LAWYERS TO THE FINANCIAL
SERVICES INDUSTRY
www.klng.com
Winter 2005
Take Stock
Alternative investment
products - the US approach
to regulation
Introduction
Until recently, alternative investment
products such as hedge funds that were
offered into the United States were
invariably structured so as to qualify for
exemptions from registration under the
US Investment Company Act of 1940
(the "1940 Act") and the US Securities
Act of 1933 (the "1933 Act"). Most still
do, and these exemptions substantially
dictate how these products can be
marketed in the United States. More
recently, certain alternative investment
products have been registered either
under the 1933 Act, the 1940 Act or
both. Registration under these statutes
can dramatically enhance distribution
options.
1933 Act limitations on
marketing
Within the United States, hedge funds
and other alternative investment
products are typically structured as
limited partnerships or limited liability
companies. The fund sponsor sells
interests in the fund in order to raise the
money that is invested in portfolio
securities or commodities in accordance
with the fund’s investment strategy.
The limited partnership or limited
liability company interests that the
sponsor sells are themselves securities.
To sell these interests, the sponsor
must comply with US federal and state
law applicable to the offer and sale of
securities. Most sponsors choose to
offer the interests pursuant to an
exemption from registration under the
1933 Act. While there are numerous
exemptions available under the 1933
Act, hedge fund sponsors rely
exclusively on the exemption in Section
4(2) of the 1933 Act. Section 4(2)
exempts from the registration
requirements of the 1933 Act
"transactions by an issuer not involving
any public offering". An offering that is
not public is generally called a private
offering, and the Section 4(2)
exemption is referred to as the private
placement exemption.
The choice of exemption under the
1933 Act is dictated by the
requirements for an exception under
the 1940 Act. The 1940 Act regulates
entities that are in the business of
investing in the securities of other
companies. A fund that invests in
securities, such as a typical hedge fund,
must either register as an investment
company under the 1940 Act or seek an
exception from the definition of
"investment company". Funds
Welcome to the Winter Edition.
We provide an integrated
international service for our financial
services industry clients. Many
readers will have attended our
successful joint US/UK seminars on
financial services topics, and this
edition of Take Stock starts with an
article penned by one of the leaders
of our hedge fund practice in the US.
Contents
Alternative investment products the US approach to regulation
1
General Insurance Regulation
4
Transaction Reporting Issues
5
Commission urges action on
clearing and settlement systems
6
The e-money directive an update
7
Financial products and
misrepresentation - the risks
8
Proposed changes to the
Consumer Credit Act
9
New company reporting
regulations from the DTI
10
D & O Insurance Cover - a few
myths and realities
11
MiFID and the FSA’s discussion
11
paper on bond market transparency
The Shell Reserves Affair
12
Who to contact
12
Take Stock
organised in the United States typically
rely on the Section 3(c)(1) or Section
3(c)(7) exception under the 1940 Act.
A fund that meets all of the
requirements of either of these sections
will be deemed not to be an investment
company for purposes of the 1940 Act
and will, therefore, not be required to
register under the 1940 Act. A
requirement of each of these sections is
that the fund not be making and not
currently propose to make a public
offering of securities. The fund must
therefore make private offerings of its
securities under Section 4(2) of the 1933
Act.
An offshore fund may make offers and
sales of its securities in the United
States or to US persons outside the
United States, but only in accordance
with the Section 3(c)(1) or Section
3(c)(7) exception under the 1940 Act.
Thus, to the extent that an offshore
fund sells its interests in the United
States or to US persons, it must do so in
accordance with all of the requirements
of the private placement exemption.
A failure by a fund to meet all of the
requirements for the private placement
exemption can give rise to a right of
rescission on the part of the investor,
meaning that the investor can demand a
return of its purchase price plus
statutory interest. An investor is of
course most likely to exercise such a
right if the fund has lost money. If the
fund no longer has sufficient assets to
meet rescission claims, the fund
sponsors may be exposed to personal
liability. Moreover, if investors
challenge the availability of the private
placement exemption in an attempt to
establish a right of rescission, the
burden of proving the availability of the
exemption is on the fund that is
claiming the exemption.
1940 Act limitations on
marketing
A fund that relies on the Section 3(c)(1)
or the Section 3(c)(7) exception under
the 1940 Act is not only limited to
offering its interests in private offerings.
Each of these exceptions imposes
additional requirements that limit a
fund’s ability to market its interests.
The Section 3(c)(1) exception limits the
number of beneficial owners in the
fund to 100. The sponsor of such a
fund will usually impose a high
minimum investment amount (typically
US$1 million) so that the fund will have
sufficient assets under management
even with just 100 investors. The
Section 3(c)(7) exception requires that
all investors in the fund be so-called
"qualified purchasers" at the time of
sale, a relatively high standard that
includes individuals with at least US$5
million in investments (as defined by
rule) and companies with at least US$25
million in investments.
New products
If a fund and its manager rely on the
exemptions described above, they will
be subject to multiple overlapping
restrictions on marketing. Some fund
sponsors have developed new products
that do not rely on one or more of these
exemptions to enhance their ability to
market the interests in their funds.
Two of these new products are
described on page 3.
2
WINTER 2005
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Registered funds of hedge
funds
A registered fund of hedge funds is
registered under the 1940 Act as a
closed-end investment company. It
invests in hedge funds that are
excepted from the definition of
investment company under the 1940
Act.
The shares in the fund may be
registered for sale under the 1933 Act,
in which case sales can be made without
regard to the prohibition against general
solicitation and general advertising.
Even if the shares are registered for sale
under the 1933 Act, however, as a
condition to declaring effective the
registration statements of such funds,
the SEC has frequently required that
the shares be sold only to accredited
investors. This requirement does not
derive from the private placement
exemption because the offering is
registered under the 1933 Act. The
SEC staff are apparently imposing the
accredited investor standard in an
attempt to assure that funds of hedge
funds will be marketed only to investors
that are capable of understanding their
relatively complex structures. The
SEC staff have also sometimes imposed
a minimum offering amount (usually
US$25,000), presumably for the same
reason.
Because the fund is registered under
the 1940 Act, sales are not limited to
qualified purchasers, nor is there a limit
on the number of investors in the fund.
Long-short mutual funds
A significant change in the US Internal
Revenue Code in 1997 paved the way
for a new breed of mutual fund that can
invest both long and short. Prior to this
change, if an investment company
derived 30 per cent or more of its gross
income from securities held for less
than three months, it would not qualify
for pass-through tax treatment under
Subchapter M of the Internal Revenue
Code. Failure to qualify for passthrough tax treatment would mean that
the investment company would be
taxed as a corporation, which would
result in taxation at both the fund and
investor levels - a very undesirable
result. Securities sold short were always
considered to be held for less than three
months, because they were sold
immediately. Few investment
companies even attempted to operate
within the confines of this so-called
"short-short" rule.
Congress amended the Internal
Revenue Code in 1997 to eliminate the
short-short rule. This has led to the
creation of numerous 1940 Act registered funds that can offer many
strategies of the sort used by hedge
funds. Such funds sell their shares
publicly to an unlimited number of
investors in minimum amounts as low
as US$500. Sales are not limited to
qualified clients if there is no
performance-based fee to the adviser, or
if the performance-based fee is a
fulcrum fee (a fee that is based on the
net asset value of the fund that
increases or decreases proportionately
with the performance of the fund
relative to an appropriate index).
Through the use of new products such
as these, hedge fund strategies are
being made available to larger numbers
of investors. They are also being made
available to investors who may not have
been able to invest directly in hedge
funds, either because they are not able
to invest the high minimum investment
amount typically required of hedge
fund investors or because they are not
accredited investors.
For further advice on hedge funds and
alternative investment products in the
US please contact Nicholas S. Hodge by
email at nhodge@klng.com or by
telephone on +1 617 261 3210.
WINTER 2005
3
Take Stock
General insurance regulation
FSA review
On 23 September 2005 the FSA
announced that it intends to review its
general insurance regulatory regime.
This review will take place alongside its
review of the mortgage regime, which
was announced earlier this year.
Although the general insurance
regulatory regime only began in January
2005, the FSA wants to assess whether
the regime is actually meeting its
objectives.
The FSA has announced that the
mortgage regime review will commence
in December 2005 and the general
insurance regime review will commence
in April 2006. These reviews are
intended as preliminary fact-finding
exercises and depending upon the
results the FSA may decide to consult
on changes in the usual way, although
any changes that the FSA are able to
make will be restricted by the
requirements of the EU's Distance
Marketing Directive and Insurance
Mediation Directive.
Virtually every adult in the UK has
some involvement with general
insurance. In 2004 some 35 million UK
consumers took out or renewed 77
million policies for contents, vehicle,
medical, payment protection and other
types of general insurance with
premiums totalling £28.5 billion. With
so many members of the public
involved, and with over 10,000
authorised brokers active in the general
insurance industry, it is a substantial
area that the FSA is keen to ensure is
efficiently regulated.
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WINTER 2005
The review will have three principal
features:
Encouraging feedback from firms
that are regulated for general
insurance activities on what they
believe is good or bad about the
existing regime and which areas of
the regime would benefit from
greater analysis and re-examination;
Undertaking consumer research to
assess whether the supposed benefits
of the regime have any real effect;
and
Assessing whether or to what extent
the general insurance industry is
actually complying with the regime.
Payment protection
insurance
The sale of insurance policies to cover
an insured person's obligation to make
mortgage, credit card or loan payments
when they are unable to as a result of
illness or redundancy, known as
payment protection insurance or "PPI"
has been the subject of much press
criticism over recent years. The FSA,
now that it has a regulatory structure in
place for general insurance, is keen to
tackle poor or aggressive sales practices,
unsuitable products, small print and
complex terms. It is also looking to
tackle the risks to consumers which
arise as a result of the sale of PPI on the
back of other transactions. In
connection with its proposed general
insurance review the FSA has, by
conducting a 'mystery shopping'
exercise, been assessing how firms sell
PPI linked to other financial products.
The FSA has been determined to
improve standards in this area. On 4
November 2005 the FSA published the
results of its exercise in the form of
examples of good and bad practice,
setting out what it expects of firms. The
FSA prefers to see the industry find its
own solution to the mis-selling of PPI
by improving its own standards; the
alternative, which is currently only
starting to be considered by the FSA, is
that the FSA may introduce more
stringent disclosure requirements, and
potentially may even require that the
sale of PPI be unbundled from the
primary transaction altogether.
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Transaction reporting issues
Transaction reporting has been a hot
topic in the financial press over the past
few months, and is set to remain a
popular discussion topic over the
coming months.
New transaction reporting
system
Earlier this year the FSA asked several
firms to test the FSA's new transaction
reporting system, known as 'TRS'. The
FSA has said that the tests were
successful and the full system will go
live during November 2005. All firms
who currently use the existing Direct
Reporting System ("DRS") will have to
migrate to the TRS before April 2006.
At an as yet undecided date in 2006 the
FSA will switch off DRS, so it is
fundamental that all firms migrate to
TRS.
The migration to TRS should be
simple and efficient for all firms since it
does not require that any software be
installed as it is web-based, and the
feedback from the FSA should be
immediate, so firms will know if they
have submitted their information
correctly. For further advice on the
change to TRS please see the FSA
website at the following link:
www.fsa.gov.uk/pages/doing/regulated/
returns/mtr/index.shtml
Penalty for breach of SUP
17 transaction reporting
rules
In August 2005 the FSA fined Bear
Stearns International Limited £40,000
for failing to report transactions in
contracts for differences ("CFDs") to
the FSA between August 2001 and
March 2005. This was the first ever fine
imposed by the FSA for failure to
report such transactions under Chapter
17.4 of the Supervision Handbook
("SUP").
SUP 17.4 requires authorised firms to
make transaction reports in respect of
all reportable transactions which they
make, either on their own account or on
behalf of another. Reportable
transactions are defined in SUP 17.5
and include transactions involving
CFDs on equities. (It does not include
contracts for differences where the
contract is based on the fluctuation in
the price or value of a basket of
equities, or on the value of a dividend
payment or payments on equities).
The FSA relies on authorised firms to
make accurate and complete
transaction reports. The FSA is
concerned that incomplete or
inaccurate transaction reporting by a
firm may hinder its ability to monitor
the market effectively and might
consequently have some impact on the
FSA's ability to maintain confidence in
the financial system and reduce
financial crime.
The FSA fined Bear Stearns even
though the failure to report was
inadvertent, it had provided all
outstanding transaction reports to the
FSA by the end of March 2005, and it
had implemented new systems and
controls to conduct regular reviews of
transaction reporting for existing and
prospective new products. Although
the FSA has not made its reasoning
explicit, it may be presumed that the
FSA sought to make an example of
Bear Stearns as a warning to other firms
who trade in CFDs. Transaction
reporting in reportable transactions is a
requirement of SUP, and with the new
TRS system there should be no
excuses for failing to report
transactions. The deadline for making
transaction reports is the end of the
business day after which the trade took
place.
Transaction reporting and
MiFID
MiFID - or the EU's Markets in
Financial Instruments Directive is
gathering pace as a pan-European
compliance blueprint which will
replace the existing Investment
Services Directive (see article in the
Summer 2005 issue of Take Stock). As
a fundamental and wide reaching piece
WINTER 2005
5
Take Stock
of European legislation it will have an
effect on many areas of the financial
services industry - from transparency in
the bond market (see article on page
11) to transaction reporting.
The FSA will be publishing a
consultation paper later this year on the
rule changes required to implement
MiFID in the UK, but in the interim
the FSA has set out the key areas of
transaction reporting that will be
affected by the implementation of
MiFID:
More transactions will have to be
reported as the definition of a
'reportable product' will be widened
to include certain interest rate and
commodity derivatives as well as
OTC derivatives.
More firms will be required to make
transaction reports as MiFID will
require that firms must make a
transaction report when their
transaction involves a financial
instrument admitted to trading on a
regulated market whether or not that
transaction takes place on a
regulated market.
EEA passported branches of a firm
will have to report to their host state
regulator.
It is likely that the content of a
transaction report will be increased,
although the additional information
that will have to be reported should
already be information available to
the reporting firm.
The FSA's consultation paper will
consider these and other issues when it
is published later this year.
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WINTER 2005
Commission Urges action on
Clearing and Settlement
Systems
Clearing and settlement involves the
various procedural steps that take place
after securities have been traded so as
effectively to transfer the securities
from the seller to the buyer and the
cash from the buyer to the seller.
In August 2004 the European
Commission (the "Commission")
launched a consultation on the clearing
and settlement process which was
followed in June 2005 by a 160 page
report describing the securities trading,
clearing and settlement infrastructures
of the cash, equities and bonds markets
in the 25 member states of the EU (for
further comment on transparency in
the bond market please see page 11).
The Commission noted that while
there have been a number of mergers
of securities market infrastructures
which have reduced the fragmentation
of the clearing and settlement systems
market in Europe, the consolidation
process is far from complete and further
structural changes are likely.
Furthermore, in terms of regulation,
there is a considerable way to go before
there will be anything that could be
described as a single European market
for such systems. In practice, in most
member states, securities traders are
required to use a specific settlement
service provider with no option to use
alternative systems (e.g. those based in
other member states).
Without some degree of consistency in
clearing and settlement systems across
the EU, for example in terms of rights
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of access and choice, common
governance arrangements and common
regulation, there will be limited
competition between clearing and
settlement systems providers and a
material restriction on the degree to
which trading takes place across the
member states of the EU. These are
serious concerns that the Commission
is keen to address.
A legal working party was established
by the Commission in 2004 which met
for the first time in January of this year
to discuss the legal issues surrounding
the possible regulation of the clearing
and settlement systems in Europe.
If the Commission does decide that
action is required, it will draft a
directive setting out certain common
principles as a means to ensure
consistency of approach and regulation
across the EU. More conservative
voices are lobbying for a laissez faire
approach - arguing that if customer
demand is calling for a more integrated
approach then the market will itself
respond. Politically, there is also some
caution within the Commission to
introduce legislation unless there is a
general consensus in favour from the
member states.
Any legislation is likely to be some
years away, but lobbying will be ongoing from regulators, trade
associations and traders themselves
each of whom will need the
Commission to understand their
perspective. If you have a particular
interest in this area then please contact
Neil Baylis in our London office by
email at nbaylis@klng.com for any
further information.
Summary and update on the
e-money directive
In the three years since the EU's Emoney directive (the "Directive") was
implemented there have been some
substantial advances and changes in the
world of technology and finance. On 14
July 2005 the European Commission
(the "Commission") launched a review
of the Directive in which stakeholders
are invited to give the Commission
their views. The deadline for responses
on the public consultation expired on
14 October 2005.
The E-money directive came into force
on 27 April 2002, and was incorporated
into English law on that date by the
Electronic Money (Miscellaneous
Amendments) Regulations 2002. Emoney may be defined as 'monetary
value that is stored on an electronic
device (e.g. as a chip card or computer
memory) that is accepted by
undertakings other than the issuer and
is intended to make payments of a
limited amount'.
The objectives of the Directive were:
To protect the consumer by ensuring
the integrity and stability of Emoney institutions;
To improve the single market in
financial services;
To avoid distortion of competition
by subjecting both E-money and
traditional credit institutions to
supervision; and
To provide the legal framework
necessary for the development of ecommerce.
Issuing E-money is a regulated activity
under the Financial Services and
Markets Act 2000 ("FSMA") and the
FSA regulates E-money in a similar
way to its regulation of other financial
products.
The Directive allows the FSA to waive
the application of the Directive to
certain E-money issuers by issuing
"certificates". HM Treasury's thinking
behind the waiver is that by exempting
as many E-money issuers as possible
from the requirements of the Directive,
this should lead to increased
competition and the development of
the industry. The FSA is empowered
to grant certificates on a case-by-case
basis, provided that issuers meet
certain criteria relating to the amount of
E-money issued, and the way it is used.
Examples of E-money formats
benefiting from the waiver might
include an electronic travelcard or
smart cards used on a university
campus.
The Directive is under review.
Conceived at the height of the ecommerce boom, it was difficult to
foresee how the E-money industry
would evolve at the time it was drafted.
Advances in technology have spawned
new business models, such as mobile
telephone payments, and internet
payment facilities. The Commission
WINTER 2005
7
Take
StockChecks
Travellers’
wants to analyse whether the Directive
still fulfils its objectives and is
conducive to the competitiveness of
the industry. This consultation is a
follow-up to a consultation that took
place earlier this year on E-money and
mobile operators, and is an important
element of the review.
The European Commission intends to
produce a report containing
recommendations arising from the
consultation by Spring 2006. As the
FSA's current stance is to encourage
competition and development through
minimal regulation, it will be
interesting to see whether this remains
the case following the consultation.
Misrepresentation and
financial products - the risks
The recently reported case of Peekay
Intermark Limited v Australia and New
Zealand Banking Group Limited may
be of some significance to institutions
that sell investment products. The High
Court's judgment highlights the issue
that those persons or firms who sell
investment products cannot be certain
that receiving signed final terms and
conditions from a client will protect
them from liability if they gave
misleading information before the sale
was concluded. It is essential to ensure
that marketing, structuring and backoffice functions verify that accurate
product details are communicated to
investors at all stages of the transaction.
In Peekay a company director signed
terms and conditions relating to an
investment which was fundamentally
different from the investment that had
been orally explained to him. Despite
the fact that he had signed explicit
terms and conditions the court found in
favour of the director and held that he
had relied on the prior oral
representation - meaning that the
person who sold him the investment had
misrepresented the investment in
question.
Forthcoming K&LNG
financial services event
in London
18 January 2006
K&LNG International Investment
Compliance Seminar
Landmark Hotel, 222 Marylebone Rd,
London.
For further details please contact
Kathie Lowe at klowe@klng.com
8
WINTER 2005
As a principle of law, a
misrepresentation is an untrue
statement of fact or law made by one
party to another party and which
induces the second party to enter a
contract, thereby causing that second
party loss. Misrepresentation can be
fraudulent, if it is a false representation
made knowingly, or without belief in its
truth, or recklessly as to its truth; or
negligent if it is made carelessly or
without reasonable grounds for
believing its truth; innocent where the
misrepresentation is made without fault.
The remedies for misrepresentation are
either that the contract can be rescinded
and/or that the court will award the party
that suffers loss damages - paid by the
party that made the misrepresentation.
For fraudulent and negligent
misrepresentation, the claimant may
claim both rescission and damages. For
innocent misrepresentation, the court
has a discretion to award damages in the
place of rescission; the court cannot
award both.
When assessing damages for
misrepresentation, the court will
attempt to place the claimant in the
position as if the misrepresentation had
never been made. Hence, in Peekay,
the court awarded damages equal to the
difference between the sum initially
invested in the product and the value
ultimately realised from it.
This case underlines the importance of
supplying an investor with accurate
information throughout the transaction.
An investor can sign a document
without having read it, in the
understanding that he is investing in the
product as described to him, and then
sue the seller if the product later differs
from what was expected. Clearly there is
a potential for a careless seller to be
liable for substantial damages.
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Proposed changes to the
Consumer Credit Act
The Consumer Credit Bill (the "Bill")
was introduced to the House of
Commons in December 2004 following
an extensive consultation period with
industry, regulators and consumer
groups. It is expected that it will
become law in Summer 2006. The Bill
aims to modernise the provisions of the
Consumer Credit Act 1974 (the "CCA")
to establish a fairer and more transparent
regime.
The proposed changes are intended to
improve consumer rights, enhance the
regulation of consumer credit and make
regulation more relevant. The
government is also currently addressing
the issue of double regulation as certain
categories of credit come within the
ambit of both the CCA, and the
Financial Services and Markets Act 2000
("FSMA"). HM Treasury and the
Department of Trade and Industry have
recently issued an informal discussion
paper and draft statutory instrument
('SI') on this subject.
Currently the CCA regulates the supply
of credit to individuals (including
natural persons, unincorporated
associations and partnerships) where the
credit or payments for hire do not
exceed £25,000. The Bill aims to:
require the lender in a consumer
credit agreement to give the borrower
more detailed information concerning
his account throughout the
agreement;
replace the current rules on
extortionate credit bargains with a
new unfair credit relationships test;
reform the licensing system and
introduce a FSMA-style requirement
for applicants to be 'fit and proper'
persons;
grant the Office of Fair Trading
greater powers to supervise licence
holders to ensure compliance with the
regime; and
introduce a Consumer Credit Appeal
Tribunal - a forum for alternative
dispute resolution.
remove the £25,000 limit, so as to
regulate all lending to individuals
(excluding mortgages already
regulated by the FSA);
exclude partnerships with four or
more members from the definition of
'individuals';
no longer apply to a credit agreement
exceeding £25,000 where the
agreement is entered into
predominantly for the purpose of a
business carried on by the borrower,
and the borrower completes a
declaration confirming this;
introduce an exemption from certain
parts of the CCA for loans to high net
worth individuals;
Double regulation
When the FSA's mortgage regulatory
regime was introduced in October 2004
changes were made to the CCA to avoid
situations where lenders were forced to
comply with both the CCA and the FSA
regime. However, two situations remain
where both regimes could apply:
Modified agreements - which exist
where a consumer credit agreement
is modified in such a way as to make
it an FSA regulated mortgage
contract ("RMC"). Currently, the
CCA states that where an existing
credit agreement is varied or
supplemented by a new contract,
they two agreements are to be
treated as one combined agreement.
The SI plans to disapply the CCA
from RMCs, thereby keeping the
agreements separate, so that RMCs
will be subject to FSMA, and the
original agreement would remain
subject to the CCA in these cases.
Credit Brokerage - in cases where
mortgage arrangers, debt adjusters or
debt counsellors broker credit for a
RMC greater than £25,000. The SI
will exempt mortgage brokers, debt
adjusters and debt counsellors from
requiring a consumer credit licence
for broking FSMA regulated
mortgages.
It is hoped that the SI will remove any
confusion and the issue of double
regulation when it becomes law later
this year.
WINTER 2005
9
Take Stock
New company reporting
regulations from the DTI
The 'Shell
reserves affair'
Three new company reporting
regulations came into effect on 1
October 2005 amending the
requirements of the Companies Act
1985 ("CA") dealing with summary
financial statements, the revision of
defective accounts, and other matters
concerning small companies. The three
regulations are:
The 'Shell reserves affair' of 2004
inevitably attracted the attention of
regulators on both sides of the Atlantic.
In an effort to draw a line under the
episode, Shell cooperated closely with
the FSA when it launched its
investigation into Shell's breach of
market abuse provisions of FSMA, as
well as the UKLA Listing Rules. After
concluding a 'concertinaed' procedure,
the FSA imposed its largest ever fine of
£17 million on Shell as a result of the
episode, and in the US, Shell agreed to
pay a civil penalty of $120 million.
The Companies Act 1985
(Investment Companies and
Accounting and Audit Amendments)
Regulations 2005, available from
http://www.opsi.gov.uk/si/si2005/2005
2280.htm
extend the option to prepare and
distribute summary financial
statements to all companies with
audited accounts;
ensure that companies that use
International Financial Reporting
Standards to prepare their accounts
can still prepare summary financial
statements;
amend and clarify one aspect of the
distribution provisions applying to
investment companies to ensure that
recent accounting changes do not
disrupt dividend practices;
The Companies (Summary Financial
Statements) (Amendment)
Regulations 2005, available from
http://www.opsi.gov.uk/si/si2005/2005
2281.htm
clarify procedures for companies
wishing to revise their Operating and
Financial Review and Directors'
Remuneration Report when errors
have been made; and
The Companies (Revision of
Defective Accounts and Report)
(Amendment) Regulations 2005,
available from
http://www.opsi.gov.uk/si/si2005/2005
2282.htm
bring forward the effective date for
Directors' report exemptions to years
beginning on or after 1 January 2005.
The regulations will:
reflect the recent change to the CA
removing the requirement for a
summarised directors' report in a
summary financial statement;
10
WINTER 2005
However, one person who was not
satisfied with the quick conclusion of
the FSA investigation was Sir Philip
Watts. As the chairman of Shell prior to
his resignation on 3 March 2004, he felt
implicated in the investigation into
Shell, particularly as the FSA had
begun a separate investigation into his
own actions. While Shell had opted to
accept the FSA's findings and move on,
Sir Philip attempted to fight the
proceedings regarding Shell, in
addition to his own.
continued on page 12
www.klng.com
D&O Insurance cover - myths and realities
The Equitable Life saga, and the court
action against 15 of its former executive
and non-executive directors, is a
salutary reminder of the importance of
sufficient and effective directors and
officers ("D&O") cover. The mere fact
that D&O cover is in place offers no
guarantee to senior executives that their
costs and liabilities will be covered in
the event that the regulators come
knocking or their name appears in court
proceedings.
The type and level of D&O cover
provided varies enormously in practice
and there may be exclusions and
conditions imposed by insurers which
prove extremely disadvantageous. It is
not just the headline exclusions and
conditions which can give insurers a
potential route to avoid cover. All too
often the fine print of the policy has not
been fully understood (or even read) by
the insured parties nor by their brokers.
That fine print is written by lawyers for
insurers and is often negotiable, just
like any other commercial contract.
The wording of D&O policies varies
from insurer to insurer and the effect, if
not understood, can be catastrophic. For
example, not understanding and
complying fully with the strict
notification provisions of a policy
recently led to a client being unable to
obtain cover under its D&O policy
which otherwise would have been
available.
There may also be potential gaps
between the cover provided by the
D&O policy and the indemnification
provided by the company, particularly
as a result of the recent changes under
English law in relation to director
indemnification. It is essential that the
D&O policy reflects the
indemnification which the company has
agreed to provide and responds where
the company does not.
If you would like a review of your D&O
cover, either now or in the run up to
renewal, please contact Jane HarteLovelace on 020 7360 8172 (jhartelovelace@klng.com) or Sarah Turpin on
020 7360 8285 (sturpin@klng.com) in
our London Insurance Coverage Group.
Alternatively, if you would like to
attend the D&O seminar we are
planning for early 2006 please let us
know.
MiFID and the FSA's discussion paper on
bond market transparency
As discussed in the last edition of Take
Stock, the Markets in Financial
Instruments Directive ('MiFID') will
introduce, with effect from April 2007,
a pan-EU transparency regime for share
trading. It is likely that this regime will
be extended to also cover bonds. As a
result, the FSA has issued a discussion
paper entitled "Trading transparency in
the UK secondary bond markets".
MiFID requires the European
Commission to hold a review of trading
transparency in the secondary bond
markets. The UK is one of the world's
leading bond trading centres, and both
issuers and investors can constructively
contribute to this review through the
FSA's consultation. The paper
concerns the cash markets for bonds;
related derivatives may be considered
later. It focuses on the risks relevant to
the FSA's roles in protecting investors
and ensuring market confidence. The
paper deals with bond markets in the
UK, the levels of transparency in the
UK's secondary bond markets, the
existence of any market transparency
failures in the UK and practical
considerations for policy development.
The key questions the FSA would like
comment on are:
Are there any market failures in
bond markets? If so, what are they
and how do they arise?
How efficient is the price-formation
process for different bonds?
Do you perceive any difficulties or
concerns with best execution in
bond markets?
Do retail investors face any particular
difficulties in participating in bond
markets?
To what extent might greater
transparency be a solution to market
failures?
What is the relationship between
transparency and liquidity in bond
markets?
WINTER 2005
11
www.klng.com
Continued from page 10
Shell (continued)
Could a pre or post-trade
transparency requirement for a
defined set of benchmark bonds have
beneficial effects for other bonds?
Would greater transparency in bond
markets bring any wider benefits?
How does the inter-relationship
between trading in the cash and
derivatives markets affect the
consideration of these issues?
What practical issues do you think
are important for regulators to
consider in formulating policy in
relation to transparency in bond
markets? What costs do you foresee?
The full paper can be downloaded from
http://www.fsa.gov.uk/pages/Library/Po
licy/ DP/2005/05_05.shtml and there is
a deadline of 5 December for responses.
Sir Philip claimed that the FSA had not
respected its rules regarding notice of
decisions when concluding the
investigation into Shell. Under FSMA
if the FSA sends a notice to the subject
of an investigation, and the notice
identifies and is prejudicial to a third
party, then the FSA must send a copy
of the notice to that third party, and
allow them to make representations on
it.
In a reference to the Financial Services
and Markets Tribunal (the "Tribunal"),
the appeal body for FSA decisions, Sir
Philip argued that the decision notices
sent to Shell identified him, and hence
the FSA was obliged to send a copy of
the notices to him, allowing him time
to make representations on them. He
further suggested that he was seen as
responsible by the public for the
misstatement of reserves. He argued
that as a result, the decision notice sent
to Shell at the conclusion of the FSA
investigation identified him, and was
prejudicial to him, even though he was
not explicitly mentioned by name, or
even by job title.
The Tribunal accepted that Sir Philip
had been the subject of significant
adverse comment in the press as a
result of the affair, but did not accept
his arguments. If his arguments were
correct, then the FSA could be obliged
to extend the third person rights to the
whole board, and perhaps other
employees, of a company being
investigated. The Tribunal decided
that the decision notice was addressed
to Shell alone and there was no reason
to assume that it concerned Sir Philip.
Even though Sir Philip and Shell
received a lot of press attention, the
FSA is still not obliged to offer a third
party protection and the right to make
representations to the Tribunal, unless
that third party is specifically identified
in the notice.
Kirkpatrick & Lockhart
Who to Contact
Nicholson Graham LLP
For further information contact the following
110 Cannon Street
London EC4N 6AR
Philip Morgan
Neil Robson
www.klng.com
pmorgan@klng.com
nrobson@klng.com
T: +44 (0)20 7648 9000
T: +44 (0)20 7360 8123
T: +44 (0)20 7360 8130
F: +44 (0)20 7648 9001
Kirkpatrick & Lockhart Nicholson Graham (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market
companies, capital markets participants, and leading FORTUNE 100 and FTSE 100 global corporations nationally and internationally.
K&LNG is a combination of two limited liability partnerships, each named Kirkpatrick & Lockhart Nicholson Graham LLP, one qualified in Delaware, U.S.A.
and practicing from offices in Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco and Washington
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© 2005 KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.
WINTER 2005
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