Under the law that governs the local unit trust industry, it is illegal for anyone to solicit an investment into a fund that is not approved by the South African regulator. The intention is to protect investors from potentially risky products.
This section of the law has however been controversial for a number of years for two reasons.
The first is that the Financial Sector Conduct Authority (FSCA) only considers funds for approval if it is asked to do so. Given that there are around 120 000 regulated funds worldwide, the FSCA cannot, and doesn’t pretend to, cover all of them.
Just because a fund is not approved by the FSCA therefore doesn’t mean that there is necessarily anything risky about it. It may just be that approval has never been sought.
Secondly, as Moonstone Compliance Chief Operating Officer Billy Seyffert points out, it’s not clear how necessary this section of the Collective Investment Schemes Control Act (Cisca) still is. In the years when it was almost impossible for someone to manage their own offshore investments, it gave the regulator control over what was available within the country. These days, however, anybody can invest just about anywhere.
“If you consider that an investor can search the internet and, subject to a direct dealing option being available, invest into unapproved funds anywhere in the world without it being a problem, I sometimes wonder about its relevance in modern times,” Seyffert notes.
The 36One case
Nevertheless, the law still stands and earlier this month 36One Asset Management found itself on the wrong side of it. Last week the Financial Sector Tribunal upheld a decision by the FSCA to fine the firm R350 000 for soliciting investments into two of its hedge funds in the Cayman Islands through presentations to clients, in its newsletter and on its website.
This finding was made despite 36One’s contention that it did not intend to promote investments into these funds, and that in fact there was never any request made to clients to do so.
Details of the funds, the asset manager argued, were only made available for informative purposes.
In addition, it pointed out that it wasn’t possible for anybody to invest into these two funds directly through its website. This was only possible for 36One’s approved South African funds.
Interested investors were only able to submit their details for 36One to get in touch with them. They could also only do so after accepting a disclaimer that noted that the information provided on these funds did not constitute solicitation.
The decision
The Act however states that ‘any act’ to promote a collective investment scheme is considered solicitation. The regulator found that in publishing the information that it did, 36One met that standard.
Sisanda Harban, specialist in the FSCA’s complex enforcement department, told Moneyweb that: “In assessing evidence to determine whether solicitation has taken place, the FSCA applies the civil law standard of proof and determines whether the weight of the probabilities on the available evidence shows that what occurred was promotion of investment in an unapproved scheme.
“In this regard, context including the wording used in the medium of communication, the potential recipients of the material [is the material directed to potential investors] and whether what is disclosed is relevant information to influence investment decisions, are some of the key factors that are considered.”
On this basis, the tribunal agreed that there had been a contravention of the Act:
“The purpose of publication of investment funds in its portfolio by a company, whose business entails administration of those investment funds, can hardly exclude the marketing of those funds,” its decision noted.
“It may not be the sole purpose for publication, but marketing or soliciting investment in those funds would definitely be among the purposes.”
It also didn’t matter that 36One had provided the disclaimer, or that it showed that no South African investor had put money into these funds after seeing the information in question.
“The fact that a promotion was ineffective does not mean that the act was not one of promotion,” the tribunal noted. “It is the act which is prohibited, irrespective of success.”
Important considerations
There are a number of noteworthy features to this finding.
The first is that ‘solicitation’ must be understood very broadly. As Harban indicated, this doesn’t mean that any mention of an unapproved fund is problematic, but financial services providers must be careful.
“The real question would be whether such disclosure is likely to result in promoting investment in that unapproved scheme,” she told Moneyweb.
Secondly, the tribunal’s ruling makes it clear that ‘reverse solicitation’, which is acceptable in many other countries, will still be seen as a contravention of the Act in South Africa.
“The tribunal, without explicitly stating it, is implying that 36One was looking to invoke a type of reverse solicitation, whereby the client makes a query and they merely respond,” Seyffert notes. “The issue here is that by creating the portal to make the query they were in fact soliciting.”
Finally, it is significant that for something to be considered solicitation, the entity involved doesn’t actually have to see any kind of benefit. As the tribunal made clear, it is that act that matters, not the result.
“Although,” added Harban, “if such solicitation results in commercial benefit, this factor may be taken into account when determining the quantum of the administrative penalty.”