A recent case serves as a useful reminder that careful consideration should be given to what happens in practice when considering whether arrangements amount to a collective investment scheme, irrespective of the wording of the relevant contractual documentation.
Although the case of Brown v InnovatorOne did not contain any new insight into the application of FSMA, it highlighted the danger of relying purely on contractual documentation when seeking to avoid classification as a collective investment scheme. This case challenged the validity of a failed tax relief scheme and in turn, considered whether the arrangements constituted by the scheme amounted to a CIS. Section 235(2) of FSMA underpins the crux of the issue whereby if the participants have no day to day control of the investments then they will constitute a CIS.
Reliance was asserted upon the contractual documentation in this case, in that the participants were given the right to control in accordance with their terms. However, it was found that in practice they did not assert such rights sufficiently to be regarded as being in effective control. The point to take away here is that the contractual documentation in itself will not be enough; there needs to be substantial evidence of practical exercise of control to avoid CIS classification.
In this case there had been a clear breach of the general prohibition under section 19 of FSMA. A scheme had been established without the requisite FSA authorisation.
There was also no doubt that the arrangements involved regulated activities and specified investments for the purposes of the financial promotion regime, therefore the judge found that the financial promotion restriction under section 21 of FSMA had also been breached. Not only did the judge not agree with the argument that the restriction did not apply because the promotions were made through IFAs, there was a mistaken assumption that the article 48 Financial Promotion Order exemption for marketing to high net worth individuals could be relied upon. Caution should be exercised when using this exemption as it does not apply to communications in respect of an investment in units in a collective investment scheme (other than one which invests wholly or predominantly in stocks and shares in an unlisted company or instruments acknowledging indebtedness in such a company). What’s more, even where that condition is satisfied, promoters must see the relevant certificate (signed 12 months prior to the communication) in advance to ensure that the recipient meets the requirements to be a certified high net worth individual under FSMA.