AANZ Update for Investors about FMCA Compliance
AANZ Advice on FMCA Compliance
Late last year the Financial Markets Conduct Act 2013 (the FMCA) came into force and brought with it a new regime for regulation of the capital markets. The “bright line” definition of an eligible person (net assets of at least $2m or gross annual income of $200,000 for the previous two years) was abandoned.
Rather than tick-box compliance, this new regime approaches compliance through the lens of what is appropriate in light of the FMCA’s purpose and acting professionally. The focus is on promoting fair, efficient and transparent markets, which means more useable disclosure documents for investors, but also appropriate exclusions so that regulatory burdens are more proportionate to the risk of potential harms being addressed.
It’s not practical or economic for early stage companies to comply with the disclosure requirements of the FMCA when raising capital so they therefore look to rely on the FMCA exclusion regime. These are generally referred to as “Schedule 1 Exemptions”.
A clear understanding of the application of these exclusions by early stage companies, their investors and advisers is therefore an important component of the vigour and health of the early stage ecosystem.
The FMA has a set of useful FAQs, which can be found here.
The FMCA specifies three broad categories of exclusion:
- wholesale investors;
- close relationships; and
- exclusions based on the nature of the offer.
Within these three categories there are two key exemptions applicable to angel investors. Satisfying the conditions of these exemptions minimises the risk of action by a disgruntled founder or fellow investor.
Angel investors fit most neatly as either meeting:
- “eligible investor” criteria under the ‘wholesale investor’ exemptions, or
- the requirements of the “small offers” regime under the ‘certain offers as a whole’ exemptions.
In our recent discussions with the FMA two additional issues have been clarified with respect to small offers:
- the implications of investors using a nominee structure; and
- the implication for angel deals of the advertising strictures under the FMCA.
There are a range of categories of wholesale investor but the one most angels will rely on is the “eligible investor”. Eligible investors may self-certify but a third party must verify the self-certification; either a lawyer, chartered accountant or authorised financial advisor.
An “eligible investor” is defined, in summary, as having “previous experience in dealing with financial products such that they can assess the risks, information needs and adequacy of the information provided.”
There was some initial concern that verifiers of eligible investor certificates would be unwilling to do so because they were left exposed due to the subjectivity implicit in making this assessment and the risk that the previous experience could be found to be insufficient.
The FMA has subsequently provided a substantial degree of comfort for certifiers and offerors.
The FMA advised that the certifier need only:
ensure that the person self-certifying has been sufficiently advised as to the consequences of being certified; and
assess whether, factually, the “relevant experience” cited has actually occurred (i.e. they do not need to provide a value judgment as to whether or not the experience cited is, in fact “relevant” experience).
By way of example, if a person, wishing to make an investment in a start up company, cites previous experience in trading listed stocks, a third party lawyer, counter signing the certificate can be comfortable in doing so as long as:
they are comfortable that the investor has been sufficiently advised as to the consequences of giving the certificate; and
they have no reason to believe that the stock trading never actually occurred (i.e. he/she does not need to consider whether or not the experience in listed stocks was actually “relevant”).
In summing up, unless there is reason to believe that the actual facts stated in the certificate are incorrect or the certificate does not include statements that it is required to include, the offeror will be able to rely on an eligible investor certificate and no action could be brought against the independent advisor on the basis that their only role is to advise the relevant person as to the consequences of self-certifying as an eligible investor.
We have been assured there is no need to certify angels on a deal by deal basis. This is certainly the case if they fall under any of the “wholesale” investor definitions. As long as wholesale investors are certified every two years and the certificate relates to the class of financial products (in most instances for angels this means acquiring equity securities or making loans convertible into equity securities) this is sufficient.
The small offers exemption (often referred to as an SOE) is a personal offer of equity or debt securities:
where no more than 20 people are issued or sold the financial products;
in any 12 month period; and
where no more than $2m is raised in the same time period.
A personal offer is one made to, and that may only be accepted by, a person who is likely to be interested in the offer having regard to:
previous contact or a professional or other connection between the offeror and the person;
statements or actions made by the person indicating that they might be interested in such offers (such as the person’s membership of an Angel network); and
An offer will also be a personal offer if it is made in the same manner to a person who has had an annual gross income of more than $200,000 per annum over the past two years.
It is also important for an angel backed company to be aware there is an obligation on them to notify the FMA within a month of the relevant accounting period that they have made a small offer. In clarifying the extent of this obligation the FMA made it clear the issuer need only report once a year on a very simple basis:
the name of company seeking investment,
note the type of securities offered,
the date of distribution of the document containing the key terms,
the number of investors (no names required); and
the amount raised.
The ‘personal offer’ nature of this exclusion has a fairly high degree of subjectivity. It is therefore important, particularly in an angel network context that any investment event is clearly introduced with the disclaimer that the offers made at the event are “personal” and do not “constitutea regulated offer of financial products i.e. an offer to the wider public”. Investors will not be able to take up any offer unless they clearly meet the criteria of FMCA Schedule 1 exemptions.
It is also important to be aware that relying on this exclusion requires the company raising funds to be very careful that ONLY those people who fit into one of the personal offer categories receive the offer. Advertising has a wide meaning under the FMCA as essentially “any communication promoting an investment offer, or intended offer, to a section of the public”.
Advertising when wholesale and ‘small offers’ investors are involved
Issues arise when a company is pitching to both wholesale investors and those who seek to invest under the ‘small offers’ criteria. The FMA’s guidance is that the company must take “all reasonable steps” to ensure any advertisement about the small offer is not received by any investors that don’t meet the ‘personal offer’ requirements.
So a company may advertise a contemporaneous wholesale offer as long as in that advertisement it is clear the ‘wholesale offer’ may only be accepted by people meeting the requirements of a wholesale investor.
It is of course common for angel investor networks to notify their existing members about new offers, and those members may then pass on information to others. For contemporaneous ‘small’ and ‘wholesale’ offers the company should ensure that any communication to the angel investor network makes it clear that there are two offers and that only the wholesale offer communication is able to be passed on to other wholesale investors.
The FMA have made it clear that they are very happy to be approached if anyone has concerns about advertising. The first port of call is [email protected] to raise these concerns.
Nominee structure and the Small Offers Exclusion
A number of angel networks operate nominee companies. These entities hold the shares of their members who invest in any individual angel deal. The nominee in most of these instances operates as a bare trustee holding the shares for the individual angel. The nominee structure minimizes the number of shareholders on the capitalization table.
In our discussions with the FMA we have been assured that the nominee structure does not limit the usefulness of the small offers exemption.
We explored a number of different factual scenarios with the FMA that lead to different assessments of how the FMCA applies, but in general, to reiterate the point just made, we were advised that the small offers exclusion does not prevent investors investing through a nominee company.
Where investors are relying on the ‘small offers’ exemption, the 20-investor limit applies to the number of persons to whom financial products are issued or sold. Where a nominee company holds shares on bare trust for an underlying investor, the effect of the FMCA is that the underlying investor is still receiving an equity security therefore the underlying investors count in the 20-investor limit, because they are still being sold financial products.
The impact of the advice we have received is that it is necessary for AANZ members to keep clear records, on a deal by deal basis of the relevant exemption under which individuals are investing. The more members categorized as ‘wholesale investors’ the easier this aspect of network administration will be.
In an ideal world, all this would be more straightforward and we would have unequivocal advice that the way we are operating is legally robust and all participants are safe. There is no such thing as an ideal world! The AANZ is nevertheless satisfied the FMA has a high level of understanding about how we operate and even more fundamentally about our intention to do so in good faith within the confines of the Act.