuccessful transaction.
Financial Services and Markets Act
The regime established under the Financial Services Act is to be superseded by the Financial Services and Markets Act. This Act is not yet in force. The date upon which it will come into force is known as N2. The Government has recently announced that N2 will be no later than November 2001. It is not proposed in this article to go into detail concerning the new regime. The major change which will come about is that the existing RSROs will disappear. In future, persons wishing to carry on investment business will have to be authorised directly by the Financial Services Authority.
Marketing a fund
When a fund is created, it is necessary to categorise it. The rules which apply to the marketing of the fund will depend upon which category it falls into.
If the fund is a company, the selling of shares in that company will have to be done by someone authorised to carry on investment business. Such selling will almost certainly constitute either arranging or dealing in investments (see above). In addition, any material promoting the company will constitute an investment advertisement. The definition of investment advertisement is wide. Unless circulation is restricted to certain very narrow categories of recipient, no person other than an authorised person may issue or cause to be issued an investment advertisement in the United Kingdom unless its contents have first been approved by an authorised person. In practice, this is not likely to cause a problem because in most cases an authorised person will have been involved in any promotion of a fund. This could either be an investment bank, or more likely, one of the large property agents, most if not all of whom have within their group an authorised person. Such authorised persons will have to follow the detailed rules which will be imposed by the relevant RSRO on that person.
If the fund is a collective investment scheme, then there is an additional, and important, layer of regulation. Under Section 76 of the Act, no authorised person shall promote a collective investment scheme unless it is an authorised unit trust, an investment company with variable capital or a recognised scheme. It is unlikely that a collective investment scheme relating to property will fall within any of these categories. As a result, any scheme involving property usually can only be sold to a limited category of persons, including the following:
- a person authorised to carry on investment business;
- a person whose ordinary business involves the buying and selling of land;
- a participant in another scheme whose underlying property and risk profile are substantially similar to those of the scheme being promoted;
- units offered when a scheme is being taken over or liquidated;
- a person for whom a person authorised to carry on investment business has taken reasonable steps to ensure that the investment in the scheme is suitable and who is a customer of that authorised person;
- a person who has sufficient experience and understanding of the nature and suitability of the investment in the scheme and the risks involved in that investment, and who is classified as a non-private customer;
- a person who is treated as a non-private customer;
- a person who has asked an unauthorised person to include that person’s name in a list of persons who are willing to receive details of unregulated schemes with underlying property of a particular description.
So far as marketing unregulated schemes in Europe is concerned, the situation is even more complicated. There has been no harmonisation in Europe of the marketing rules for most investments, including units in collective investment schemes. Each country has its own rules. These will have to be obeyed whether the fund is constituted as a company and is therefore selling shares, or whether it is constituted as a collective investment scheme and is selling units in such a scheme.
Conclusion
As will have been seen from this article, those people who are becoming involved in the creation, promotion or management of property funds will need to make sure that they do not fall foul of the provisions of the Financial Services Act or its successor, the Financial Services and Markets Act. They will almost certainly need to involve a person authorised to carry on investment business and, in the case of collective investment schemes, they will need to ensure that they are only promoting such schemes to those persons to whom it is permitted.
For further information please contact John Newbegin at john.newbegin@cms-cmck.com or on on +44 (0) 20 7367 2703.
This article first appeared in Estates Gazette on 12 May 2001.
