Countdown to N2

Regulatory Timetable

The Financial Services Authority (FSA) will assume its full powers as the single regulator for regulated activities (mainstream investment business) in the United Kingdom on 1st December 2001. The FSA’s powers are set out in the Financial Services and Markets Act 2000. The Act provides that no person may carry on a

regulated activity unless that person is an authorised person or an exempt person. Authorisation to carry out regulated activities will principally come from the FSA. The main exemption arises when a person is an appointed representative of another authorised person. The net effect of these provisions within the Act is that if a firm of solicitors wishes to conduct regulated activities it will have to be authorised by the FSA.

At midnight on 30th November 2001 the Society will cease to be a Recognised Professional Body and will no longer have the power to authorise its firms for regulated activities. 

The Society will have residual powers to licence firms to conduct what will be referred to as incidental investment business, but there are strict statutory provisions which will govern the manner by which such incidental work must be carried out.

The activities which constitute regulated activities are listed not in the Act but in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001 No.544) (“The Regulated Activities Order”).

A firm which conducts regulated activities without FSA authorisation will be committing a criminal offence under Section 23 of the Act.

The Regulated Activities Order also sets out a number of exclusions which will not be regulated activities nor will these exclusions be considered to be incidental investment business. A significant exclusion is contained within Article 33 of the Order which allows introductions to be made by a professional firm to an independent financial adviser. Detailed conditions often apply to the exclusions and the legislation should be carefully considered.  Firms are therefore faced with four options under the new regime (not all of which are exclusive) and these are as follows:

• Direct authorisation by the FSA.
• Licensed to undertake Incidental Investment Business by the Society.
• Acting as an introducer to an IFA (this option can also be undertaken in conjunction with options 1 or 2).
• None of the above.

Each of the three main options is now considered in more detail.

Direct Authorisation by the FSA

In late August/early September currently authorised firms will receive from the FSA an opt-in notice and information pack. The opt-in notice must be completed and returned to the FSA by 31st October 2001 if a firm is to be authorised by the FSA for regulated activities at the start date of the new system. It is anticipated that the FSA will be charging firms a periodic fee which will be based on the scope of the firm’s regulated activities and a measure of the size or extent of its regulated activities, for example, the number of approved persons.

A firm which is authorised by the FSA should also, under the FSA’s regulatory regime authorisation, be able to undertake most types of incidental investment business work.

The principal activities which are classified under the Regulated Activities Order and for which FSA authorisation may be required are as follows:

• Effecting and carrying out contracts of insurance.
• Dealing in investments as principals.
• Dealing in investments as agents.
• Arranging deals in investments.
• Managing investments.
• Safeguarding and administering investments.
• Sending dematerialised instructions.
• Establishing etc. a collective investment scheme.
• Establishing etc. a stakeholder pension scheme.
• Advising on investments.
• Advising on syndicate participation at Lloyd’s, managing the underwriting capacity of a Lloyd’s syndicate and arranging deals in contracts of insurance written at Lloyd’s.
• Entering as a provider into a funeral plan contract.
• Administering and entering into a regulated mortgage contract as a lender.

The Regulated Activities Order then proceeds to define investments to include:

A deposit, rights under a contract of insurance, shares, instruments creating or acknowledging indebtedness, government and public securities, instruments giving entitlement to investments, certificates representing certain securities, units in a collective investment scheme, rights under a stakeholder pension scheme, options, futures, contracts for differences etc., Lloyd’s syndicate capacity and syndicate membership, funeral plan contracts, regulated mortgage contracts and rights to or interests in investments.

For each of the activities which are defined as regulated activities under the Regulated Activities Order there are a number of exclusions and one of the exclusions is, as previously mentioned, where an introduction is made with a view to the provision of independent advice.

A firm which is already authorised by the Society under the existing regime will only be “grandfathered” into the new FSA regime if it notifies the FSA by 31st October 2001 that it wishes to opt-in to direct FSA authorisation using the FSA opt-in notice. Once this process is complete the FSA will, sometime later, advise a firm of the scope of business it will be permitted to conduct. This will mirror the business conducted under the Society’s existing regime, although firms may also be offered one or more restricted alternatives, so as to reflect the particular business they have been carrying on or intend to carry on. The FSA will also seek identification and confirmation from a firm of the individuals who will actually conduct regulated activities. Such individuals will be referred to as approved persons, and the  FSA must be notified if they carry out specified functions known as controlled functions. The FSA has identified twenty seven functions as controlled functions but these can be broadly divided into three categories which are:

• Functions where individuals have a significant influence on the conduct of the authorised person’s affairs, so far as relating to the regulated activity.
• Dealing with customers of the authorised person in a manner substantially connected with the carrying on of the regulated activity.
• Dealing with the property of customers of the authorised person in a manner substantially connected with the carrying on of the regulated activity.

Any individual who is currently licensed by the Society to conduct investment business and who will carry out a controlled function in the new regime will not need to apply for approval but will be grandfathered into the new regime.  A firm must, once it has decided to opt-in to the FSA regime, complete a list for the FSA of those individuals who will be undertaking controlled functions, to allow the grandfathering of all such individuals.

Incidental Investment Business Regime

The second option which is open to a firm is that of a licence from the Society to undertake incidental investment business. A firm which chooses this option cannot also be directly authorised by the FSA.  It is, however, possible for a firm to have an Incidental Investment Business Licence and also act as an introducer. 

The Society will send out its application forms together with information packs on incidental investment business at the end of August. The application form for incidental investment business must be returned to the Society by 28th September 2001 if a firm is to be licensed for such work from the start date of the new regime on 1st December 2001.  The charge which the Society will make for such a licence will be based on a flat fee per firm and the number of individuals within a firm who seek to undertake incidental investment business work. The incidental investment business application form will ask firms to identify all those solicitors and non-solicitors which the firm wishes to be licensed for such work.

The Act, under Section 327, provides the conditions which must be met if a firm is to undertake incidental investment business work (or exempt regulated activities as defined in the Act). The first condition is that the work must be incidental to the provision of another professional service. This means that a firm cannot have stand-alone incidental investment business work.  Furthermore, a firm carrying on incidental investment business work must not hold itself out as carrying on regulated activities. The Act also provides that a firm undertaking incidental investment business work must not receive from a person other than his/her client any pecuniary award or other advantage, for which the firm does not account to its client. This means that any commission arising from incidental investment business work must either be given to the client or, where a fee is charged for the incidental investment business work or the professional services to which it is attached, the fee must be reduced by the amount of commission. There is no prohibition under the Act against firms charging fees for incidental investment business work.

One of the difficulties which has not been resolved is what activities constitute incidental investment business work as no definitions are provided in either the Act or the Regulated Activities Order. It is easier, by considering the list of activities previously stated under Section 2 which will be regulated activities, to be clear on what cannot be conducted as incidental investment business.

The following activities are, however, some examples of what may constitute incidental investment business:

• Arranging for the sale of shares on the instructions of the executors in an executry without providing investment advice.
• Arranging for the purchase of shares for a trust on the instructions of the trustees without providing investment advice.
• Discussing with a client advice which has been provided by another authorised person (who takes full compliance responsibility for that advice).
• A firm may comment upon such advice and, acting on the client’s instructions, arrange deals consequent upon it, provided the firm does not give an alternative product recommendation to the client.
• A solicitor undertaking matrimonial work can obtain the advice of an IFA regarding the matrimonial investment assets. The solicitor may also seek the IFA’s valuation of the assets and the IFA’s advice on the best ways of dealing with those assets and the solicitors can comment on such advice in negotiating a financial settlement in the matrimonial dispute on the client’s instructions.
• A solicitor who acts for an estate or trust can hold investments for the estate and trust and also collect dividends.
• Where another authorised person advises a firm’s clients on the disposal of their investments, the firm may administer the collection of the dividend on the investments and arrange for the sale of the investments.
• A solicitor, at his/her own initiative, can advise a client that the investment advice or investment arrangements provided by another party do not appear to be in the client’s best interests and his/her client should then seek mainstream investment advice elsewhere.
• A solicitor acting for an estate advises the sale of all investment assets to pay for funeral expenses and debts.

It can be seen from the types of activities that may constitute incidental investment business work that this work is restrictive in its scope and also in the manner in which it must be conducted. The restrictive nature of this type of work is clearer when consideration is given to the following list of activities which are considered not to be incidental investment business:

• Making markets in investments.
• Recommendation or arrangements for a client to buy a packaged product except where the recommendation or arrangement for such a purchase is by means of an assignment or the arrangement is made as a result of a firm managing assets due to it, or one of its officers’ appointment as a trustee, personal representative or donee of a power of attorney, or where the arrangement is made on the basis that the client is not relying on the firm as to the merits or suitability of the transaction.
• A firm must not recommend a client to buy or dispose of any rights or interests in a personal pension scheme except where the firm assumes on reasonable grounds that the client is not relying on the firm as to the merits or suitability of the transaction.
• The firm must not provide advice or make arrangements in relation to a pension transfer or pension opt-out.
• Entering into a broker fund arrangement.
• Act as a sponsor to an issue in respect of securities to be admitted for dealing on the London Stock Exchange.
• Act as a nominated adviser to an issue in respect of securities to be admitted for dealing on the Alternative Investment Market.
• Act as a corporate adviser to an application on behalf of a company to join OFEX.
• Approving the financial promotions (for example, advertisements) of others.

Furthermore, firms relying on conducting incidental investment business or not carrying on regulated activities at all will be subject to the restriction on financial promotion in Section 21 of the Act. The FSA will provide guidance to firms on this subject in order to assist firms with their opt-in decision.

Introductions

The Regulated Activities Order provides a number of exclusions which will not count as investment business, whether mainstream or incidental. One of the main exclusions is contained within Article 33 of the Order which provides that a firm may introduce a client to an IFA and the firm may retain any payment received from the organisation to whom the introduction was made. The firm making the introduction must do no more than bring together the investor and the IFA firm to whom the introduction is made. Furthermore, this “introductory” option does not necessarily allow a firm to market the services of an IFA or other authorised person.

There are several other exclusions within the Regulated Activities Order which do not amount to either mainstream or incidental investment business and these include:

• The taking of a deposit if it is received by a practising solicitor acting in the course of his/her profession.
• The provision of advice or the making of arrangements in relation to breakdown insurance for cars.
• Making arrangements whose sole purpose is the provision of finance to enable a person to buy, sell, subscribe for or underwrite investments.
• Managing investments under a power of attorney where all routine day to day investment decisions are taken by an authorised person.
• Arrangements made by a person acting as a trustee or personal representative.