What is a Financial Promotion (2nd Article)

Financial promotions.  At some point, nearly all businesses use them, but most people are unaware of what they are.  Do you know what they are?

Financial promotions and the surrounding legislation is an often overlooked and complex area. In this article, coupled with practical examples, we are going to explore the relevant law (FSMA 2000 Section 21) in detail.  We will determine what a financial promotion is, why they are important and what you should do if you require professional advice.

Do any of the following questions sound familiar?

  • Can I approach investors with a financial promotion?
  • Could my financial promotion satisfy an exemption?
  • Do financial promotions apply to all types of investments?

So what is the definition of a Financial Promotion?

A financial promotion is defined by the Financial Conduct Authority (FCA) in Section 21 of the Financial Services and Markets Act (FSMA) 2000 as “an invitation or inducement to engage in investment activity, communicated by a person during the course of business, whether written or oral”.

Companies and individuals that are not authorised and regulated by the FCA must ensure that any financial promotions that they communicate comply with the requirements of the financial promotion restriction.  Only firms that are authorised and regulated by the FCA can issue or approve communications that amount to financial promotions.

In simple terms, it is the promotion of an investment from one person to another.  Let’s explore important sections from the statement a bit further:

  • What is the FCA?

The FCA, the Financial Conduct Authority is the U.K. financial regulator.  The role of the FCA is to maintain the integrity of the financial markets and regulate financial firms who provide services to consumers.

  •  What is an investment?

An investment is a security that is purchased, such as equity, with the future expectation that it will appreciate in value.

  • What is an invitation or inducement?

This is the marketing of an investment through a distribution channel, digital or traditional. Historically, this may have been a letter or an email, but has recently extended to social media posts and even SMS messages.  The FCA is media neutral.  This is important, it means that no matter how digital the world becomes or how many more types of marketing platforms come into existence, the location/origination of the invitation or inducement is irrelevant.  All inducements are treated the same.

Here’s an example:

A local business in London wants to expand to Birmingham, UK.

The FCA does not regulate the local business.  The owner wants to fund his expansion by selling part of his company by issuing equity.  Issuing equity is an investment and is an activity that is regulated by the FCA.  Therefore, the unregulated firm wants to carry out a regulated activity.

The owner contacts Blue Water Capital, an FCA regulated firm, who advises, develops and approves an investment offer.  This can be compliantly distributed to potential investors.

This example constitutes a financial promotion.  The investment is the equity issued, the invitation/inducement is the marketing of the investment.  The key to the process is that a firm that is authorised and regulated by the FCA approves the communication.

Blue Water Capital approved the financial promotion.  This ensured the equity raise was conducted in line with the FCA’s requirements.

It is extremely important to be very careful when communicating with another individual that you are not accidently transmitting a financial promotion in an unauthorised manner.

So how did the Financial Promotions regime come about?

The origin of the financial promotion regime dates back to the 1800’s.  The Manchester cotton industry was booming and Leeds had a growing trade in weaving.  However, the required expansion of the key canal system was being restricted, the solution was the emerging railway network.

Soon over one thousand railway schemes were put forward; all promoted by commercial interests.  This led to a speculative investment frenzy which was largely based on the over promotion of the shares.  The inevitable collapse of the bubble occurred and ‘Railway Mania’ came to an abrupt end.

Importantly, out of the carnage, no fewer than 272 Acts of Parliament were created.   Many were directly aimed at ensuring that future financial promotions were published in a fair, clear and not misleading way.

Has history repeated itself?

A very similar scenario can be seen in the blockchain technology sector.  A new and innovative technology associated with being able to solve an array of commercial challenges and limitations has emerged. Offering radical change and disruption, the technology has already lead to a huge number of ICO’s. These have resulted in an investment frenzy around token and crypto currencies however, sadly the stories of lost capital and fraudulent activity are starting to emerge… Sound familiar?

Initially, ICOs were successfully funding genuine projects seeking to solve very real problems.  However, the initial hype led to frenzy and very quickly, investors started to lose money.  This was largely due to the fraudulent promotion of ICOs.  As we are currently observing, the regulators across all jurisdictions are actively taking an increasingly tough stance on the fraudulent promotion of these schemes and are striving to prevent the continuance of this.

Railway Mania – 1840’s, ICO Mania – 2018

So what’s the difference with the financial promotions of today?

There is no difference.  Financial promotions created in the 1800s are no different to those that are created today.

The purpose of one individual engaging with another and promoting an investment opportunity has not changed.  Whether the investment opportunity is buying into a railway in the 1800s or a clever utility token in 2018, the event of inviting another individual to engage in an investment constitutes a financial promotion.

What is Section 21 and how does it relate to Financial Promotions?

The financial promotion regime can be found in Section 21 of the Financial Services and Markets Act (FSMA), 2000.  The legislation’s primary purpose is that of protecting investors.  In the U.K. a person cannot communicate a financial promotion during the course of business.

The Act is made up of the following key elements:

  • Requirements under the FCA’s conduct of business sourcebook (COBS 4)
  • Exemptions under the Financial Services and Markets Act 2000, Financial Promotion Order 2005
  • Promotion of unregulated investment schemes

COBS 4

‘COBS 4’ states the prescribed rules that the authorised person who is approving a financial promotion must adhere to.  These rules can be found in the FCA Conduct of Business Sourcebook.

One of the primary rules laid out in ‘COBS 4’ is that all communications and statements made in promotional material must be fair, clear and not misleading.  This is to ensure that investors can make a fair and unbiased decision as to whether they purchase the investment or not.

Authorised firms who sign off promotions are required to put relevant controls and systems in place to ensure compliance with the rules listed in ‘COBS 4’.

Real time/non-real time communications:

The FCA has defined two types of financial promotion; real time and non-real time. Both are treated equally and require observance.

Real time:

These are communications that are carried out during a dialogue that is dynamic and interactive.  Examples would be a telephone call or a face-to-face conversation.  The FCA has accepted that these promotions cannot be regulated in the same manner as non-real time communications, but has stated that all communications should:

  • Be transmitted in a way that is fair, clear and not misleading
  • Do not make untrue claims
  • Make clear the purpose of their communication, and identifies the firm in which he/she represents

Non-real time:

On the flip side, non-real time communications are interactions that:

“do not involve any simultaneous interaction”.

This is the term used to cover every other financial promotion that a firm would issue.  Examples would be emails, a website publication and a letter.

There are stringent regulations surrounding these types of communication.  Before distributing a non-real time financial promotion, the issuer should almost certainly obtain professional advice to ensure that the content and structure of the communication released is compliant.

Is anyone exempt from the financial promotions regime?

Given that non-compliance is a criminal offence, firms and individual need to take care when attempting to determine whether they may successfully utilise an exemption.  If unsure, professional advice should be sought prior to distributing any promotions.

Unless an authorised person has approved a financial promotion, the promotion can only be communicated if it is covered by an exemption.  Within the Financial Promotions Order (FPO) 2005, over 65 exemptions have been laid out, and are directly applicable to the promotion restrictions. These allow for a select type of individual to be engaged without obtaining a section 21 sign off.

The most common exemptions are:

  • High Net Worth Individuals

Those who earn over £100,000 or who have net assets of over £250,000

  • Investment Professionals

Individuals whose ordinary activities involve carrying on certain investment related activities

  • Self Certified Sophisticated Investor

Individuals who have signed a current certificate confirming terms as set out in part 2 of Annex 3

It’s important to note that a firm engaging with an exempt individual should be very careful as to how they obtain the written clarification prior to releasing the promotion.

  • There should be no reference of the detail of the offer.
  • Ensure the appropriate statements are included in the signed confirmation letter.

Obtaining a section 21 sign off enables for a wider distribution of the promotional material.  This is important to attract investors, but crucially, in compliance with FSMA 2000 Section 21.

The Misrepresentation Act 1967

An important piece of relevant legislation worth nothing is the Misrepresentation Act 1967.  This piece of legislation protects consumers who have entered into a contract and have bought goods or services based on false statements made by the seller.

There are 3 types of misrepresentation:

  • ‘Fraudulent’ – Statements made that are made knowing that they are untrue
  • ‘Negligent’ – Statements made carelessly
  • ‘Innocent’ – Statement made without fault

Everyone who enters into a contract is automatically bound by the Act.  Consequently, if a person believes that they have been mis-sold, they are within their rights to terminate the contract and file for compensation.

It is to be noted that if a firm obtains a section 21 sign off, the immediate liability for the content of the financial promotion resides with the authorised firm that approved the financial promotion.  This works in favour of the security issuer and their legal counsel preparing the offer. In addition, it provides a regulatory framework to govern the resolution of any conflicts should they arise, further protection and confidence for both investors and issuers.

Are Appointed Representatives Exempt from the Act?

In short, no. Appointed Representatives are not exempt from section 21 of FSMA.

Appointed Representatives are defined by the FCA as those who:

‘Conduct regulated business on behalf of a directly FCA-authorised firm, who is its ‘principal’.  The principal firm takes regulatory responsibility for the appointed representative and must ensure it meets FCA requirements.’

This means that a firm is responsible for any 3rd party that may be operating on the firm’s behalf.  This is inclusive of any promotional material that the appointed rep may also distribute on the firm’s behalf. 

For example

ABC Company created a new pension fund.  The company appoints an external sales consultant to sell the fund to members of the public.

In this instance, ABC Company would be acting as the principle firm and would be responsible for the external sales consultant’s actions, inclusive of any promotional material distributed.  The sales consultant is the appointed representative.

Promotion of Collective Investment Schemes (CIS)

As well as the exemptions previously mentioned, there is another high-level rule in FSMA 2000, COBS 4 that permits the promotion of certain types of Collective Investment Schemes by authorised persons.

A Collective Investment Scheme (CIS) is often referred to as a pooled investment, where numerous investors can invest money alongside each other.  Regulated CIS are those that are recognised and authorised by the FCA.  The FCA permits these schemes for promotion.

If a CIS is not recognised by the FCA then the investment scheme is assessed as being an Unregulated Investment Scheme (UCIS).  COBS 4.12 Section 21 of FSMA does not permit for the promotion of these schemes to the general public.

General Information Regarding Section 21

FCA’s Principles for Businesses:

The FCA has created important, obligations that firms are required to observe.  These can be found in the FCA handbook. Some of which are directly applicable to the financial promotions regime:

  • Principle 2 – A firm must conduct its business with due skill, care and diligence
  • Principle 3 – A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems
  • Principle 6 – A firm must pay due regard to the interests of its customers and treat them fairly
  • Principle 7 – A firm must pay due regard to the information needs of its clients, and communicate information to them in a way that is fair, clear and not misleading

In a recent court case a barrister referred to these principals as high level and therefore somewhat subjective. Interestingly, the judge countered and pointed out the principals referred to were NOT high level, they were in fact the very DNA of the regulatory framework and at the source of rule and regulation. They are to be applied in every case and with clear objectivity

IMPORTANT

Failure to comply with the financial promotion regime can be a criminal and/or civil offence.  The offender can face up to a maximum of 2 years in prison and a potential unlimited investor liability fine.

The FCA also has the power to direct firms to withdraw all previously distributed financial promotions and publicly list offenders on their website.

FCA Authorised – As stated in FSMA 2000, the FCA has a mandated requirement to regulate all financial activities that occur within the U.K.  Therefore, regardless of whether the activity is not-for-profit or tailored to an individual, any regulated activity that the FCA lists must be authorised and registered in order for the regulated activities to be carried out in the UK.

For example:

Blue Water Capital’s activities include approving section 21 sign offs and the creation of instruments.  These are activities that need to be regulated. Blue Water Capital can provide the services as it is authorised and regulated by the FCA and listed as an FCA Authorised firm.

Closing Summary

In summary, Section 21 has very clear guidelines around the creation and approval of financial promotions. Arguably, the most relevant 3 points to remember should be:

  • Only FCA Authorised firms may issue and approve financial promotions unless the financial promotion is exempt. Even if exempt it does not exclude the issuer from abiding by the FCA principals.
  • All financial promotional material should be created in a fair, clear and not misleading manner.
  • Failure to comply may constitute a criminal and civil offence. Any agreement that has been entered into in breach of the provision is unenforceable as against the other person entering into it.

An FCA Authorised Firm, Blue Water Capital has developed its services to advise, develop and construct investment offers that can be compliantly distributed to U.K. investors.  Blue Water Capital has a wealth of experience in working with and providing solutions for a wide range of firms, from companies engaging in Initial Coin Offerings, to the more traditional debt and equity issue.

As technology advances, the digital distribution space naturally becomes ever more complex. It’s important to be aware of all legislation that is relevant to your business and put the required protection in place.  All firms looking to engage in a round of fundraising should be aware Section 21 and where required, obtain the required sign off.

If you would like to know how Blue Water Capital can help you, please contact us at: freddie@bluewatercapital.co or call  +44 (0)121 725 1951

Please note this article does not constitute legal advice and should not be used for the basis for any business decision.