Advertisement of unauthorised investments – Court of Final Appeal clears up professional investors exemption under SFO

In Pacific Sun Advisors Limited & Anor v. Securities and Futures Commission (FACC 11/2014), the Court of Final Appeal (CFA) upheld an appeal by the defendants, Pacific Sun Advisors Limited and its director, Andrew Pieter Mantel, against their conviction in the Magistrates’ Court in relation to certain advertisements for a collective investment scheme (CIS) intended for professional investors that were not authorised by the SFC under Section 103(1) of the Securities and Futures Ordinance (SFO). Apart from clarifying the construction of the professional investors exemption under Section 103(3)(k), the case is a useful reminder to insurers of investment advisers of the nature of enforcement actions that might be brought against their insureds in Hong Kong.

Background

Pacific Sun and Mantel were charged in 2013 with issuing unauthorised advertisements to the public to subscribe for interests in a CIS in contravention of Section 103. Section 103 requires any advertisement, invitation or document containing an invitation to the public to acquire securities or interest in a CIS to be authorised by the SFC unless it falls within a specified statutory exclusion – Section 103(3)(k) (“the Exemption”).

At the Magistrates Court, the defendants successfully argued that they could rely upon the Exemption which applies where the advertisement, invitation or document relates to a product are or are intended to be disposed of only to professional investors.

The SFC appealed to the Court of First Instance, which held the Exemption was only available if the offer to the public explicitlymentioned that it was limited to professional investors only. The matter was remitted to the Magistrates’ Court and on the remitter, the defendants were convicted. The defendants then appealed to the CFA and the main issue on appeal was whether the Exemption, on its proper construction, required the advertisement to explicitly mention that it was intended for professional investors only.

Judgment of the CFA

The CFA disagreed with the Court of First Instance and restored the acquittals. The CFA held on a purposive construction that the defendants could avail themselves of the Exemption as the CIS was intended to be disposed of only to professional investors. Mr. Justice Fok PJ (who delivered the leading judgment) held that the Exemption “goes to the substance of the investment and it is therefore necessary for a person claiming its benefit to demonstrate that the relevant investment is in fact intended solely for professional investors. It is the demonstration of this fact that shows that a retail investor is protected against exposure to an unsuitable investment product. Once it is accepted that the substance of the question of whether the investment product is or is not intended for professional investors has to be investigated in order to invoke the exemption, the statutory purpose of investor protection is achieved, without reference to the express wording of the advertisement in question”.

Takeaway

The CFA’s judgment usefully clarifies the construction of the Exemption for investment advisers. The ruling means advertisements, invitations or documents of CIS that may be unsuitable for retail investors can be issued to the general public even if the issuer only intends to sell them to professional investors. The SFC has indicated that it will consider the judgment to determine whether section 103 would need to be amended.

For insurers of investment advisers in Hong Kong, the case serves not only as a reminder of the nature of enforcement actions that might be brought against their insureds in the financial services sector but also the complex regulatory environment they operate in. Whilst insurers do not usually provide coverage for defence costs for such regulatory proceedings, some policies contain an extension for costs incurred by their insureds in dealing with regulatory investigations and such investigations may relate to their conduct of advertising of unauthorised investments. Investment advisers are encouraged to look at their insurance policies to ascertain whether they are entitled to coverage for costs incurred in regulatory investigations and also the limits of cover.