An update on regulatory developments for angel syndicates in Scotland

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Five regulatory forces affecting the angel market.

Over the Easter weekend, the family and I went down to Northumberland. I took the kids to Lindisfarne, because that's the sort of thing you might do.

Now, my son is a cautious lad. I had told him stories about cars getting stranded. Crossing the causeway to Holy Island made him nervous. So, we double- and triple-checked the tide tables.

In the café, I watched the other families. There were those, like my son, who were quite clear about the time to leave.

There were those using what looked like older tide tables. And there were those waiting until the tables gradually emptied, until it was obvious that the time to go had come.

The North Sea can be an unforgiving place. The force of the wind. The strength of the current. The speed of the tide. The narrowness of that road. The low sun. These factors have caught people out.

And so, let me tell you about five regulatory forces affecting the angel market.

The prevailing wind: high risk investments

The FCA has always treated shares in private companies as a higher risk investment. New rules place unlisted shares within a new class of restricted mass market investments.

The point I want to make here is not about marketing restrictions. It is that the FCA firmly believes that this asset class is inherently high risk and should only be accessed when retail consumers understand the risks involved.

And that is a good time to remind everyone that high net worth (HNW) and sophisticated investors are, under the FCA Rules, retail customers.

The current: reform of the HNW limits

Turning to the financial promotion exemptions. Treasury has consulted on changes to the process for high net worth and sophisticated investors.

The threshold limits for HNW may change from the current £100,000 to £175,000 for income and from £250,000 to £900,000 for assets.

I appreciate that, for a proportion of the angel investors represented here, that will make no impact. But it is worth acknowledging that those changes are likely to have a disproportionate effect on regions such as Scotland or Northern Ireland.

To borrow a phrase, the total addressable market is shrinking.

Further, the Government proposes to shift the burden, such that firms seeking to rely on a HNW or sophisticated statement should have a "reasonable belief" that the investor does, in fact, meet the criteria. Before they receive the financial promotion.

The tide: the section 21 Gateway

In relation to business plans and pitch decks, a new section 21 gateway will require authorised firms to take additional steps before they approve any financial promotion for an investee company.

The FCA thinks that increasing the burden for HNW and sophisticated certificates will push more companies to get their share offers signed-off by regulated firms.

This may be the case. But it seems Or companies will bring things to you that wouldn’t pass muster elsewhere.

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The narrowness of the causeway: the arranging perimeter

Away from the angel market for a moment. The introduction of pension freedoms attracted sharks and bottom feeders, eager to help people liberate their retirement pots. And instead offer opportunities to invest their savings into storage pods and forestry schemes.

But the litigation that followed has given us the clearest sense of the two arranging activities for a decade.

Let me clarify a few things.

The arranging perimeter is distinct to the preceding financial promotion points. There is no HNW or sophisticated exemption to the arranging activities.

Arranging is not advising. It is not dealing. It is not managing.

Arranging deals are steps likely to cause a person (any person) to subscribe for shares.

The broader activity of “making arrangements with a view” involves an ongoing activity of 'encouraging' or 'assisting' a party to the arrangement to subscribe for, buy or sell shares generally. One does not need to cause the deal to happen, but the purpose - the end view - of the arrangements is for an investor to subscribe for shares.

As a Court of Appeal judge described it:

'You cannot make the proverbial horse drink, but taking it to water involves making arrangements with a view to it drinking.’

The end view, the business model employed by these firms, was all about generating commission from the investments.

What might that look like in practice? The following scope of engagement was deemed to be within the scope of article 25(2):

  • Assisting an issuer in identifying interested parties
  • Communicating the issuers financial promotions to potential investors
  • Ensuring confidentiality provisions were in place
  • Collecting expressions of interest and communicating the terms of the offer to the issuer
  • Coordinating the additional due diligence requirements of the investors
  • Reviewing legal agreements
  • Project management through to completion

In most circumstances, the starting proposition for management gatekeepers should be that the arranging perimeter does apply.

Please take a moment to review any exemption under which you purport to operate, to ensure it is fit for purpose.

The setting sun: the appointed representative regime

Finally, changes to the appointed representative regime. Notwithstanding a recent crackdown, this continues to be one of the FCA's focus areas.

The AR regime offers firms the ability to undertake regulated activities without being directly authorised.

However, many principal firms have been forced to curtail their activities, formally or informally.

For those that are still in the market, more diligence, more supervision, and more reporting are the order of the day. Inevitably this impedes the ability of firms to find safe harbour.

Make sure you have the latest tide tables to guide you. Ensure that there is leeway to navigate the causeway. We want everyone to make it back to the mainland safely.

To conclude with a self-serving quote. People who carry on regulated activity and are ignorant of the law, even if reasonably so, … are more of a danger to the public.

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