Marketing to professional investors – the Court of Final Appeal's verdict
In Securities and Futures Commission v Pacific Sun Advisors Ltd, the Hong Kong Court of Final Appeal recently ruled that the advertisement of a collective investment scheme intended to be disposed of only to professional investors ...
…was exempt from the Securities and Futures Commission (SFC) authorisation requirement under the Securities and Futures Ordinance (Chapter 571), even though it was not apparent from the advertisement itself that the scheme was confined to professional investors at the exclusion of the general public.
Section 103(1) of the Securities and Futures Ordinance requires any advertisement, invitation or document containing an invitation to the public to acquire securities or interest in a collective investment scheme to be authorised by the SFC unless it falls within the ambit of a statutory exemption, including the exemption under Section 103(3)(k) which exempts securities that are or are intended to be disposed of only to professional investors (the 'PI exemption').
In 2011, Pacific Sun Advisors Limited (on the instruction of its chief executive officer, Andrew Pieter Mantel) circulated an email to promote the launch of a collective investment scheme to all potential investors maintained in Pacific Sun's database, as well as entities on Pacific Sun's 'general list' (ie, those which have professional dealings with Pacific Sun, including brokers, auditors, accountants and officers of the SFC).
Pacific Sun's corporate website also published documents relating to the fund, including a press release, a fact sheet and a PowerPoint presentation containing a large amount of information concerning the fund.
The release of the email and the fund documents had not been approved or authorised by the SFC. The SFC therefore commenced criminal proceedings against Pacific Sun and Mantel on four counts of issuing advertisements to promote a collective investment scheme without the authorisation of the SFC in contravention of Section 103(1).
The SFC submitted that the PI exemption was inapplicable because the advertisement failed to state expressly that the investment product was or was intended to be disposed of only to professional investors.
Decision of the lower courts
The SFC subsequently sought clarification from the Court of First Instance regarding the application of the PI exemption.
The Court of First Instance concluded that the SFC has a duty to protect retail investors in relation to the marketing of risky investment products. As such, the SFC must be able to see from the advertisement or invitation itself that the terms of the offer are limited to professional investors to the exclusion of the public. The screening process which Pacific Sun and Mantel claimed would have ensured that all investors in the fund were professional investors was, from the perspective of the Court of First Instance, irrelevant to its determination.
It was important to the Court of First Instance that retail investors are protected against having their time wasted in pursuing an interest in investing only to be subsequently told that they are not eligible to do so. The Court of First Instance therefore concluded that the Securities and Futures Ordinance prohibits "offers" to the public, not simply "investments" by the public.
On this basis, the Court of First Instance allowed the appeal and the case was remitted back to the magistrate for reconsideration. Pacific Sun and Mantel were ultimately convicted of the charges made against them. Pacific Sun was fined $20,000 and Mantel was sentenced to four weeks' imprisonment, suspended for 12 months.
Pacific Sun and Mantel appealed to the Court of First Instance against their conviction. They also appealed to the Court of Final Appeal in relation to the Court of First Instance's interpretation of the PI exemption.
The Court of Final Appeal scrutinised the ambit of the PI exemption and considered the following key issues in the appeal:
- whether for the PI exemption to be applicable, it must be seen from the advertisement or invitation itself that it is, by its terms, confined to professional investors to the exclusion of other members of the investing public; and
- what the entity issuing the advertisement or invitation must show in order to establish the application of the PI exemption.
Decision of the Court of Final Appeal
The Court of Final Appeal overturned the decision of the Court of First Instance in relation to the interpretation of the PI exemption.
The Court of Final Appeal accepted Pacific Sun's and Mantel's argument that the PI exemption applies even if the intention to dispose of the securities or interests in the collective investment scheme only to professional investors is not expressed in the advertisement or invitation. This finding was based on the following grounds:
- There is no express requirement under Section 103(3)(k) of the Securities and Futures Ordinance that an express statement be made to the effect that the collective investment scheme is intended to be disposed of only to professional investors. The Court of Final Appeal took the view that if it was intended that an advertisement must contain a particular express statement in order for the PI exemption to apply, the legislature would have clearly and expressly stated this and identified the substance of the particular form of words to be used.
- Retail investors will be protected against exposure to an unsuitable investment product so long as the issuer of the advertisement or invitation can demonstrate that the relevant investment is in fact intended solely for professional investors.
Despite the above, the Court of Final Appeal made it abundantly clear in the ruling that:
- the burden of establishing the PI exemption lies strictly with the issuer of the advertisement or invitation; and
- the presence of express wording in the advertisement or invitation might go towards satisfying the burden of establishing the application of the PI exemption.
The Court of Final Appeal ruling means that if an issuer intends to sell a collective investment scheme that is unsuitable for retail investors to professional investors only, the corresponding advertisement can nevertheless be issued to the general public without SFC authorisation. The determination over the application of the PI exemption therefore turns upon whether the collective investment scheme is indeed intended to be disposed of to professional investors only.
However, significant caution should still be exercised by issuers of such advertisements seeking to rely on the PI exemption in ensuring that only persons who are professional investors are permitted to subscribe to the collective investment scheme. To avoid unnecessary compliance risks, it would be prudent for entities seeking to rely on the PI exemption to state explicitly on the face of each and every advertisement, invitation or document containing an invitation that the terms of the offer are limited to professional investors.
In the aftermath of the Court of Final Appeal decision, the SFC expressed that it would consider whether Section 103 of the Securities and Futures Ordinance needs to be amended to provide additional protection to retail investors.
 The term 'professional investors' is defined at length in the Securities and Futures Ordinance Schedule 1 Part 1 Section 1.