PROPOSED CHANGES TO THE FINANCIAL PROMOTIONS ORDER

On 26 January 2004 Her Majesty's Treasury published a consultation document seeking feedback on the operation of the existing exemptions in the Financial Promotion Order, concerning specifically high net worth individuals and sophisticated investors.

An essential element of the review was that the Treasury would propose changes to the boundary of regulation, particularly with regard to capital raising (to ensure that only necessary restrictions are imposed on those seeking to market shares to potential investors such as 'business angels') and financial advice (financial promotion and the simplification of regulation in other areas where it gives rise to unnecessary difficulties).

The prohibition of financial promotion is media-neutral and applies to all types of communications, whether they are real time (e.g. face-to-face and telephone communications) or non-real time (e.g. letters, websites and emails).

1 Background: the current exemptions
Section 21 of the Financial Services and Markets Act 2000 (FSMA) prohibits any person from "promoting" financial products and services (communicating an invitation or inducement to engage in investment activity), unless he is an authorised person or the content of the communication is approved by an authorised person or the communication is exempt. Breach of section 21 constitutes a criminal offence and can also give rise to civil liabilities.

The current regime allows two exemptions. Unlisted firms are allowed to raise equity capital without the substantial costs of getting their financial promotion approved if the promotions are made to potential investors whom the promoter knows are certified as either high net worth individuals or sophisticated investors:

The sophisticated investor exemption: this exemption requires an authorised person to certify that the investor is sufficiently knowledgeable to understand the risks associated with the relevant description of investment.
These two exemptions aim to allow unlisted firms to raise informal capital from experienced, wealthy individuals and groups. It seems however in practice that the exemptions are not working as planned, as there have been low levels of certification, particularly for sophisticated investors.

2 Consultation paper: update
The Government is seeking feedback on the functioning of the two existing exemptions above. In particular, it seeks views on the following:

2.1 Self-certification: whether self-certification should be introduced. The Government seeks views on 3 possible models:

(a) Model 1: Allow self-certification as a high net worth individual and continue the current certification process for sophisticated investors. The self-certification could either replace or be introduced alongside the current high net worth exemption.
(b) Model 2: Allow self-certification for high net worth individuals and self-certification for sophisticated investors. The same test would apply to high net worth investors as under Model 1, as well as a new test for sophisticated investors. The idea is that the new test would permit investors to self-certify that they meet at least one of a number of objective criteria: they have worked for a minimum of 12 months in the financial services and markets sector in a position requiring knowledge of financial instruments; they are a member of one of the bodies in the FSMA Bodies Designated Professional Bodies Order; or they have carried out a certain number of transactions on securities markets and have portfolios exceeding £100,000.
(c) Model 3: Allow self-certification for both high net worth individuals and sophisticated investors. The idea under this model is that anyone who regards him or herself as sufficiently knowledgeable would be able to self-certify as a sophisticated investor in respect of investment into unlisted firms, without detailed criteria to judge him or herself against;

2.2 Number of certifications: whether the current exemptions allow sufficient numbers of high net worth individuals and sophisticated individuals to become certified. If not, the Government seeks responses as to whether this poses a problem for smaller firms wanting to raise capital via unlisted equity and for investors;

2.3 FSMA 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001: whether amendments equivalent to those proposed for the Financial Promotion Order should be made to the FSMA 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001;

2.4 Reasonable belief: whether promotions should be allowed on the basis of reasonable belief that a person is either a certified high net worth individual or a certified sophisticated investor;

2.5 Net assets: whether the net assets test for self-certification by high net worth investors should remain at £250,000, be increased to £500,000, or be set at another level;

2.6 Private sector intermediation: whether there is an under-provision of private sector intermediation in this area and if so, what are the causes;

2.7 Regulatory constraints: whether other regulatory constraints or costs have an impact on access to equity finance for growing firms;

2.8 Business angels: whether any other regulations are constraining business angel investment; and

2.9 Angel syndication: whether there are particular regulatory barriers preventing angel syndication.

3 Conclusion
The proposed criteria for "self-certified sophisticated investors" in the Treasury's second model are very similar to the requirements of the Prospectus Directive (2003/71/EC). The Prospectus Directive will enable EU member states to treat individuals as "qualified investors", to whom one may offer securities without the need of a prospectus, if certain criteria are met. There is a very grey area concerning whether the proposal takes sufficient account of the Prospectus Directive and ideally the Prospectus Directive test should be used, so that approval is not necessary where there are promotions to sophisticated investors in offerings where a prospectus is not needed.
The proposal for self-certification has been put forward to remove barriers to the raising of capital by small and medium-size organisations. It should make the exemptions easier to use, however it is restricted to promotions of unlisted securities and investments relating to them. This raises the issue of whether the exemption from approval for high net worth individuals and sophisticated investors applies to listed securities. However there is no guidance on this point and we will have to wait and see the approach of the Treasury and the Courts.

If you require further information on any matter covered in this note, please contact your principal contact at Charles Russell or Simon Gilbert, Katy Knight, Clive Hopewell or Alexander Keepin (London), Francis Rundall or Richard Norton (Cheltenham) or Geoff Sparks (Guildford) and on 0207 203 5000.

Please note that the summaries above are a general indicative guide only. They are not exhaustive. This information has been prepared by the firm as a service to our clients. As it is a general guide, we recommend that you seek professional advice before taking action. No liability can be accepted by the firm for any action taken or not taken as a result of this information. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Law Society. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide.