FSA comments on the marketing of unregulated collective investment schemes, September 2010

The FSA has revealed the findings of a project which has highlighted concerns about the distribution of unregulated collective investment schemes (“UCIS”) by some small firms.

The project reviewed financial promotions and advice provided by a sample of Independent Financial Advisers.  Although the regulator’s project appears to have had its genesis in concerns about retail distribution, the results have some relevance to all firms who are either promoting or recommending investments in UCIS.

UCIS are described (perhaps unhelpfully) as “unregulated” because they are not subject to the same restrictions on investment powers as regulated funds which are available for distribution to the general public. Many hedge funds and private equity funds are classified as such. There is a UK statutory prohibition which restricts the promotion of a UCIS, so authorised firms must therefore apply exemptions available under either The Financial Services or Markets Act 2000 (Promotion of Collective Investment Schemes (Exemptions) Order 2001 or Section 4.12 of the FSA’s Conduct of Business Sourcebook (“COBS”) before they may lawfully promote such a scheme in the UK.

The FSA’s report states that most of the firms reviewed were unaware of the restriction and available gateways. A stunning revelation was that many of the firms sampled erroneously believed that unregulated funds were not subject to any sort of regulation at all, including the statutory restriction on their promotion.

The project found that only 2 firms from the sample of 14 appeared to adequately understand, and had adequately implemented, the regulatory requirements for UCIS business. From a sample of 119 UCIS transactions the regulator found that in most cases (76% of promotions) the firms in question had failed to use the available exemptions.

As a result of these findings, 11 firms have been ordered to cease advising and promoting any UCIS.These firms must also appoint a skilled person under FSMA Section 166 to conduct a review which may result in the firms being required to pay compensation to their customers.   Furthermore, the FSA’s Enforcement and Financial Crime Division is currently investigating 6 small firms that have been promoting and recommending UCIS to their customers. This is likely to result in enforcement action for some, if not all of the firms concerned.

Having identified poor practice in relation to the promotion and selling of UCIS, the regulator has since produced a good and poor practice report (Click Here) and a UCIS Factsheet (Click Here) to help firms understand the rules that apply to these investment vehicles.

Firms that promote collective investment schemes clearly need to know whether or not each scheme promoted is a UCIS.  Firms must also be aware of and have suitable systems to meet the regulatory requirements for the promotion of UCIS including to whom the promotion may validly be directed. Generally, money raised from institutional investors will fall within the available exemptions while a private individual may not be marketed to unless the firm has already established (and also recorded the grounds for so believing) that the individual meets either net worth or suitable experience thresholds.  In any event, all firms promoting UCIS need to have records which can demonstrate that promotion is taking place in the knowledge of the exemptions.  To use the exemptions validly, but by lack rather than by design, will suggest a weakness in compliance systems.