Chapter 5: Equity Finance Flashcards

Question

Convertible shares

Answer 1

Such shares will usually carry an option to ‘convert’ into a different class of share according to stipulated criteria.

Answer 2

A company may issue different classes of share, as seen above. The rights attaching to each class are usually set out in the company’s Articles. In relation to any type of share, you should always refer to the Articles to find the relevant rights attaching to a share, since there are no formal, universal definitions of different types of share.

Answer 3

If an attempt is made to alter the Articles of a company such that existing class rights are varied, the resolution in question will not be effective unless varied in accordance with provisions in the company’s Articles for the variation of those rights or, where Articles don’t contain such provisions, by consent in writing of holders of at least 75% of the issued shares of that class or by means of a special resolution passed at a separate general meeting of holders of that class (s 630 CA 2006).

Answer 4

Shareholders holding 15% of the relevant shares may (provided they did not vote in favour of the variation) apply to court within 21 days of the resolution to have a variation cancelled (s 633(2) CA 2006). Following such application, the variation will not take effect unless and until it is confirmed by the court. The court will not confirm the variation if it feels that the variation unfairly prejudices the shareholders of the class in question.

Answer 5

The main reason for shareholders to invest in shares in a company is generally to make money. Shareholders may receive a return on their investment in two ways: * By receipt of dividends (income receipts), and * An increase in the capital value of the shares. Dividends are only payable by a company if it has sufficient distributable profits (s 830(1) CA 2006). 'Distributable profits' means the company's accumulated realised profits less its accumulated realised losses (s 830(2))

Answer 6

Final dividends – Final dividends are recommended by the directors and declared by the company by an ordinary resolution of the shareholders following the financial year end. Interim dividends - The articles of a company normally give the directors the power to decide to pay interim dividends if the company has sufficient distributable profits (MA 30 allows this). Interim dividends can be paid without the need for an ordinary resolution of the shareholders. Interim dividends are often paid where the company has realised an investment.

Answer 7

*The term 'share capital’ relates to the money raised by the issue of shares. * A share is a ‘bundle of rights’ in a company that often provide voting rights. Shares (and the rights attaching to them) can broadly be categorised into six groups: * ordinary shares; * preference shares; * participating preference shares; * deferred shares; * redeemable shares; and * convertible shares. * There are no statutory definitions of different types of shares. The rights attaching to shares are set out in the company’s Articles.

Answer 8

This element considers some important restrictions on allotment and sets out the process by which a company may transfer shares. Transmission of shares on death or bankruptcy is also covered. The procedure for issuing new shares is covered in the next element.

Answer 9

An allotment of shares is a contract between the company and a new/existing shareholder under which the company agrees to issue new sharesin return for the purchaser paying the subscription price. A transfer is a contract to sell existing shares in the company between an existing shareholder and the purchaser.The company is not a party to the contract on a transfer of shares (with the exception of a sale out of treasury of treasury shares).

Answer 10

The s 755 restriction on private companies offering shares to the public. Under s 755 CA 2006 a private company limited by shares is prohibited from offering its shares to the public. As a result, private companies are essentially restricted to offering their shares to targeted investors only and not to the public indiscriminately.

Answer 11

The expression ‘offer to the public’ (as defined in s 756 CA 2006) covers offers to ‘any section of the public’ but excludes offers which are intended only for the person receiving them and offers which are a ‘private concern’ of the persons making and receiving them. This latter exclusion covers offers made to existing shareholders, employees of the company and certain family members of those persons, and offers of shares to be held under an employee’s share scheme. These excluded offers will not fall foul of the s 755 restriction. This restriction must be considered carefully when a private company is proposing to allot shares.

Answer 12

Every time that a company offers shares you will need to consider whether it is required to publish a prospectus to would-be investors. A prospectus is an explanatory circular giving investors details about the company and about the investment itself on which to base their investment decision. A prospectus should contain all the information necessary to enable investors to make an informed assessment of the financial status of the company and the rights attaching to the shares (s 87A(2) FSMA), and preparing a prospectus is therefore an expensive and time-consuming process. In an offer of shares by a private company, it will usually be the case that a prospectus will not be required. However, you will need to consider the rules each time.

Answer 13

Under s 21 FSMA (as amended by FSMA 2023) a financial promotion is any invitation or inducement (in the course of business) to engage in investment activity (which includes buying shares). Financial promotions are prohibited (for all companies) unless certain requirements set out in FSMA are fulfilled. Clearly this is potentially relevant when a company is considering issuing shares to investors. Communications made by a company when issuing its shares must, either be within an exemption from the s 21 FSMA prohibition or be issued or approved by an authorised person, who must now be appointed by the FCA to approve financial promotions. There is more information about this in the Legal Services Workbook.

Answer 14

Transmission of shares is an automatic process in the event of death or bankruptcy of a shareholder as follows: * If a shareholder dies, their shares will automatically pass to their personal representatives. * If a shareholder is made bankrupt, their shares automatically vest in their trustee in bankruptcy.

Answer 15

Shares may be transferred from an existing shareholder to a new shareholder by way of sale or gift. Shareholders are free to transfer their shares subject to any restrictions in the Articles (s 544(1) CA 2006). It is therefore important to check the Articles for any restrictions on transfer. Some common restrictions are set out below.

Answer 16

The two most common forms of restriction are: 1. Directors’ power to refuse to register Article 26(5) MA states: “The directors may refuse to register the transfer of a share, and if they do so, the instrument of transfer must be returned to the transferee with the notice of refusal unless they suspect that the proposed transfer may be fraudulent”. Under s 771 CA 2006, a company must give reasons if it refuses to register a transfer.

Answer 17

2. Pre-emption clauses (rights of first refusal) Here we are looking at pre-emption rights on a transfer of shares (which should not be confused with pre-emption rights on allotmentunder s 561 CA 2006). Such rights are usually set out in the articles. CA 2006 and MA do not contain any pre-emption rights on transfer, so they must be specially inserted into the Articles of any company wishing to establish them. Pre-emption rights on transfer will often require that a shareholder wishing to sell shares must offer them to the other existing shareholders before being able to offer them to an outsider.

Answer 18

A transfer of shares is made by way of a stock transfer form, which has to be signed by the transferor and submitted, with the share certificate, to the new shareholder (s770 CA 2006).

Answer 19

Beneficial title to the shares passes on the execution of the stock transfer form. Legal title passes on the registration of the member as the owner of those shares in the register of members by the company (s 112 CA 2006). The company will also send the shareholder a new share certificate in this name within two months (s 776 CA 2006).

Answer 20

The stock transfer form must be stamped before the new owner can be registered as the holder of those shares. Stamp duty is payable by the buyer at 0.5% of the consideration rounded up to the nearest £5. No stamp duty is payable where the consideration is £1000 or less; but where the consideration is more than £1000, a minimum fee of £5 is payable.

Answer 21

* It is possible for a company to allot new shares or for existing shares to be transferred between shareholders by way of sale or gift. * Private limited companies are prohibited from offering shares to the public. * When a shareholder is seeking to transfer shares, the Articles must always be checked to ensure there are no restrictions on transfer or pre-emption rights. * Transfer of shares is effected by the transferor signing a stock transfer form and giving this to the transferee together with the share certificate. * Stamp duty is payable on transfer of shares at 0.5% (subject to a minimum payment of £5) where the sale price exceeds £1,000. * Transmission of shares is an automatic process in the event of death or bankruptcy of a shareholder.

Answer 22

Remember, in company law, the term ‘share capital’ relates to the money raised by the issue of shares. The share capital is contributed by investors in the company and is represented by shares that are issued to such investors. Many companies will be incorporated with just one single share. As a way of raising finance, the company may choose to issue more shares.

Answer 23

In the context of issuing shares, it is important that you appreciate whether the company you are instructed by has been incorporated under the CA 2006 or the CA 1985 as there are differences between the way in which these companies will issue shares. In this element, you will consider the five-step process which a company needs to go through to issue shares. It could be that no action is needed at one or more of the stages. However, working through the five stages in each case will aid your understanding and ensure that you identify all the steps required in each particular case.

Answer 24

Before issuing new shares, you must check the company’s Articles for any cap or limit on the number of shares that may be issued. If this is to be exceeded, the cap must be removed, or the limit increased. A company incorporated under CA 1985 will originally have had an authorised share capital (‘ASC’), which acted as a ceiling on the number of shares it could issue. These companies (since 1 October 2009) will continue to have a deemed ceiling on the number of shares that can be issued, in their articles, unless such cap is removed from their Articles. The requirement for a company to have an ASC no longer exists under CA 2006. Companies incorporated under CA 2006 will not have an authorised share capital and shareholders wishing to impose a cap to restrict the number of shares which such a company can issue will need to amend the Articles (by special resolution) to include suitable provisions.

Answer 25

For companies incorporated under CA 1985, shareholders wishing to remove or amend the deemed restriction in a company’s Articles may do so by ordinary resolution. This is despite the fact that removing such a deemed restriction involves changing the Articles, which would normally require a special resolution under s 21(1) CA 2006. Any such deemed restriction will also fall away as a consequence of the company adopting, wholesale, new Articles (such as MA) which do not include provision for any cap (applying s 21(1) CA 2006).

Answer 26

Companies incorporated under CA 2006 will not have an authorised share capital. For such companies, therefore, there will be no bar to issuing shares under step 1. The only exception would be if the company has placed a provision in its Articles limiting the number of shares that may be issued. If such a restriction exists, it can be removed, or the limit increased, by special resolution under s 21(1) CA 2006. Under s 617(2)(a) CA 2006, each time a company issues shares, its share capital increases automatically.

Answer 27

* whether any resolutions to remove, impose or change any cap, or increase the share capital, have been passed, and ensure that you have up-to-date information (particularly checking the company’s Articles); and * whether any shares have been issued by checking the register of members or the most recent confirmation statement*filed at Companies House and any subsequent forms filed on allotments of shares (using Form SH01 under s 555 CA 2006).

Answer 28

* If the company does not have a limit on its share capital or if there are sufficient unissued shares available within any cap for a proposed new issue, the company can proceed to step 2. *Companies are required to file an annual confirmation statement. This confirmation statement states (‘confirms’) that the company has filed all necessary returns in the previous 12-month period (eg changes to registered address, changes to directors or company secretary etc). It also sets out any changes to share capital.

Answer 29

Directors are responsible for the actual allotment of shares to a shareholder and they must resolve by board resolution to make an allotment. However, they may need to have the prior authority of the shareholders to be able to do this. Section 549 CA 2006 provides that the directors of a company must not exercise any power of the company to allot shares in the company except in accordance with:

Answer 30

* s 550 CA 2006: for private companies with only one class of shares in existence, the directors will have automatic authority to allot new shares of the same class, or * s 551 CA 2006: for all other companies, the directors will need to be granted authority to allot the new shares by the shareholders by way of ordinary resolution.

Answer 31

In private companies with only one class ofshare, s 550 CA 2006 provides that directors have the automatic power to allot shares of that same class, unless they are prohibited from doing so by the company’s Articles. This helps many smaller companies to simplify the process of issuing shares, since no shareholder resolution is required to grant authority to directors to allot the new shares. Note that for companies incorporated under CA 1985, an ordinary resolution is required to authorise the directors to rely on s 550 CA 2006.

Answer 32

If s 550 CA 2006 cannot be relied upon, directors require authority under s 551(1) CA 2006, which provides that authority may be given by a provision in the company’s Articles or by shareholder resolution. Under s 281(3), this means an ordinary resolution unless the Articles require a higher majority. You would therefore need to check the latest version of the company’s Articles and any resolutions that have been passed giving the directors authority, in order to establish whether further authority is required.

Answer 33

Authority to allot under s 551(1) CA 2006 can only be given subject to limits in terms of both time and number of shares (s 551(3) CA 2006). This means that if the company has already granted its directors a s 551(1) CA 2006 authority, it must be checked to ensure it is still valid.

Answer 34

It means the ‘right of first refusal’. New shares should be offered pro rata to existing shareholders before any new investor. This is because, when a company allots shares to new shareholders, there is an effect on the proportionate ownership of the company held by the existing shareholders. Their ownership is diluted, and therefore their entitlement to dividends and voting power is also diluted.

Answer 35

Due to the potential dilution, s 561 CA 2006 contains pre-emption rights, which give protection to existing shareholders. Where pre-emption rights apply, the most usual approach is for the company to request the existing shareholders to disapply these pre-emption rights by special resolution.

Answer 36

Section 561 CA 2006 states as follows: ”(1) A company must not allot equity securities to a person on any terms unless (a) it has made an offer to each person who holds ordinary shares in the company to allot to him on the same or more favourable terms a proportion of those securities that is as nearly as practicable equal to the proportion in nominal value held by him of the ordinary share capital of the company …”

Answer 37

As a result, any new ‘equity securities’ (defined ins 560 CA 2006) must be offered to the existing shareholders of a company (holding ordinary shares), in proportion to their existing shareholdings, before they can be offered to anyone outside the company. Under s 560(1) CA 2006, ‘equity securities’ are (i) ‘ordinary shares’ or (ii) rights to subscribe for, or convert securities into, ordinary shares. However, under s 560(1) there is a special statutory definition of ‘ordinary shares’, the meaning of which is wider than we are accustomed to in everyday parlance.

Answer 38

‘Ordinary shares’ are shares ‘other than shares that as respects dividends and capital carry a right to participate only up to a specified amount’ for this purpose. This means that if a class of shares carries a right to receive dividends and, on a winding up, capital payments, and these rights are both capped, the shares will not fall within the definition of ‘equity securities’ and will not need to be offered pre-emptively. In every other case, the shares will fall within the definition of ‘equity securities’ and be subject to pre-emption rights under s 561 CA 2006.

Answer 39

Yes. The procedure for giving effect to pre-emption rights (which can be found in s 562 CA 2006) can be lengthy and, especially for companies with numerous shareholders, complicated to carry out. On many occasions it will not be appropriate or desirable to follow the pre-emption rights procedure set out in CA 2006: for example, where all shareholders agree that the company ought to bring in a new shareholder. In such a case, the company would want to disapply or exclude the pre-emption rights. This is permitted in CA 2006, with the permission of the company’s existing shareholders. In practice, companies usually use one of these two methods to disapply pre-emption rights, depending on the source of the directors’ authority to allot the shares.

Answer 40

A company may disapply pre-emption rights where the directors are generally authorised for the purposes of s 551 CA 2006 by passing a special resolution or by including the disapplication in its articles, both under s 570(1) CA 2006. This is not a permanent disapplication, but attaches to a particular, pre-existing s 551 authority. In practice, this is the most common means by which companies dispense with pre-emption rights on allotment.

Answer 41

Section 569 CA 2006 provides for disapplication of pre-emption rights for private companies with only one class of share by special resolution. Such a disapplication presupposes the directors’ authority to allot the shares derives froms 550 CA 2006 and therefore can apply for so long as the company has in issue, and allots, shares of only one class.

Answer 42

* Specific disapplication of pre-emption rights: It is possible, although uncommon, for a company to disapply pre-emption rights in relation to a specific allotment of shares (eg in relation to shares being issued to a particular person or as consideration for a specific purpose) by passing a special resolution under s 571 CA 2006 (rather than s 570 CA 2006). The procedure for specific disapplication is more cumbersome than that for a general disapplication. Directors will need to provide the company’s shareholders with a written statement explaining (i) the reasons for the specific disapplication, and (ii) the amount to be paid to the company pursuant to the allotment along with justification for the amount, under s 571(6) CA 2006. A specific disapplication under s 571 attaches to a particular, pre-existing s 551 authority.

Answer 43

Private companies can exclude statutory pre-emption rights permanently, by way of a provision in their Articles. However, companies rarely exclude pre-emption rights on a permanent basis because this would give existing shareholders no protection from dilution (there is no such provision in MA). In practice, only subsidiary companies commonly exclude statutory pre-emption provisions in their Articles.

Answer 44

provides for disapplication of pre-emption rights for private companies with only one class of shareunder the Articles. This is also unusual in practice because it leaves existing shareholdings with no protection from dilution.

Answer 45

When issuing new shares, a company may also wish to create a new class of shares, such as preference shares. You considered some examples of rights typically attached to different classes of shares in element 1. In order to create a new class of shares, it is necessary for the company, in addition to taking some or all of the steps set out previously, to insert new provisions in its Articles dealing with the rights attached to those new shares. An alteration to the Articles, you will recall, requires a special resolution of the shareholders under s 21 CA 2006 (except with a CA 1985 company if removing a cap transferred from a company’s authorised share capital in its memorandum).

Answer 46

The directors will resolve by board resolution to allot new shares on behalf of the company. Any requirements for shareholder resolutions must be dealt with in a general meeting before the board meeting is held at which the new shares are allotted. A general meeting will not be needed in advance of the board meeting if:

Answer 47

* has no limit in its constitution on the number of shares which can be issued by the company; and * does not require directors’ authorisation because the company is a private company with only one class of shares and there is no restriction in the company’s Articles – s 550 CA 2006) or has already given the directors authority to allot shares; and

Answer 48

* is issuing the shares to existing shareholders in proportion to their existing shareholdings and follows the procedure in s 562 CA 2006 or has already disapplied s 561 CA 2006 or is a private company and has taken advantage of s 567 CA 2006; and * has the relevant class rights in its Articles.

Answer 49

Copies of resolutions to be sent to Companies House within 15 days (s 29, s 30(1), s 26(1)) *CA 1985 companies: need to file any ordinary resolution removing the cap on authorised share capital and any ordinary resolution allowing the company to use s 550 CA 2006 if passed *Any s 551 ordinary resolution granting the directors authority to allot if passed *All special resolutions regarding the disapplication of pre-emption rights and/or amending articles if passed *Amended Articles must also be sent to Companies House if a new class of shares has been created and the Articles amended

Answer 50

* Return of allotment (Form SH01) and statement of capital within one month * If the persons with significant control have changed as a result of allotment, the relevant forms (PSC01, PSC02, PSC04, PSC07)

Answer 51

* Update register of members within two months of the allotment. * Update PSC register if necessary

Answer 52

* Share certificates must be prepared and sent to new shareholders within two months of the allotment.

Answer 53

* When issuing shares, a company needs to follow a 5-step procedure. * Step 1 – check whether there is a cap on the amount of shares that can be issued by the company. * Step 2 – check whether company directors need authority to allot the shares. * Step 3 – are the shares equity securities? You will be able to work this out by looking at the dividend and capital payout on the shares. If both are capped, the share is not an equity security and therefore pre-emption rights are not relevant. If the shares are equity securities, consider whether the company needs to disapply pre-emption rights. * Step 4 – is the company creating a new class of share? If so, the Articles will need to be amended to incorporate the new class rights. * Step 5 – Board will resolve to allot the shares. This step will always be required, regardless of the other steps. * Finally, there will be administrative matters to attend to.

Answer 54

When shares are being acquired in a company, there are statutory rules prohibiting certain companies involved in the acquisition from giving assistance for the purpose of the acquisition. Very broadly speaking, the statutory rules are relevant to public companies and private companies in groups which contain public companies.

Answer 55

An individual wishes to purchase shares in a public company but is having trouble raising finance. The company whose shares are to be purchased may consider making a loan to that individual to enable them to proceed with the share purchase. However, the directors need to be aware that the proposed loan may constitute financial assistance in accordance with CA 2006 and thus be illegal. The statutory provisions on financial assistance are derived from the doctrine of maintenance of capital and the legislation is designed to protect public companies’ assets representing share capital.

Answer 56

Acquisition or sale of shares Financial assistance is relevant when there is an acquisition (or proposed acquisition) of shares. A share sale involves an acquisition by way of a share transfer. When a share sale is contemplated, therefore, the funding arrangements should be examined carefully to see if they fall foul of the financial assistance prohibitions. Issue of shares Financial assistance is also relevant on an issue of shares by a company to an investor, since that equally amounts to an acquisition of shares by the investor.

Answer 57

Sections 678(1), 678(3), 679(1) and 679(3) CA 2006 set out the basic prohibitions on the giving of financial assistance. It is important to analyse the wording of ss 678 and 679 CA 2006 very carefully to determine which companies are caught by these prohibitions.

Answer 58

* On a share sale this will be the company which is the subject of the acquisition. * On an issue of shares this will be the company doing the issuing of the shares.

Answer 59

It is then necessary to consider whether the target company is a public company, in which case the relevant section to consider is s 678 CA 2006, or a private company, in which case the relevant section to consider is s 679 CA 2006. If the target company is a public company, under s 678(1) and (3) CA 2006 the prohibition on giving financial assistance applies to: * The target company itself; and * any subsidiary of the target company, whether private or public

Answer 60

A Ltd is selling the shares in its subsidiary B Plc. B Plc in turn has a subsidiary, C Limited. In this case the target company, B Plc, is a public company, so the prohibition on giving financial assistance would apply to both B Plc and its subsidiary, C Ltd (s 678(1) and (3) CA 2006). If the target company is a private company, under s 679(1) and (3) CA 2006 the prohibition on giving financial assistance applies to any public company subsidiary of the target company.

Answer 61

E Ltd is proposing to issue shares to an investor, Mr D. E Ltd has a subsidiary, F Plc. In this case the target company, E Ltd, is a private company, so the prohibition on giving financial assistance to Mr D as the buyer of the new shares would only apply to E Ltd’s public company subsidiary, F Plc (s 679(1) and (3) CA 2006), and not to E Ltd itself.

Answer 62

Financial assistance is very broadly defined in s 677 CA 2006. Section 677 sets out a number of different types of transaction that may amount to financial assistance: * Financial assistance given by way of gift (s 677(1)(a) CA 2006). * Financial assistance given by way of guarantee, security or indemnity, release or waiver (s 677(1)(b) CA 2006). * Financial assistance given by way of loan or similar agreement (s 677(1)(c) CA 2006).

Answer 63

* Any other financial assistance given by a company where the net assets of the company are reduced to a material extent by the giving of the financial assistance or the company has no net assets (s 677(1)(d) CA 2006). Note that the last of these provides a “catch-all” for any type of transaction not expressly listed in the preceding sub-sections, if it materially reduces a company’s net assets or if the company has no net assets. Note also that, because of the wording of s 677 CA 2006 (“financial assistance means… financial assistance given by way of…”), it is not enough that a transaction is of the type listed above – it must also actually constitute financial assistance. In other words: * assistance must be being given; and * the assistance must be financial in nature.

Answer 64

It has been held that these terms should be given their ordinary meaning, bearing in mind the commercial realities of the transaction eg actions which merely "smooth the path to the acquisition“ (such as the payment, by a subsidiary of the target, of due diligence fees incurred by the buyer) have been held to amount to financial assistance. Financial assistance is covered by the rules whether it is direct (eg a loan given to the buyer of shares) orindirect (eg a guarantee given to a bank in relation to a loan made by the bank to a buyer of shares).

Answer 65

Financial assistance is also covered by the rules whether it is given before or at the same time as the acquisition (s 678(1) and s 679(1) CA 2006), or after the acquisition (s 678(3) and s 679(3) CA 2006). Finally, to fall within the statutory provisions, the financial assistance must be being given for the purpose of the acquisition (or, if given after the acquisition, for the purpose of reducing or discharging a liability incurred for the purpose of the acquisition), ie the company giving the assistance must have intended to facilitate the acquisition.

Answer 66

Answer: A loan given by I Plc to J Ltd to enable J Ltd to fund the purchase of shares in H Ltd would amount to prohibited financial assistance under s 679(1) CA 2006 for the following reasons: * There is an acquisition of shares, in H Ltd, by way of a share sale (transfer). * The target company’s subsidiary, I Plc, is subject to the prohibition in s 679 CA 2006 since it is a public company subsidiary of a private company target. * A loan is a specified type of transaction under s 677(1)(c)(i) CA 2006. * The transaction does constitute actual financial assistance since the loan is clearly enabling J Ltd to pay for the shares and a loan is financial in nature.

Answer 67

Sections 678(2), 678(4), 679(2) and s 679(4) CA 2006 set out “purpose” exceptions in relation to ss 678(1), 678(3), 679(1) and s 679(3) CA 2006 respectively. Essentially, the purpose exception states that the giving of financial assistance will not be unlawful if the principal purpose in giving it is not for the purpose of the acquisition or if that purpose (the acquisition) is only an incidental part of some larger purpose. It should be noted however that because of its narrow application as stated in case law and because of the very serious consequences of giving unlawful financial assistance, this exemption is not normally relied upon.

Answer 68

Section 681 CA 2006 lists a number of specific types of transaction which will be exempt from the ss 678 and 679 CA 2006 prohibitions, eg dividend payments (s 681(2)(a) CA 2006).

Answer 69

Section 682lists a number of specific types of transaction which will be exempt from the ss 678 and 679CA 2006 prohibitions provided certain conditions are met. These transactions include, for example: * Money lending in the ordinary course of business (s 682(2)(a) CA 2006). * Assistance in respect of employee share schemes (s 682(2)(b) CA 2006).

Answer 70

The conditions are that (i)the company giving the assistance is a private company or (ii) the company giving the assistance is a public company and the net assets of that company are not reduced by the giving of the assistance or to the extent that they are reduced the assistance is provided out of distributable profits (s 682(1) CA 2006). It is important to note that, to fall within the s 682 CA 2006 exception, a transaction must be of a type listed in s 682(2) CA 2006 and fulfill the conditions contained in s682(1) CA 2006.

Answer 71

Under s 680 CA 2006, breach of s 678 or s 679 CA 2006 is an offence which can lead to penalties for: * the company (a fine) and * the officers of the company (fine/imprisonment). In addition to the criminal penalties, under case law the transaction amounting to prohibited financial assistance (eg the loan made to the buyer) would be void and the wider transaction (eg the share acquisition itself) may be void as well.

Answer 72

* The term "financial assistance" is extremely broad and captures many different types of assistance (see s 677 CA 2006). * The prohibitions on a company providing financial assistance for the purchase of its own shares apply only to public companies (and private companies offering assistance for the purchase of shares in a public holding company) - ss 678 - 679. * There are conditional and unconditional exceptions set out in ss 681 and 682. * There are also principal purpose and incidental part of a larger purpose defences set out in s 678(2) and (3) and s 679 (2) and (3) but these will be extremely narrowly construed by the courts. * Financial assistance is a criminal offence and the company and defaulting officers are liable to a fine and/or up to 2 years' imprisonment.

Answer 73

This element introduces the doctrine of maintenance of capital and the procedure by which a company may buy back its shares. The next element looks at the prohibitions under FSMA 2000 on giving financial advice.

Answer 74

Once a shareholder has decided to invest in shares in a company, that investment cannot normally be returned to the shareholder. In other words, a company is not usually permitted to return capital to its shareholders – all payments by a company to its shareholders should be made out of distributable profits.

Answer 75

The shareholders’ investment in a company is recorded in the accounts in the bottom half of the balance sheet. Generally speaking, a company cannot release the sums represented in the equity account and the share premium account to return value to shareholders. The money represented in these accounts may be used to carry on the business of the company as working capital but generally it cannot be returned to the shareholders while the company is a going concern. This is known as the doctrine of maintenance of share capital.

Answer 76

This is primarily for the benefit of the company’s creditors. It is a fundamental and long-established concept of company law that the share capital of a company is seen as a permanent fund available to its creditors. In practice, many private companies have only a small issued share capital, so this capital maintenance regime is of little relevance.

Answer 77

The principle of maintenance of share capital has a number of important consequences, in particular: * Dividends may only be paid out of distributable profits, not capital (s 830(1)), and * Companies generally must not purchase their own shares. However, there are some exceptions to these rules. For example: * A company may buyback its own shares (or redeem redeemable shares) provided it follows the procedures set out in CA 2006, and * A company may purchase its own shares where a court order is made for this following a successful shareholder petition for unfair prejudice. This element reviews in detail the procedure for buyback of shares. We do not consider the procedure for redemption of redeemable shares in detail.

Answer 78

There are two types of situation when a company can effectively buy its own shares: * redemption of redeemable shares; and * purchase of own shares (‘buyback’). One reason a company may wish to do this is that (in a private company) a shareholder may want to leave and cannot find a buyer for their shares. Shareholders in private companies are prohibited from offering their shares to the public.

Answer 79

In order to prevent a shareholder being locked into the company with no way to sell their shares, the company can purchase or redeem the shares if they were issued as redeemable. However, because of the principle of the maintenance of share capital, there are very strict controls on the purchase or redemption of a company’s shares. Both private and public companies may buyback their own shares or redeem redeemable shares provided they comply with the provisions of CA 2006

Answer 80

A buyback of shares takes place when a company purchases its own shares from an existing shareholder. A company may decide to purchase shares from a shareholder when there is no other buyer available. Generally, the kind of companies that you are looking at on this module will be making ‘off-market’ purchases of own shares ie the purchase of own shares will take place otherwise than on a ‘recognised investment exchange’. In this case, the company will need a contract setting out the terms of the purchase and this contract will need to be approved by the shareholders by an ordinary resolution. Where a company uses capital to fund the buyback there is a lot more regulation and procedure. In this element we look in detail at the procedure by which a company may buyback its shares.

Answer 81

There are three ways in which a company may fund a buyback of its own shares. The company may use: Distributable profits; Proceeds of a fresh issue of shares made for the purpose of financing the buyback; or Capital. However, the use of capital to fund a buyback is strictly regulated. You should note that: * The option to use capital is only available to private companies. A public company can never use capital to purchase its own shares; * Any redemption or purchase out of capital must comply with the restrictions in ss 709 - 723 CA 2006 inclusive; and * Companies must first use any money available either in the form of distributable profits or the proceeds of a fresh issue of shares to fund the purchase before using capital.

Answer 82

A company may purchase its shares out of distributable profits or the proceeds of a fresh issue of shares for the purpose of the purchase provided: The purchase of own shares is not restricted or prohibited in the company’s Articles (s 690(1)(b));The shares being purchased by the company are fully paid up (s 691(1)); andFollowing the purchase, the company must continue to have issued shares other than redeemable and treasury shares.

Answer 83

A contract to purchase own shares is required (s 694(1)); and the terms of the contract need to be approved by ordinary resolution (s 694(2)). The contract must be available for inspection at the company’s registered office for a period of 15 days before the GM and also at the GM. If a written resolution is used, a copy of the contract must be sent together with the copy of any written resolution (s 696(2)).

Answer 84

Initial steps * Check there is no limit in Articles on s 690 power to buyback shares * Prepare accounts to check there are sufficient distributable profits * Confirm shares are fully paid

Answer 85

* BR to approve the draft contract * BR to call a GM and approve form of notice / propose a WR * Contract to be made available to shareholders: - If GM: contract must be available for inspection at the company’s registered office for at least 15 days prior to and at GM - If WR: circulate contract with WR

Answer 86

* Shareholders pass OR to approve contract. * Holders of shares being bought are not eligible to vote.

Answer 87

* BR to enter into the contract * BR to appoint a director(s) to sign the contract

Answer 88

* File return, notice of cancellation & statement of capital within 28 days * Keep copy of contract for 10 years * Cancel shares, update register of members (and PSC register if applicable)

Answer 89

Remember, only private companies are permitted to fund a purchase of their own shares out of capital. The following conditions apply in addition to those set out above in relation to the buyback of shares out of profits or the proceeds of a fresh issue:

Answer 90

The purchase of own shares out of capital is not restricted or prohibited in the company’s Articles; Check that the accounts were prepared no more than three months before the directors’ statement; Check if the company has any distributable profits available. If so, those profits (or funds from a fresh issue of shares for the purpose) must be used to fund the buyback before capital can be used (s 710). A directors’ statement of solvency must be prepared together with an auditors’ report (s 714);A special resolution to approve payment out of capital must be passed within a week after the directors sign the written statement of solvency (s 716).

Answer 91

The directors’ statement of solvency must be made no earlier than one week before the GM. The statement confirms that the company is solvent and able to pay its debts as they fall due and that it will remain solvent for a period of 12 months after the buyback (s 714). The directors need to be careful when making this statement, since if the company does become insolvent and is wound up within one year, they may be required to contribute to the assets of the company and may face criminal sanctions if they had no reasonable grounds for making the statement of solvency.

Answer 92

An auditors’ report must be annexed to the written statement of solvency confirming that the auditors are not aware of anything to indicate that the directors’ opinion is not reasonable (s 714). A copy of the directors’ statement and auditors’ report must be made available to members (sent with the written resolution or available for inspection at the GM).

Answer 93

Within seven days of the passing of the special resolution approving the payment out of capital, under s 719 CA 2006 the company must give notice to its creditors by:

Answer 94

Publishing a notice in the Gazette. The notice must state: * that the company has approved a payment out of capital for the purpose of purchasing its own shares; * where the directors' statement and auditors’ report are available for inspection; and * that any creditor of the company may, at any time within the five weeks immediately following the date of the resolution, apply to the court under s 721 CA 2006 for an order preventing the payment.

Answer 95

Publishing a notice in the same form as the Gazette notice in an appropriate national newspaper, or give notice in writing to each of its creditors, andFiling copies of the directors’ statement and auditors’ report at Companies House. This is so that any interested creditor may inspect these.

Answer 96

The share purchase can take place no earlier than five weeks, and no later than seven weeks, after the date of the special resolution (s 723 CA 2006). This period cannot be reduced even if the special resolution is passed unanimously – the five week delay is designed to enable shareholders and/or creditors of the company to object to the payment out of capital by lodging an application at court for cancellation of the resolution (s 721 CA 2006).

Answer 97

The seven week longstop period is intended to ensure that the view formed by the directors in their statutory declaration as to the solvency of the company is still likely to be accurate at the time the share purchase is made. Within 28 days of the date on which the shares that are bought back are delivered to the company, the company must send a return to Companies House under s 707(1) CA 2006 and a notice of cancellation under s 708(1) CA 2006, together with a statement of capital (s 708(2) CA 2006).

Answer 98

Initial steps * Check there is no limit in Articles on s 690 power to buyback shares * Prepare accounts to check there are sufficient distributable profits * Confirm shares are fully paid Board Meeting * BR to approve the draft contract * BR to call a GM and approve form of notice / propose a WR * Contract to be made available to shareholders: - If GM: contract must be available for inspection at the company’s registered office for at least 15 days prior to and at GM - If WR: circulate contract with WR

Answer 99

GM / WR * Shareholders pass OR to approve contract. * Holders of shares being bought are not eligible to vote. Board Meeting * BR to enter into the contract * BR to appoint a director(s) to sign the contract Post meeting matters * File return, notice of cancellation & statement of capital within 28 days * Keep copy of contract for 10 years * Cancel shares, update register of members (and PSC register if applicable)

Answer 100

Remember, only private companies are permitted to fund a purchase of their own shares out of capital. The following conditions apply in addition to those set out above in relation to the buyback of shares out of profits or the proceeds of a fresh issue: The purchase of own shares out of capital is not restricted or prohibited in the company’s Articles;Check that the accounts were prepared no more than three months before the directors’ statement;Check if the company has any distributable profits available. If so, those profits (or funds from a fresh issue of shares for the purpose) must be used to fund the buyback before capital can be used (s 710). A directors’ statement of solvency must be prepared together with an auditors’ report (s 714);A special resolution to approve payment out of capital must be passed within a week after the directors sign the written statement of solvency (s 716).

Answer 101

The directors’ statement of solvency must be made no earlier than one week before the GM. The statement confirms that the company is solvent and able to pay its debts as they fall due and that it will remain solvent for a period of 12 months after the buyback (s 714). The directors need to be careful when making this statement, since if the company does become insolvent and is wound up within one year, they may be required to contribute to the assets of the company and may face criminal sanctions if they had no reasonable grounds for making the statement of solvency.

Answer 102

An auditors’ report must be annexed to the written statement of solvency confirming that the auditors are not aware of anything to indicate that the directors’ opinion is not reasonable (s 714). A copy of the directors’ statement and auditors’ report must be made available to members (sent with the written resolution or available for inspection at the GM).

Answer 103

Within seven days of the passing of the special resolution approving the payment out of capital, under s 719 CA 2006 the company must give notice to its creditors by: Publishing a notice in the Gazette. The notice must state: * that the company has approved a payment out of capital for the purpose of purchasing its own shares; * where the directors' statement and auditors’ report are available for inspection; and * that any creditor of the company may, at any time within the five weeks immediately following the date of the resolution, apply to the court under s 721 CA 2006 for an order preventing the payment.

Answer 104

Publishing a notice in the same form as the Gazette notice in an appropriate national newspaper, or give notice in writing to each of its creditors, andFiling copies of the directors’ statement and auditors’ report at Companies House. This is so that any interested creditor may inspect these.

Answer 105

The share purchase can take place no earlier than five weeks, and no later than seven weeks, after the date of the special resolution (s 723 CA 2006). This period cannot be reduced even if the special resolution is passed unanimously – the five week delay is designed to enable shareholders and/or creditors of the company to object to the payment out of capital by lodging an application at court for cancellation of the resolution (s 721 CA 2006).

Answer 106

The seven week longstop period is intended to ensure that the view formed by the directors in their statutory declaration as to the solvency of the company is still likely to be accurate at the time the share purchase is made. Within 28 days of the date on which the shares that are bought back are delivered to the company, the company must send a return to Companies House under s 707(1) CA 2006 and a notice of cancellation under s 708(1) CA 2006, together with a statement of capital (s 708(2) CA 2006).

Answer 107

Initial steps * Check there is no limit in Articles on s 690 power to buyback shares or s 709 power to use capital to fund the buyback * No earlier than three months before the directors prepare the statement of solvency, prepare accounts to ascertain available profits * Confirm shares are fully paid

Answer 108

* BR to approve the directors’ statement of solvency (‘DSS’) and the auditors’ report (‘AR’) * BR to approve the draft contract * BR to call a GM and approve form of notice / propose a WR * Contract to be made available to shareholders: - If GM: contract must be available for inspection at company’s registered office for at least 15 days prior to and at GM - If WR: circulate contract with WR * DSS and AR must be signed no earlier than one week before the GM or the passing of the WR

Answer 109

WR * Circulate WR with contract, DSS and AR. * SR to approve payment out of capital and OR to approve contract. * Holders of shares being bought back are not eligible to vote.

Answer 110

ALTERNATIVELY GM * Shareholders pass OR to approve contract. * Shareholders pass SR to approve payment out of capital. * Holders of shares being bought are not eligible to vote. * Contract, DSS and AR must be available at the meeting.

Answer 111

Following GM / WR * Within 7 days: place notices in Gazette and national newspaper and file DSS and AR at Companies House. * Within 15 days: file SR at Companies House. * For five weeks after date of SR: creditors and shareholders have right to object. Copies of DSS and AR must be available for inspection at company’s registered office.

Answer 112

Board Meeting * BR to enter into the contract. * BR to appoint a director(s) to sign the contract. * Payment out of capital must take place between 5-7 weeks after SR passed.

Answer 113

Post meeting matters * File return, notice of cancellation & statement of capital within 28 days. * Keep copy of contract for 10 years. * Cancel shares, update register of members (and PSC register if applicable).

Answer 114

* Check Articles for any prohibition on buyback * Verify distributable profits * Terms of buyback must be set out in a contract - must be available for inspection at least 15 days before GM and at GM itself (or circulated with written resolution) * Shareholders must approve the contract by OR

Answer 115

* Check Articles for any prohibition on buyback and on use of capital * Terms of buyback must be set out in a contract (day display/send out with WR) * DSS and AR; accounts (<3 mths old) * Shareholders must approve the contract by OR * Shareholders must approve the payment out of capital by SR * Detailed notification requirements for creditors

Answer 116

Redeemable shares are shares which are issued as redeemable shares. Redeemable shares effectively give the holder temporary membership in the company. They are issued to be redeemed on the occurrence of certain circumstances (for example by providing for redemption on a fixed date and at a fixed price) or may be redeemed at the option of the issuing company or the shareholder. All details of the redemption, including date of redemption and the price to be paid at that date, will either be in the Articles or determined by the directors. As a result, a contract is not required to redeem shares, irrespective of the source of funding used. This is because the terms of the redemption have already been set out in the company’s Articles (or determined by the directors) prior to the shares being allotted. Where a company uses capital to fund the redemption there is a lot more regulation and procedure. The procedure is very similar to the buyback of shares out of capital.

Answer 117

* It is a fundamental and long-established concept of company law that the share capital of a company is seen as a permanent fund available to its creditors. * However, companies may buyback their own shares (or redeem redeemable shares) provided they meet the conditions in CA 2006. * A buyback of shares may be funded out of distributable profits, the proceeds of a fresh issue of shares or (for private companies only and only to the extent that there are no profits / proceeds of a fresh issue available), out of capital.

Answer 118

* Where a buyback is funded out of profits / proceeds of a fresh issue, a contract is required which must be approved by an OR of the shareholders. * Where capital is used there are further procedural requirements: a DSS and an AR are required, a SR is needed to approve payment out of capital and there are detailed requirements to notify creditors. The buyback must take place within five to seven weeks following the passing of the SR.

Answer 119

This element will give you an overview of how the conduct of financial services is regulated in the UK and how the regulatory framework applies, with particular reference to work done by solicitors in the corporate sector. It is essential that you, as a solicitor, are aware of the scope of financial services regulation in the UK.

Answer 120

There is a huge variety of investments available in the market today. The term ‘investment’ can be used to refer to a wide variety of products including bank deposits, pensions, endowment policies, shares, unit trusts, bonds and many others. For your purposes, the term ‘financial services’ refers (in the most part) to services such as: * advising on investment products on behalf of clients * dealing in investment products on behalf of clients * arranging investment products on behalf of clients

Answer 121

When an individual decides to invest money in an investment, they have a number of difficult decisions to make. For example: * What type of investment should they invest in? * What level of risk are they willing to take (as one type of investment may be riskier than another)? * What is the return from the investment – does the investor want regular income payments or do they want the long-term capital value of the underlying investment to increase? * Are there tax advantages to be gained from investing in one type of investment or another? As there are so many different products available on the market, individuals increasingly look to professional advisers to help them decide which investment to make.

Answer 122

The provision of financial services is heavily regulated in the UK to ensure that those providing such services are approved and authorised and that consumers are adequately protected from negligent advisers.

Answer 123

The key statute governing the provision of financial services is the Financial Services and Markets Act 2000 (‘FSMA’) together with several statutory instruments, one of which is the Financial Services and Markets 2000 (Regulated Activities) Order 2001 (SI 2001/544), as amended, is known as the Regulated Activities Order (‘RAO’) and establishes the activities to be regulated by FSMA if they are carried on in the UK by an entity by way of business.

Answer 124

FSMA and the statutory instruments arising out of FSMA are important not just from the perspective of a solicitor having to ensure that in the course of their practice the solicitor does not commit an offence, but also in terms of being aware of the statutory constraints which might be placed on a client in terms of the deal being proposed.

Answer 125

There are two regulators: the Prudential Regulation Authority (‘PRA’) and the Financial Conduct Authority (‘FCA’). Few law firms have obtained direct FCA authorisation because the stringent level of regulation imposed by the FCA, coupled with the relatively small proportion of work for clients which would require direct FCA authorisation, compared to a firm’s overall workload, means it is not cost efficient.

Answer 126

s 19(1) FSMA states: "No person may carry on a regulated activity in the United Kingdom…unless he is – (a) an authorised person; or (b) an exempt person." It is a criminal offence to breach s 19(1) FSMA. In order to avoid criminal liability a solicitor must always assess whether or not the activity they are proposing to carry out for a client is governed by s 19(1) FSMA.

Answer 127

s 22(1) FSMA states: "An activity is a regulated activity for the purposes of this Act if it is an activity of a specified kind which is carried on by way of business and…relates to an investment of a specified kind; …" ie Regulated Activity = Specified Investment + Specified Activity

Answer 128

1) Is the investment ‘specified’ under FSMA? (see Part III RAO)? If yes 2) Is the activity a ‘specified activity’ under FSMA? (See Part II RAO) If yes 3) Is the activity excluded under FSMA? (See Part II RAO)? If no 4) Does the activity fulfil the basic conditions in s. 327 of FSMA and SRA Scope Rule 2? If yes, exemption is possible; if no, authorisation is required.

Answer 129

The first thing a solicitor must therefore decide is whether they (or the client) are carrying out an activity in relation to a ‘specified investment’. The term ‘specified investment’ is not defined within FSMA itself. The list of specified investments is to be found in in Part III of the RAO. The investments which are regulated are specified in Part III of the RAO and include: * shares (Article 76) * instruments creating or acknowledging indebtedness (Article 77) including bonds (for example an interest-bearing debt instrument issued by a company) and certain other instruments where the investor is lending money to a third party. * **regulated mortgage contracts (Article 88)**as defined in in Article 61(3) RAO. These are the specified investments that you will focus on in this module.

Answer 130

A person will not require authorisation however, unless they are carrying out a ‘specified activity’ by way of business in relation to the ‘specified investment’. Part II of the RAO lists the specified activities. Activities listed include: * dealing in investments as principal (Article 14) or as agent (Article 21). This includes buying, selling, subscribing for or underwriting securities or contractually based investments. * arranging deals in investments (Article 25); * managing investments (Article 37) (ie exercising discretion in relation to investments which are securities or contractually based investments); and * advising on [the merits of] investments (Article 53(1)). Again, these are the most likely specified activities that arise for a corporate lawyer, especially advising on the merits of investments.

Answer 131

Often corporate solicitors will be giving advice; after all, a solicitor’s job is to advise. Giving generic advice (eg how to invest in China, as opposed to Europe) is not a specified activity, nor, generally, is giving information as opposed to advice, although the context may affect the character of the information. Only advice which is given to someone who holds or is a prospective investor in a security or relevant instrument relating to the merits of buying, selling, subscribing for, exchanging, redeeming, holding or underwriting such investments will fall within Article 53(1). To be caught, the advice requires an element of opinion on the part of the solicitor and a recommendation as to a course of action.

Answer 132

A solicitor giving generic advice relating to investments (for example, explaining the legal rights attaching to two different classes of shares) will not require FCA authorisation. However, the advice would be regulated if the solicitor recommended to their client to purchase ABC plc shares, or to take out an endowment mortgage with XYZ Building Society.

Answer 133

Excluded activities can be carried on without the need for further authorisation. Specific Exclusions Each specified activity in the RAO has a Chapter devoted to it and any exclusions which are specific to that specified activity are included in the relevant Chapter. Eg For example, Chapter V of the RAO covers ‘Dealing in Investments as Agent’. Article 21 sets out what it means to be ‘dealing in investments as agent’ and Article 22 contains the exclusion of ‘deals with or through authorised persons’, ie such activity can usually be referred to an authorised person

Answer 134

Some exclusions apply to more than one activity.In the context of the corporate lawyer, two of these may assist you. * Regulated activities that are a necessary part of other services carried on in the course of a profession or non-investment business (Article 67 RAO) * Regulated activities in connection with the sale of a body corporate (Article 70 RAO) Regulated activities that are a necessary part of other services carried on in the course of a profession or non-investment business (Article 67 RAO)

Answer 135

Among other things, a solicitor will generally not be ‘dealing as an agent’ (Art 21 RAO) or ‘arranging deals’ (Art 25 RAO) or ‘advising [on the merits]’ (Art 53(1) RAO) in relation to investments for the purposes of FSMA and therefore will not be carrying on a specified activity, provided that these activities are: * carried on in the course of carrying on any profession or business which does not otherwise consist of the carrying on of regulated activities in the UK; and * the activities can reasonably be regarded as a necessary part of other services provided in the course of that profession or business.

Answer 136

This exclusion will not apply if the specified activity is remunerated separately from the other services. What constitutes a ‘necessary part’ of other services is not specified in the RAO. The FCA’s view is that it must not be possible for the other services to be provided unless the dealing / arranging / advising is also provided. Example: when a client is selling a leasehold flat, the transaction might also involve the transfer of a share in a management company or the company that owns the freehold for the block of flats. Although shares are specified investments, arranging their sale would be a necessary part of the other property work the solicitor is carrying out.

Answer 137

A solicitor will not be ‘dealing as principal’ (Art 14 RAO), ‘dealing as an agent’ (Art 21 RAO), ‘arranging’ (Art 25 RAO) or ‘advising [on the merits]’ (Art 53(1) RAO) if such activity is carried out in connection with the purchase or sale of shares in a company (if the transaction to buy or sell the shares is entered into for the purposes of buying or selling the shares), PROVIDED THAT: the shares consist of or include 50% or more of the voting shares in the company AND the acquisition or disposal is between parties each of whom is a body corporate, partnership, single individual or a group of connected individuals; orthe shares, together with any shares already held by the purchaser, consist of or include 50% or more of the voting shares in the company AND the acquisition or disposal is between parties each of whom is a body corporate, partnership, single individual or a group of connected individuals; orthe object of the transaction may reasonably be regarded as being the acquisition of day-to-day control of the affairs of the body corporate. Note: the two entities do not each have to have the same legal status to fall within paragraphs i) or ii) eg a company can sell its shares to an LLP; a company can sell its shares to an individual and still fall within i) or ii) above.

Answer 138

If a solicitor’s work involves carrying out a ‘regulated activity’ (i.e. a ‘specified activity’ in relation to a ‘specified investment’) and the activity is not excluded from regulation under FSMA by the RAO, the statutory regime set down by FSMA will apply. The solicitor will either need to be: * Directly authorised – iewhere the firm is authorised by the FCA directly; or * Supervised by a Designated Professional Body - The Law Society is a law firm’s ‘DPB’ but responsibility for regulation rests with the SRA as the profession’s independent regulator. To rely on this exemption, s 327 FSMA must be satisfied and the firm must comply with the SRA Scope Rules.

Answer 139

Under FSMA, the Law Society, as a DPB, is required to make rules governing the carrying on of regulated activities by firms of solicitors. FSMA enables firms authorised and regulated by the SRA to carry on exempt regulated activities provided the firms can comply with the SRA Financial Services (Scope) Rules 2019 (the ‘Scope Rules’). The Scope Rules set out the scope of the regulated financial services activities that may be undertaken by firms authorised by the SRA (but not the FCA).

Answer 140

In order for the regulated activities to be exempt regulated activities all the conditions set out in s 327(2) – (7) FSMA must be satisfied. The key conditions we focus on in in this module are: the person carrying on the regulated activities must be a member of a profession (such as practising as a solicitor – see s 325(2) FSMA); that person must not receive a commission from a third party in respect of the regulated activities, unless he accounts to his client for the commission; The SRA guidance states that you must hold the commission to the client’s order and may only keep it if the client gives you informed consent to do so. the specified activity must be provided in a way that is incidental to the provision of professional services (see the next slide); and the person must only carry out regulated activities which he is permitted to carry out as a result of s 332(3) FSMA (i.e. he has to comply with the rules set by his relevant designated professional body - for the SRA, the Scope Rules).

Answer 141

The FCA considers that to satisfy the incidental requirement, the regulated activities cannot be a major part of the practice of the firm. The FCA also considers the following factors are relevant: * what is the scale of the activity in proportion to the other professional services provided by the firm? * to what extent are these services held out by the firm to be separate services to the other professional (legal) services it offers to clients? * what impression does the firm give of how it provides regulated activities e.g. through its advertising or other promotion of its services? In the FCA’s opinion, the firm will not be providing incidental regulated activities if they amount to a separate business conducted in isolation from the provision of the professional services provided by the firm. However, the FCA has confirmed this does not stop the firm from operating its business in a way which involves separate departments, one of which handles the regulated activities.

Answer 142

In the FCA’s opinion, the firm will not be providing incidental regulated activities if they amount to a separate business conducted in isolation from the provision of the professional services provided by the firm. However, the FCA has confirmed this does not stop the firm from operating its business in a way which involves separate departments, one of which handles the regulated activities.

Answer 143

To work out whether or not the activity in question is incidental you need to look at the overall work the firm does - is the specified activity the solicitor is being asked to do a small part of what the firm does for clients overall? If so, it will be incidental.

Answer 144

The further condition contained in Scope Rule 2 of the Scope Rules is that a firm must ensure that: the activity arises out of OR is complementary to the provision of a particular professional service to a particular client (Scope Rule 2.1(b)). To work out whether or not the activity arises out of the (non-regulated) work the solicitor is doing for the client you need to ask what has happened to prompt the activity in question. If, for example, you are acting for a client on the sale of a company and the client asks for advice as to how best to invest in a personal pension, the advice would not arise out of the work being done for the client because it is completely unrelated to the non-regulated work. To work out whether or not the activity is complementary you need to ask yourself if the specified activity arises naturally out of the work the solicitor is doing for the client - if it does not then the work is not complementary. Eg giving legal or tax advice, drafting documents to effect the sale of shares or other (specified) investments.

Answer 145

Can you satisfy all the requirements under s 327 FSMA AND Scope Rule 2? IF YES: the activity is an exempt regulated activity. In order to be able to carry out an exempt regulated activity, the law firm must 1) ensure it complies with the Scope Rules; and2) be authorised by the SRA in relation to this activity_and_ must comply with any relevant SRA Financial Services (Conduct of Business) Rules 2019. IF NO: The firm must be authorised by the PRA or FCA and must comply with the PRA or FCA Handbook in relation to this activity OR refuse to carry out the activity. If the firm is not PRA or FCA authorised, and carries out the activity, the person carrying out the activity is likely to have breached s 19(1) FSMA which is a criminal offence.

Answer 146

* Financial services are heavily regulated in the UK to protect consumers from negligent advice. * There is a General Prohibition under s 19 FSMA from Solicitors carrying out Regulated Activities. * Regulated Activities means you are carrying out ‘specified activities’ (eg advising on the merits) in relation to ‘specified investments’ (eg shares). * If you are carrying out a Regulated Activity, you need to check if there are any specific or general exclusions. * If there are no exclusions, you need to satisfy s 327 FSMA and Scope Rule 2. * If you can satisfy s 327 FSMA and Scope Rule 2, you are carrying out an exempt activity. If not, you need to be regulated or refrain from carrying out the activity. * There are criminal sanctions for breaching the s 19 FSMA General Prohibition.

Chapter 5: Equity Finance Flashcards

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