Communications from Collective Investment Schemes Authorized in Hong Kong: A Snapshot of SFC Proposals
March 18, 2008
By Timothy Loh
Proposed changes will reduce regulatory burdens by dispensing with pre-vetting by the SFC of a wide range of notices and advertisements issued by collective investment schemes authorized by the SFC. At the same time, they will harmonize requirements for advertisements. However, the changes introduce now complexity into the regulatory regime and shift greater responsibility and liability on the issuers of such notices and advertisements.
TIMOTHY LOH | Financial Services & Law Review
Vol. 2 (2008) at p. 1
On January 29, 2008, the Securities and
Futures Commission ("SFC")
proposed changes to the regulatory regime for notices and advertisements issued
by collective investment schemes ("authorized
schemes") authorized by the SFC. The changes are intended to harmonize and simplify
requirements for advertisements for, and other communications with investors
in, unit trusts, mutual funds, Mandatory Provident Fund ("MPF") schemes, investment
linked assurance schemes and pooled retirement funds.
These are laudable objectives. However, the manner in which some of these
changes have been proposed appear to limit the benefits of these changes and
may create confusion and uncertainty. At the same time, these changes will shift a greater degree of
responsibility and liability to managers of authorized schemes.
BACKGROUND
Broadly, the Consultation Paper on the Proposed
Streamlining of the Pre-Vetting of Notices and Advertisements of Relevant
Authorized Collective Investment Schemes ("Consultation
Paper") proposes that the SFC will no longer vet:
- a range of notices, letters and public announcements
(together "notices")
to investors of authorized schemes which do not contain an invitation to the
public to acquire or dispose of an interest in such schemes, and
- advertisements or other documents (together "advertisements") to the
public which contain an invitation to the public to acquire or dispose of an
interest in an authorized scheme if such advertisements are issued in
circumstances where authorization is not required under the Securities and
Futures Ordinance ("SFO").
Statutory Framework for Investment Offers
By way of background, the SFO and the Companies Ordinance ("CO") together establish the
statutory framework for the regulation of collective investment schemes. Broadly, there are 2 elements to the
framework, namely authorization of the collective investment scheme itself and
authorization for each marketing communication.
Authorization of Schemes
Under the SFO, the SFC may authorize a collective
investment scheme subject to conditions it considers appropriate. Historically, the SFC has imposed 2
such conditions. The first
condition is that all notices, letters and public announcements to existing
investors be submitted to the SFC for prior approval. The second condition is that the authorized scheme comply
with the applicable product code, such as the Code on Unit Trusts and Mutual
Funds ("UT Code") in
the case of an authorized scheme in the form of a unit trust or mutual fund or
the Code on Investment-Linked Assurance Schemes ("ILAS Code") in the case of an authorized scheme
in the form of an insurance policy.
Authorization of Advertisements
Separately, the SFO requires SFC authorization for
each advertisement. The CO
establishes similar requirements for SFC authorization for collective
investment schemes in the form of a company. These requirements for SFC authorization under the SFO and
the CO apply even if the scheme itself is an authorized scheme but do not apply
if the issue is exempted under either the SFO or the CO, as the case may
be.
Authorization of Notices
There is no requirement under the statutory
framework for SFC approval of notices to investors of authorized schemes as
such do not contain an invitation to the public to acquire or dispose of an
interest in such schemes. However,
as a result of the 2 statutory conditions described above, for authorized
schemes, the requirement for SFC approval applies to (i) all notices even
though authorization is not required under the SFO, and (ii) all advertisements
even if they fall within an exemption under the SFO from the authorization
requirement. In this latter
regard, this is because the product codes require authorization of all advertisements
whether or not required under the SFO.
PROPOSAL TO REDUCE VETTING OF NOTICES
Broadly, the Consultation Paper takes the position
that the time and cost of prior SFC approval of notices, other than in respect
of major changes, is not justified by investor protection concerns. It proposes:
- to replace the statutory condition that requires
authorized schemes to submit to the SFC for prior approval, all notices,
letters and public announcements to investors with a new condition for approval
only of notices to investors related to the withdrawal of authorization or
mergers or termination and for filing within 2 weeks of issuance of all notices
to investors not approved by the SFC, and
- to amend the relevant product codes so that notices
to holders of authorized schemes will no longer be subject to a requirement for
prior approval by the SFC except in relation to changes in the constitutive
documents or the offering document, notices of such changes, increases in fees,
withdrawal of authorization and mergers or termination of the scheme.
Consistency With Regulatory Trend
The proposal appears to be sensible and is
consistent with trends in the SFC's recent practice. For example, as from November, 2001, the SFC no longer
required notices of suspension in dealings to be submitted to the SFC for prior
approval before issuance but instead, required such notices to contain minimum
prescribed content. Equally, for
example, as from February, 2006, the SFC no longer required notices relating to
routine administrative and operational matters to be submitted to the SFC for
prior approval before issuance.
It is also consistent with a broader regulatory
trend towards placing greater responsibility on issuers of notices. The Stock Exchange of Hong Kong itself
proposed in January, 2008 that it would cease pre-vetting of a wide range of
notices issued by listed companies, relying instead on post-publication monitoring
and enforcement to ensure that such companies satisfied their regulatory obligations.
Drafting Point
While the shift in regulatory philosophy on notices
is sensible, it is not clear why it remains necessary at all for the SFC to
impose a statutory condition for approval of any notices if there is a statutory
condition to comply with the applicable product code and the applicable product
code sets out definitively the approval requirements for communications.
PROPOSE TO PERMIT USE OF OFFER EXEMPTIONS FOR ADVERTISEMENTS
The Consultation Paper separately proposes that all
advertisements of an authorized scheme be submitted to the SFC for
authorization prior to their issue unless such authorization is not required
under the SFO. This differs from
current product code requirements in which all advertisements, whether or not exempted
from authorization under the SFO or CO, must be authorized. Collateral changes are proposed in this
regard, including a new statutory condition for the issuer to cease issuing an
advertisement on request of the SFC and a requirement to keep records of
advertisements issued for 3 years.
Advertisements Issued by Securities Dealers and
Advisers
As issuers of advertisements for authorized schemes
will be able under the proposals to take advantage of exemptions under the SFO,
the Consultation Paper suggests that it will be possible to dispense with SFC
authorization for the issuance of advertisements of an authorized scheme where
the advertisement is issued by a person licensed or registered for dealing in
or advising on securities. At
first glance, this would appear to remove the need for authorization of fund
fact sheets, billboard, newspaper and magazine advertisements and radio,
television and internet advertisements of an authorized scheme issued by a
manager or Hong Kong representative who is licensed to deal in or advise on
securities. However, there are
major reservations.
- Where advertisements are issued on behalf of an
authorized scheme which is in the form of a company, such advertisements may
constitute prospectuses which will nevertheless require authorization under the
CO. This is because even though
the SFO exempts the issue of advertisements issued by or on behalf of persons
licensed or registered for dealing in or advising on securities, the CO does
not.
- The exemption from authorization for advertisements
issued by or on behalf of persons licensed or registered for dealing in or
advising on securities only applies to securities. Under the SFO, the term "securities" excludes certain collective
investment schemes, including MPF schemes and investment linked insurance
contracts. Thus, advertisements
for MPF schemes and investment linked insurance contracts will still require
SFC authorization unless an alternative exemption avails.
In light of the foregoing, it appears that the main
beneficiaries of the proposal to permit usage of statutory exemptions are
authorized schemes in the form of unit trusts. However, even then, such a scheme may not have access to a
person licensed or registered to deal in or advise on securities who is willing
to issue advertisements on its behalf. For example, an authorized scheme may have a Hong Kong manager who is
not licensed or registered to deal in or advise on securities. In the absence of a person licensed or
registered for dealing in or advising on securities to issue the advertisement,
the advertisement may still require SFC authorization unless an alternative
exemption avails.
Where it is not possible to rely upon exemption as
a result of an advertisement being issued by a person licensed or registered to
deal in or advise on securities, other exemptions may apply. However, the availability of these
exemptions will depend to some degree on the form of the authorized
scheme.
Advertisements for Unit Trusts and Investment
Limited Insurance Contracts
In the case of an authorized scheme in the form of
a unit trust or investment linked insurance contract, it is possible that the
professional investors exemption will not be available. The SFO exempts from
the authorization requirement advertisements made in respect of interests in
collective investment schemes which are or are intended to be disposed of only to professional
investors. Whilst the better view
may be that the SFO exempts from authorization an advertisement for an
authorized scheme to the extent
that interests in the scheme are disposed of only to professional investors, it
is at least arguable on the statutory language that authorization will be
required if even a single interest in the scheme is disposed of to a person who
is not a professional investor.
Equally, for an authorized scheme in the form of a
unit trust or investment linked insurance contract, it seems that a private
placement cannot be effected. This
is because private placements of such schemes are not the subject of any
express exemption. Instead, they
simply fall outside the ambit of the authorization requirement under the SFO
whereas the draft language in the Consultation Paper suggests an exemption is
specifically required. In any
event, it is also unclear if it is possible as a matter of statutory
interpretation of the SFO to effect a private placement alongside a public
offer of interests in an authorized scheme.
Advertisements for Mutual Funds
On the other hand, in the case of an authorized
scheme in the form of a company, it appears that authorization would no longer
be required for the issue of advertisements where the minimum investment size
is HK$500,000 or where the offer is limited to professional investors as
defined under the SFO. There is no
reference in the proposals to the exemption under the CO for advertisements
issued only to persons whose ordinary business is to buy and sell shares or
debentures.
PROPOSALS FOR ADVERTISEMENTS IN STANDARD FORMAT BUT UPDATED CONTENT
The Consultation Paper proposes that once an
advertisement for a scheme is authorized by the SFC, performance information of
the scheme and general market commentary thereon may be updated in the advertisement
without further authorization provided that the content and the format of such
advertisement remain fundamentally the same as the version submitted for
authorization and the information within the advertisement remains
current. Thus, for example,
it ought to be possible to authorize presentation materials for an authorized
scheme and to update the performance information in these materials from time
to time without obtaining further SFC authorization.
Significance of Proposal
The significance of this proposal appears limited
to cases where the advertisements are not exempted. However, to the extent the proposal will apply, it
effectively extends the current SFC practice of authorizing the standard format
of fund fact sheets and newsletters, without requiring further versions of
those publications, with content contemplated within the format updated from
time to time, to be authorized.
Uncertain Application to Offering Documents
Because the SFC has indicated that it wishes to
specifically approve changes to offering documents, it is not clear whether
under this proposal it will be possible to obtain SFC authorization for an
offering document which will be updated from time to time with the latest
performance information and to dispense with further SFC approval each time the
offering document is updated with the latest performance information.
Statutory Compliance
In any event, whilst the proposal would likely
facilitate advertising of authorized schemes, it does not address uncertainty
as to statutory compliance. Under
the SFO, unless exempted, each advertisement must be authorized by the
SFC. Where the content of an
advertisement changes from version to version, even if the format remains the
same, it is at least arguable that each version of the advertisement which
contains different content must be authorized by the SFC on the basis that each
version is a different advertisement.
In practice, it is unlikely that the SFC itself
would take enforcement action for failure to obtain authorization for each
version of an advertisement. However,
if authorization of each advertisement is in fact required by the SFO and this
is not done, other persons (e.g.
the Secretary for Justice on behalf of the Government of the HKSAR) may
prosecute. Furthermore, there may
be civil consequences. As a result,
it may be desirable for the standard SFC authorization for advertisements to
provide wider language not just for approval of the format but also for
approval of all versions of the advertisement contemplated by the format.
RESPONSIBILITY OF MANAGEMENT COMPANIES
A point closely tied to dispensation with the
requirement for SFC pre-vetting of notices and advertisements is the
corresponding potential increased liability for management companies of
authorized schemes in preparing such communications.
Codification of Issuer Liability
The Consultation Paper itself proposes that the
management company has the responsibility to ensure that notices to investors
in an authorized scheme are not misleading and contain accurate and adequate
information to keep investors informed. However, this does no more in essence than re-state the current
statutory position. Under
the SFO, a management company that materially participates in or approves the
making or issuing of a communication may bear statutory liability if the
communication is false or misleading in a material particular and it knows
that, or is reckless or negligent as to whether the communication is false or
misleading.
Risks of Proposal
Pre-vetting provides a degree of comfort as the SFC is unlikely to approve any notice or advertisement which it considers to be defective and the SFC is less likely to challenge any notice or advertisement it has approved. In the absence of pre-vetting, there is a higher
risk that notices and advertisements may omit material information or may
otherwise be false or misleading in a material particular. At the same time, there is a risk that notices or advertisements may need to be amended or clarified at the request of the SFC after their publication. Consequently, management companies may
wish to rely more heavily on independent and competent outside counsel to
review communications to manage this risk.
ADVERTISING GUIDELINES
The Consultation Paper proposes new Advertising
Guidelines, which will apply to all authorized schemes other than real estate
investment trusts. These new
Advertising Guidelines will harmonize requirements for different types of
authorized schemes under different product codes. They are intended to simplify and codify requirements.
Application of New Guidelines
The new Advertising Guidelines will apply to all
forms of advertisement for an authorized scheme whether or not SFC
authorization is required. Thus,
for example, the Advertising Guidelines will apply to all fund fact sheets,
billboard, newspaper and magazine advertisements and radio, television and
internet advertisements for authorized schemes.
Content Requirements
The Advertising Guidelines will require
advertisements for authorized schemes not to be false, biased, misleading or
deceptive, to be clear and fair, to present a balanced picture of the scheme
with adequate risk disclosures and to contain information that is timely and
consistent with the offering document. At the same time, they will prescribe minimum content in the form of
risk disclosures and warning statements and will establish parameters for the
presentation of information, such as performance information.
Concerns
The general principles of the Advertising
Guidelines are sound. However,
there may be concerns in requiring all advertisements for authorized schemes
which are issued pursuant to exemptions from authorization requirements to
comply with all aspects of the Advertising Guidelines. For
example, the Advertising Guidelines limit references to past performance of
unauthorized schemes when advertising an authorized scheme unless the
authorized scheme is newly launched. If materials are used for a sales presentation to institutional
investors, it may not be objectionable to refer to past performance of an
unauthorized scheme. This would be
particularly so if the presentation sought to cover the full range of
authorized and unauthorized schemes available from the manager.
RESPONSIBILITY OF SALES INTERMEDIARIES
As drafted, the Consultation Paper proposes that
advertisements including but not limited to those issued by licensed or
registered persons acting as the distributors of the scheme (i) must comply
with prescribed advertising guidelines, and (ii) must be submitted to the SFC
for authorization prior to their issue or publication in Hong Kong unless
exempted under the SFO.
Recommendations
The language including advertisements issued by
licensed and registered persons acting as distributors suggests that
recommendations prepared for clients by sales intermediaries of authorized
schemes may now be subject to the Advertising Guidelines. However, presumably, SFC authorization
of such recommendations would not be required as such recommendations would in
the normal course be exempt from authorization under both the SFO and the CO.
Uncertain Application
At the same time, there is some uncertainty as to
who is a "distributor" of an authorized scheme. For example, if a financial adviser licensed only for Type 4
(advising on securities) regulated activity prepares a note to a number of
clients in identical form suggesting that they acquire interests in an
authorized scheme, is the financial adviser a distributor within the Advertising
Guidelines?
CORPORATE AND INTERNATIONAL MEDIA ADVERTISEMENTS
The Consultation Paper proposes to remove from the
Advertising Guidelines text which provides a degree of safe harbour for
corporate advertisements and advertisements in international media. In its stead, the Consultation Paper
proposes that a separate FAQ will provide guidance on SFC policy in relation to
when corporate communications may be regarded as containing an invitation to
the public to acquire or dispose of an interest in a collective investment
scheme and when international media communications may be regarded as being
issued to the public in Hong Kong.
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