DECEMBER 2005
BACKGROUND - POSSIBLE CUSTODIAL SENTENCE
FOR UNLAWFUL CONDUCT OF FSA-REGULATED
ACTIVITIES
In the United Kingdom, the Financial Services
Authority (“FSA”) has delivered a wake-up call to anyone in the betting and gaming industry who believes that they do not need to concern themselves with FSA regulation.
By pursuing a recent case against a betting scheme, the FSA has highlighted the fact that the managers of some betting schemes may need to be FSA authorized.
The key issue in Financial Services Authority v.
Fradley & Woodward [2005], EWCA Civ. 1183 was whether the managers of a betting scheme had been operating a collective investment scheme, as defined in section 235 of the Financial Services and Markets
Act of 2000, without the required authorization from the FSA.
Failure to be FSA authorized when required is a criminal offense carrying a possible tariff of up to two years in prison and leaves scheme operators liable to compensate anyone who has lost money as a result of the unlawful scheme. It is, therefore, vital to be able to identify the key features of a collective investment scheme.
WHAT IS A COLLECTIVE INVESTMENT SCHEME?
Generally, a collective investment scheme is an arrangement under which at least some of the people who are involved hand over their money or property, and relinquish day-to-day control of it, to some other person or persons who pool the contributions, seek to make a profit out of them and subsequently distribute profits to the contributors.
Typically, a collective investment scheme might be structured as a unit trust or fund of some sort, but this is not always the case. Any pooling of any kind of assets involving the owners of those assets giving up day-to-day control of them can be a collective investment scheme. Clearly this could apply to a number of arrangements that might be made in the betting and gaming industry—for example race horse syndicates.
There are various exemptions which will sometimes be relevant—such as for certain companies whose shares are not redeemable. Some informal schemes may be exempted because the legislation only regulates schemes carried on “by way of business.”
FSA V. FRADLEY & WOODWARD - THE FACTS
The FSA's case against Mr. Fradley and Mr.
Woodward was, broadly, that they were jointly operating a collective investment scheme without
FSA approval by jointly providing a betting service which involved collecting money from the public and selecting and placing bets on their behalf on horse races.
The betting service was advertised by way of unsolicited mailings to members of the public inviting participation in a scheme to make money on horse race betting by using information not generally available to the public.
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The scheme was characterized as “investing in horse racing,” although nothing turned on this description.
Investors in the scheme would provide a minimum sum of £500 (~$877) and were told that they stood a realistic chance of increasing their money by a factor of 10 each year. There was a membership charge.
The mailings included an application form for membership of 147 Racing Limited, of which Mr
Woodward was a director, and a form appointing Mr
Fradley (trading under the name "Top Bet Placement
Services") as the member's agent. 147 Racing
Limited provided the tips and sent the marketing mailings, and Mr Fradley placed the bets. For part of the time during which this scheme operated,
"investors" were offered an automated service under which use of Mr Fradley's services by 147 Racing
Limited on behalf of members was mandatory.
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A single collective investment scheme can have two or more operators.
The operators of a single collective investment scheme can be independent entities.
Not all of the customers of the scheme need to have relinquished day-to-day control of their money for the scheme as a whole to be characterized as a collective investment scheme.
If the case does in fact go to a full trial, we will report in a further alert on the final judgement.
CAUTIONARY TALE - NEXT STEPS
THE JUDGEMENT - KEY POINTS
The case was most recently taken to the Court of
Appeal as an appeal against a summary judgement by the first instance judge to the effect that there were periods during which the betting scheme had been an unlawful collective investment scheme. The Court of
Appeal's principal task was to determine whether the case could go to full trial on the grounds that Mr
Fradley had some chance of showing that there was no collective investment scheme. There was no reexamination of the facts by the Court of Appeal, which decided (in Mr Fradley's favor) that there was a triable issue as to whether there was a collective investment scheme – i.e., Mr Fradley had some chance of success at trial.
It was clear from the Court of Appeal's judgement, however, that, depending on the precise nature of the arrangements between Mr Fradley and Mr
Woodward, the betting scheme could well have been a collective investment scheme. The Court made the following interesting observations on collective investment schemes:
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The "arrangements" which make up a collective investment scheme do not necessarily require any formality or need to be legally binding.
The property of a collective investment scheme can comprise just money—i.e., there is no necessity for it to be invested in anything.
Those in the betting and gaming industries should clearly take careful note of this case. Any pooling of customer assets and use of those assets on customers' behalf should set alarm bells ringing. Anyone who organizes arrangements which may have these characteristics should be particularly wary as to how their services are being sold: Mr Fradley's troubles were exacerbated by the marketing of his services as a single "scheme" with the services of 147 Racing
Limited.
In addition to collective investment scheme issues, arrangements such as joint ownership of race horses can also raise other securities law concerns: for example, marketing to encourage people to join schemes of this kind may need to be approved by an
FSA-authorized firm, and syndicates organized as, for example, private companies will need to avoid unlawful public offers of their securities.
If you have any doubts at all, come and speak to our financial services and betting and gaming lawyers, as the FSA is clearly looking very carefully at suspect arrangements in the betting and gaming industry.
P hiilliip ga n
+44 (0)20 7360 8123 pmorgan@klng.com
W arrrre n P ello pss
+44 (0)20 7360 8129 wphelops@klng.com
2 Kiirrk pa & L occk Niicch ollsso ah am L P || DECEMBER 2005

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doverstreet@klng.com
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