Regulator Takes Strict Approach

Managers seeking to rely on reverse solicitation by EU investors should take note of last year’s enforcement action by the French regulator. The enforcement action, while confirming that reverse solicitation remains valid in the right circumstances, focused on the need for a specific request from the prospective investor and demonstrated the regulator’s willingness to look to the substance, rather than the form, of the communications leading up to the investment.

Summary

Auvergne, a French distributor, claimed to have reverse solicited investors for its German fund manager client. The French regulator disagreed, finding that the distributor had unlawfully marketed the funds. The regulator fined Auvergne and also fined its chairman, on the basis that he was personally liable for its failings, banning him from acting as an investment adviser for five years.

Background

Marketing funds into the EU is governed by the Alternative Investment Fund Managers Directive (AIFMD). EU funds with EU managers benefit from a pan-EU marketing passport, enabling access to professional investors across the EU, once the fund is registered for marketing, but non-EU funds have to rely on each country’s individual National Private Placement Regime. Some countries have effectively shut the door to active marketing of non-EU funds (e.g. France, Italy). However, where the approach is at the initiative of the investor (“reverse solicitation”), these restrictions do not apply. The facts here were a little unusual in that the fund was based in the EU but had not been registered for marketing and was sold to non-professional investors which requires additional authorisation in France.

Decision

Four elements prevented the distributor from relying on reverse solicitation:

• While the investors had in some cases written reverse solicitation letters, the regulator concluded that these were identical to a template provided to the distributor by the underlying fund manager and therefore did not have the required “spontaneous, unpredictable” nature required.
• Crucially, the letters indicated a general interest in the manager’s products but did not refer to a specific investment fund.
• Similarly, where the distributor gave presentations about the manager without mentioning funds, it would if requested by a potential investor follow-up with a presentation covering the whole suite of the manager’s investment products. Again, there was no specific request relating to a named fund.
• The terms of the distribution agreement with the manager, by which the distributor was engaged to supply potential investors for the manager’s funds, contradicted the claimed reverse solicitation.

Takeaways

• Substance over Form: In line with last year’s statement from ESMA (the European Securities and Markets Authority), the existence of a reverse solicitation letter (or contractual clause or disclaimer to that effect) is not a “get out of jail free” card if it contradicts the underlying facts.
• “Be specific”: Investors must request information about a specific fund or product. General interest in the manager or its products is insufficient.
• Reverse Solicitation remains valid in the right circumstances: The regulator found that one investor, whose family company had already invested in a fund and who wrote requesting to invest in that named fund, had made a valid reverse solicitation and no active marketing had taken place. This is an important finding (although last year’s introduction of the cross-border distribution rules in the EU means that in future, reverse solicitation may effectively be barred in an EU state for 18 months following any pre-marketing in that jurisdiction).
• Managers can meet investors to discuss the market; their track records and related activities without closing the door to reverse solicitation: The regulator accepts that a fund manager may participate in conferences or investor meetings to discuss the market, the activities of the manager and its track record, where such events are restricted to professional investors, so long as there is no solicitation to invest in, or communication about, a fund which is open for investment. It follows that reverse solicitation could be available for professional investors who are already invested in an existing, closed, fund managed by the manager as they might naturally enquire as to the specific successor fund as part of their ongoing relationship.
• Unclear why regulator investigated: It isn’t clear why the regulator commenced investigating: there is just a statement that, in 2019, it decided to monitor the distributor’s compliance with its professional investigations.

Sanctions Available

• The regulator has substantial powers to impose fines and other sanctions, up to a maximum financial penalty of €100 million for businesses (or $15 million for individuals) or ten times the benefit derived. Factors to be taken into account include any losses suffered by the investors. Here, the distributor claimed that no investor had complained. The investors subscribed a little under €14 million into the underlying funds, and the distributor received a commission of approximately €375,000. In addition to the breaches of the marketing rules, the distributor was also found to have failed in certain anti-money laundering obligations and the regulator was unimpressed by the distributor’s claim to have co-operated, finding it was no more than would be expected of a regulated business.

The Punishment

• The regulator fined the distributor €150,000. It also found that the chairman of the business was personally liable for its failings and fined him €50,000 personally, and banned him from acting as an investment adviser for five years. The regulator did not allocate the punishment between the different failings. The distributor disputed the findings of the regulator and has the option of appealing the decision.