Financial promotions: an introduction
Most founders would agree that fundraising for a company in the early stages can be very challenging. Quite often founders turn to friends, family and… Read more
Most founders would agree that fundraising for a company in the early stages can be very challenging. Quite often founders turn to friends, family and other third parties for equity finance. If a person intends to invite or induce to engage in investment activity during the course of business, it is important to bear in mind the rules of UK’s financial promotions regulations. The following note intends to provide only a brief introduction to the Financial Conduct Authority’s (FCA) financial promotion regime.
Under section 21 of the Financial Services and Markets Act 2000 a (natural or legal) person must not, in the course of business, communicate an invitation or inducement to engage in investment activity unless the promotion has been made or approved by an authorised person or it is exempt. It is a criminal offence for an unauthorised person to communicate a financial promotion in breach of the section 21 restriction. The penalty could be either a fine or up to two years’ imprisonment, or both. Further, any agreements entered into by a person as a customer as a result of an unlawful financial promotion are unenforceable against that customer.
The purpose of the section 21 restriction is to protect uninformed and unsophisticated investors from being misled into investing in a company which might lead to losing their entire investment. Hence the restriction applies to formal communications such as business plans and prospectuses as well as to informal communications such as a conversation with a potential investor at a social event.
The three main elements that make a communication a financial promotion are:
- the communication is an invitation or an inducement to engage in investment activity;
Communications that are purely factual often do not amount to an invitation or inducement unless they have a promotional element. Merely asking a person if they wish to enter into an agreement where there is no element of persuasion or incitement will not amount to an invitation. An objective test is to be applied in establishing whether a communication is an invitation or an inducement.
- the communication is made in the course of the business;
The intention of this limb is to exclude genuine non-business communications such as communication between family members and friends. An issue arises where capital is raised for small private companies. The FCA’s view is that where such a company is already in operation, it will be acting ‘in the course of business’ when seeking to generate additional share or loan capital. At the pre-formation stage, however, it will often be the case that individuals who are proposing to run the company will approach a small number of friends, relatives and acquaintances to see if they are willing to provide start-up capital. In the FCA’s view, such individuals will often not be acting ‘in the course of business’ during the pre-formation stage of a small private company.
- the communication does not fall within one of the exemptions set out in the Financial Promotion Order (“FPO”).
The FPO provides several exemptions from the section 21 restriction.
The most useful exemptions to small private companies are:
The section 21 restriction does not apply to communications which are made only to recipients whom the person making the communication believes on reasonable grounds to be ‘investment professionals’ or may reasonably be regarded as directed only at such recipients. An “investment professional” includes:
- an FCA authorised firm such as a bank, broker or financial intermediary; or
- any other person whose ordinary activities involve them in carrying on the activity to which the communication relates for the purpose of business carried on by him or where it is reasonable to expect that individual to carry on such an activity for the purpose of business; or
- a government, local authority or an international organisation; or
- any person who is a director, officer or employee of any person listed in (i) to (iii) where the communication is made to that person in their capacity as such.
In order to rely on this exemption, it is necessary that the communication contains, or is accompanied by, a clear indication that the communication is directed only at investment professionals. In addition, it is necessary to have in place proper systems and procedures to prevent recipients other than investment professionals (or investors permitted under one of the other exemptions) engaging in the investment activity to which the communication relates.
Self-certified sophisticated investors
The section 21 restriction does not apply where the communication is made to individuals whom the person making the communication believes on reasonable grounds to be a self-certified sophisticated investor.
A “self-certified sophisticated investor” is an individual who has signed a statement in the form prescribed by the FCA certifying that one or more of the following statements applies to him:
- he is a member of a network or syndicate of business angels and has been so for at least the last six months prior to the date on which the certificate was signed; or
- he has made more than one investment in an unlisted company in the two years prior to that date; or
- he is working, or has worked in the two years prior to that date, in a professional capacity in the private equity sector, or in the provision of finance for small and medium enterprises; or
- he is currently, or has been in the two years prior to that date, a director of a company with an annual turnover of at least £1 million.
For the exemption to apply, the certificate must have been signed within 12 months of the date on which the communication is made. Communication to a self-certified sophisticated investor must also be accompanied by a suitable warning that the communication has not been approved by an authorised person and that reliance on the communication for the purpose of engaging in any investment activity may expose an individual to a significant risk of losing all of the property or other assets invested. Such a warning must either be given to the recipient at the beginning of the communication or, if this is not possible in light of the means of communication used, the recipient must be given an oral warning at the beginning of the communication and must be informed that a legible copy will be sent to him within two business days.
High net worth investors
The section 21 restriction does not apply where the communication is made to individuals whom the person making the communication believes on reasonable grounds to be a high net worth investor. A certified high net worth individual is an individual who has signed a statement in the prescribed form (please see attachment) certifying that one or more of the following statements applies to him:
- he had an annual income to the value of £100,000 or more during the preceding financial year; or
- he had net assets to the value of £250,000 or more, where net assets do not include property that is a primary residence or any loan secured on this residence, rights under an insurance contract, or benefits in the form of pensions or otherwise that are payable on the termination of service, death or retirement, to which he may be entitled.
The FPO also contains exemptions in relation to financial promotions made to overseas recipients and certain one-off communications. One key point to note for persons who intend to rely on these exemptions is that before any communication is made, they should be clear about the scope and extent of such communication – the narrower the target the lesser the risk of making an unlawful financial promotion. The FCA has also published guidelines on financial promotions using social media. An analysis of these guidelines by our financial regulation team can be found here.
If a person intends to communicate information which would amount to a financial promotion and if none of the exemptions set out in the FPO apply, then such financial promotion should be communicated or approved by an authorised person.