Stephen Gilchrist: Blog

Thursday 22nd December 2011

Unauthorised regulated business

Last month, the press reported that the FSA had arrested five people over allegations relating to land banking investments sold through an unauthorised collective investment scheme.

‘Land banking’ involves the purchase of land by purchasers who believe that they will be able to sell it on at a profit when planning permission has been obtained.

This year, the FSA has stepped up action against unauthorised land banking operations, pursuing seven separate cases in the High Court. In June, it secured a summary judgment in one of these cases against Stephen Watkins, who traded as Consolidated Land UK.

The judgment held that Mr Watkins sold land illegally to UK consumers and ordered him to make an interim repayment of £920,000, via the FSA, to his victims. Mr Watkins has also been banned for life from selling plots of land.

The FSA does not regulate the sale of land but land banking may amount to collective investment – something that requires FSA authorisation.

The above exemplifies the efforts being taken by the FSA to close down operations which involve the sale of products that are not otherwise ‘specified investments’ (which broadly speaking include financial products) but which are being sold in a way which contravenes the Financial Services and Markets Act 2000 (FSMA).

Entrepreneurs are constantly looking at new products and new markets. Selling those products, whatever they are, in a way which includes misrepresentation or aggressive sales techniques, may fall foul of trading standards law, legislation regarding the operation of limited liability companies, or even the criminal law in the event of blatant fraud. However, the role of the FSA is often forgotten or a blind eye is turned.

Carrying on a regulated activity without Authorisation

Section 19 of the FSMA provides that no person may carry on a regulated activity in the UK, or purport to do so, unless he is an authorised person or an exempt person.

The prohibition is referred to in this Act as the ‘general prohibition’. Apart from any civil proceedings which the FSA may bring to stop such activities and recoup all such funds received by the operator, under Section 23 of the FSMA it is a criminal offence to contravene the general prohibition and punishable in the magistrates’ court with six months’ imprisonment and/or a fine of £5,000; in the crown court it is punishable with two years’ imprisonment and/or an unlimited fine.

Action by the FSA is predicated upon the presumed unauthorised undertaking of a ‘regulated activity’.

An activity, for the purposes of this Act, is one of a specified kind that is carried on by way of business and (a) relates to an investment of a specified kind; or (b) is carried on in relation to property of any kind (Section 22).

Schedule 2 of the FSMA (which has been subject to a series of amending orders) sets out the parameters of such activities and includes offering investment advice, deposit taking, managing investments and establishing a collective investment scheme. ‘Investment’ is defined to include ‘any asset, right or interest’ and ‘Specified’ means specified in an order made by the Treasury.

Generally speaking, as already noted, specified investments are those pertaining to financial products which include, for instance, shares, deposits, futures, options, and rights under regulated mortgage contracts. They are fully defined in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO), which is secondary legislation under FSMA.

Regulated activities which are also defined more fully in the RAO include the management, advising upon, and promotion of those specified investments. Significantly it also includes (together with s. 22 FSMA) the establishment, operation or winding up of a Collective Investment Scheme (CIS).

Readers of ‘Introducer Today’ will no doubt be aware that mortgage and other financial advisers who provide advice on ‘regulated mortgage contracts’ will need to be authorised by the FSA if they

Give advice to a person in their capacity as borrower or potential borrower; and advise on the merits of:

i) Entering into a particular regulated mortgage contract, or

ii) Varying the terms of a regulated mortgage contract entered into by them.

Providing such advice without authorisation may also amount to a breach of the ‘general prohibition’.

In general terms, when deciding whether you need to seek FSA authorisation for an undertaking, ask yourself the following four questions:

1. Do I want to carry on a regulated activity in the UK?

2. If so, will I be carrying on a regulated activity by way of business?

3. If so, will my regulated activities be excluded? (There are limited exclusions in various categories of regulated business)

4. If not, what options do I have other than becoming authorised?

But to come back to the example of land banking, how is it that Mr Watkins & Co fell foul of FSMA and the FSA?

Land is not a specified investment and so the sale of land, even at prices which produce disproportionate profits for the operator, is not, in itself, a regulated activity. The same would apply to the sale of carbon credits (an ever-increasing market for non-authorised operators) or businesses selling wine for investment purposes. None are specified investments and so, on the face of it, the sale of these products are not unlawful.

The FSA’s interest in these activities arises as a result of the suggested operation of a collective investment scheme.

What is a Collective Investment Scheme?

The definition of a collective investment scheme can be found in section 235 of the Financial Services and Markets Act 2000 (FSMA).

A collective investment scheme is an arrangement that enables a number of investors to ‘pool’ their assets and have these professionally managed by an independent manager. Typically, unit trusts (with which readers will be familiar) are collective investment schemes. Investments may typically include gilts, bonds and quoted equities, but depending on the type of scheme may go wider. For example some investments may be in unquoted investments or property.

In essence, a collective investment scheme arises when the persons who are to participate do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions, but the arrangements must also have either or both of the following characteristics:

(a) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled;

(b) the property is managed as a whole by or on behalf of the operator of the scheme.   

So how was it that Mr Watkins was operating a CIS? Essentially, the FSA claimed that Mr Watkins’s customers were told by his sales staff that he would seek planning permission for them and also help them to re-sell the land at a profit.

In fact (the FSA claimed), Mr Watkins had no intention of seeking permission or helping his purchasers, many of whom paid him their life savings. Unfortunately for Mr Watkins, it is not only unlawful (a breach of the general prohibition) to operate a CIS, but also to purport to operate one.

The FSA claimed that the promise of his business to apply for planning permission, and manage a subsequent re-sale of the land, brought the mechanics of his operation within the definition of a CIS: no day to day control by the participants of the scheme and management of the investment by Mr Watkins’s business. Obviously, issues arise as to any further culpability as a result of alleged misrepresentations in the product sale, but this is not the province of the FSA.

Consequences of Breaching the Prohibition

According to s.26 FSMA, an agreement made by a person in the course of carrying on a regulated activity in contravention of the general prohibition is unenforceable against the other party and the other party is entitled to recover both any money or other property paid or transferred by him under the agreement; and compensation for any loss sustained by him as a result of having parted with it.

The FSA has powers to act, effectively, in the public interest, and will take civil proceedings in the High Court against the operators of, eg, an unauthorised CIS for a declaration that the defendant has in fact been operating a CIS, and if found, for an account of how much money has been taken in.

The defendant can be ordered to repay all monies which have been received from participants in the scheme (in Mr Watkins’s case, the purchasers of the land). In the event of non-payment, or an inability to pay, bankruptcy proceedings may follow. All other methods of enforcing civil judgements are also available.

More pertinently, at the outset of proceedings, the FSA may apply for injunctive relief against the operator, stopping him from operating and freezing his assets. Even when the scheme is operated by a limited liability company, the principals behind the scheme may also be joined in these proceedings.

Reference has also been made to the criminal consequences of carrying on a regulated activity without authorisation.

For example, in June 2011 the FSA secured a criminal conviction for boiler room fraud against David Roger Griffiths Mason, who was sentenced to two years in prison and disqualified from being a director for six years. Mason pleaded guilty to 13 counts of carrying on a regulated activity without authorisation; one count of making false or misleading statements, promises or forecasts; and three counts of money laundering. Mason was unauthorised by the FSA but was running a ‘boiler room operation’.

Although Mason was an ‘approved person’ (by the FSA), victims were cold-called and offered shares in a particular company by overseas firms none of which were authorised by the FSA nor by any other overseas regulators. Promoting investments from an offshore base while unauthorised is also unlawful under FSMA if UK customers are targeted. 

The moral for unregulated entrepreneurs is to ensure that whatever product they may be selling to the retail market or whatever advice they may be giving, they do not breach the ‘general prohibition’ on the carrying out of unauthorised regulated business, thus attracting the attention of one of the UK’s fiercest regulators.

Alternatively, of course, you could always seek FSA authorisation!

Stephen Gilchrist is a solicitor and Chairman and Head of Regulatory Law at Saunders Law Ltd

www.saunders.co.uk

For further information contact gilchrist@saunders.co.uk (tel 020 7632 4300)