Public Companies Update January 2005

3 FSMA - CONSULTATION ON CHANGES TO HIGH NET WORTH INDIVIDUALS AND SOPHISTICATED INVESTOR EXEMPTIONS

In January last year, HM Treasury published a consultation document seeking views on the operation of, and possible changes to, the exemptions for high net worth and sophisticated investors in the FSMA 2000 (Financial Promotions) Order 2001 ("Financial Promotions Order") and the FSMA 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001 ("CIS Exemptions Order").

Since December, following such consultation, HM Treasury outlined the amendments it proposes to make to the existing exemptions for high net worth and sophisticated investors in the Financial Promotions Order and CIS Exemption Order. There are two principal changes proposed to the current regulatory regime which are expected to be adopted shortly:

It is thought the Government has instigated these changes so that companies facing difficulties in obtaining funding will find it easier to approach and attract investors. By introducing self-certification for high net worth and sophisticated investors it will make it easier for small firms to approach wealthy or experienced investors. Taking each of these proposals in turn:

Self-certification

Currently, under Article 48 of the Financial Promotions Order, high net worth individuals must have a statement confirming that they meet the relevant criteria signed by their accountant or employer. Following the proposed amendment, high net worth individuals will be able to self-certify that they meet these criteria, namely, that they have an annual income of at least £100,000 or hold net assets of at least £250,000 (excluding their primary residence, rights under a qualifying contract of insurance and certain pension benefits).

Similarly, individuals will be able to certify themselves as sophisticated investors if they meet one or more of the following criteria:

• member of a network or syndicate of business angels for at least 6 months;
• made more than one investment in unlisted companies in the previous 2 years;
• currently works, or has worked in the previous 2 years, in a professional capacity in the private equity sector, or in the provision of finance for small and medium enterprises; and/or
• is currently, or has been in the previous 2 years, a director of a company with an annual turnover of at least £1million.

Promotions to self-certified high net worth and/or sophisticated investors will be limited to investments in unlisted securities (or, in the case of collective investment schemes, unregulated schemes investing wholly or predominantly in unlisted companies).

The existing sophisticated investor test (Financial Promotions Order Article 50/CIS Exemptions Order Article 23) will be retained for those wishing to be certified in respect of a wider range of investment products such as listed securities, which includes shares in companies which are traded on AIM. There will also be provisions aimed at ensuring that investments made as a self-certified high net worth or sophisticated investor cannot result in the investor losing more money than he/she invested.

All unapproved promotional material sent to certified high net worth individuals or self-certified sophisticated investors will be required to carry a prescribed health warning in a prominent place at the start of the promotion. The warning should state that the content has not been approved by an authorised person and that reliance on it may expose the investor to a significant risk of losing all property or other assets invested.

"Reasonable belief" promotions

The second amendment to the Financial Promotions Order and CIS Exemption Order will allow promotions to be made to individuals where the person making the communication has a reasonable belief that the investor is (a) a self-certified high net worth individual or (b) a self-certified sophisticated investor.

The "reasonable belief" relates only to the existence of a signed statement. The intention is that it will be sufficient for an individual to demonstrate that they have taken sufficient steps to form a reasonable belief that a signed statement exists and that confirmation (even if only oral) from a potential investor may suffice. Ultimately however, the interpretation of "reasonable belief" will fall upon the courts.

Conclusion

The introduction of these proposals will make it easier for unlisted companies to attract investment in the future, particularly if an investor can certify himself as being sophisticated even if he has made only two investments in an unlisted company in the previous two years. However, pending these changes, companies and their advisers will need to continue to comply with the existing rules, even if this is comparatively restrictive, as they will when seeking to rely on the sophisticated investor exemption in relation to listed securities.

If you require further information on any matter covered in this note, please contact your principal contact at Charles Russell or Simon Gilbert, Katy Knight, Clive Hopewell or Alexander Keepin (London), Francis Rundall or Richard Norton (Cheltenham) or Catherine Drew or Geoff Sparks (Guildford) on 0207 203 5000.

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