The Prospectus Directive (the
"Directive" or "PD"), forming a major part of the EU Financial Services
Action Plan, requires member states to implement its provisions by 1 July 2005.
The main aims of the Directive are to create a common standard for prospectuses throughout the EU and to provide the procedure whereby a prospectus produced in any member state will be effective for use throughout the EU.
In the UK the Directive will be implemented by revising the Financial
Services and Markets Act 2000
("FSMA"), and by amending the current
FSA Rules; the Public Offers of
Securities Regulations 1995 ("POS
Regs") will be repealed in their entirety.
In addition, EU Regulation
EC/809/2004 (the PD Regulation) which prescribes detailed disclosure requirements will have direct effect in the UK from 1 July 2005.
The Treasury and the FSA have released consultation papers in respect of the implementation of the Directive.
The recent general election caused the
FSA to delay publication of the final
Prospectus Rules (and the associated new version of the Listing Rules).
Near final Prospectus Rules were published at the start of June.
When is a prospectus required?
A PD-compliant prospectus must be published in two situations:
1. Where an offer of securities is made to the public in any country in the
EU. The Directive introduces a very broad EU-wide definition of what constitutes an offer to the public: "a communication to persons in any form and by any means, presenting sufficient information on the terms of the offer and the securities to be offered, so as to enable an investor to decide to purchase or subscribe for these securities."
2. Where admission to trading on a regulated market is sought.
There are a number of exemptions available, including:
Q
Any public offer below 2.5 million euros (calculated over a 12 month period); and/or
Q an offer of securities only to
'Qualified Investors'. The FSA will set up and maintain a Qualified
Welcome to the Summer Edition.
Kirkpatrick & Lockhart Nicholson
Graham LLP
On 1 January 2005 Nicholson Graham
& Jones combined with US law firm
Kirkpatrick & Lockhart LLP to form
Kirkpatrick & Lockhart Nicholson
Graham LLP ("K&LNG"). This merged firm has over 950 lawyers in
12 US offices and London.
K&LNG maintains one of the most prominent financial services practices with over 150 lawyers working on transactional, regulatory, compliance, enforcement and litigation matters for financial services institutions.
Contents
The Prospectus directive - changes 1 to the EU and UK prospectus rules
Soft Commissions 3
4 Market abuse regime - further analysis
Stakeholder products 5
6 MiFID
New green paper on EU FSP 7
The money laundering regulations 8
Who to contact 8

Take Stock
Investor register and selfcertification as a 'Qualified Investor' will be permitted; and/or
Q an offer of securities to less than 100 people per Member State (other than
Qualified Investors); and/or
Q an offer where the minimum subscription commitment is 50,000 euros per investor.
There are also a number of exemptions
(for both offerings and admissions to trading) which largely track existing exemptions and cover situations such as conversion offers, mergers and takeovers and employee offers.
The major change in respect of the format of a prospectus is that prospectuses can now either be drawn up as a single document, or as a tripartite document comprising the following:
Q a registration document containing information in relation to the issuer;
Q a securities note, containing details of the securities to be offered or admitted to trading; and
Q a summary note of not more than
2,500 words conveying the essential characteristics and risks associated with the issuer and the securities.
An issuer can file a registration document at any time, which, once approved (see below) is valid for 12 months. Once securities are to be offered to the public or admission to trading is sought, the issuer only has to submit the securities note and summary for approval.
Generally, the content requirements under the PD Regulations have not changed much from the previous regime, and the biggest change is in relation to accounts. The Directive is being introduced in conjunction with the pan-EU move to International
Accounting Standards
("IAS")/International Financial
Reporting Standards. The Directive starts from the premise that all issuers must include in any prospectus IAS accounts, or accounts reconciled, restated or equivalent to IAS.
Also, the new Prospectus Rules will allow incorporation of documents by reference for the first time in the UK, although only if such information has already been approved by or filed with the FSA.
Under the Directive, each issuer has a
'home member state', the competent authority of which is the entity responsible for approval of prospectuses. For EU issuers, the
'home member state' is the state where it has its registered office. For non-EU issuers, the 'home member state' is the
EU state where they first offered securities to the public or sought admission to trading after 31 December
2003. Once the document has been approved by the home member state authority, it will be issued with a certificate of approval and with this it will be valid for use in any other EU member state for a period of 12 months.
As a result of AIM's change of regulatory status (it became an
'exchange regulated market' rather than a 'regulated market' in October 2004), companies will not have to produce a full PD compliant prospectus on admission to AIM, unless an offer of securities is being made to the public.
The LSE have concluded that the most appropriate way of replacing the POS
Regs will be to adopt the PD requirements into the AIM Rules with certain carve-outs to reflect the nature of AIM and the companies seeking admission (referred to as "AIM-PD").
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In March 2005 the FSA issued its final consultation paper on bundled brokerage and soft commission arrangements (Consultation Paper
05/5), together with its proposed rules for a new regime that will be effective from 1 January 2006. The FSA anticipates that the new regime will be more transparent and prevent conflicts of interest between investment managers, brokers and the customer.
'Soft commissions' typically occur when a broker agrees to pay for goods or services supplied directly to a fund manager by third-party suppliers. How much the broker will pay is usually dependant upon the fund manager sending a specific volume of business to the broker.
The FSA intends to insert a new 'use of dealing commission' paragraph into the
Conduct of Business rules (COB 7.18).
This will run concurrently with the existing soft-commission rules for a sixmonth transitional period until end
June 2006. It will apply to dealing commission charges incurred in the execution of customer instructions relating to the sale or purchase of shares, as well as certain other investments, to the extent they relate to shares. It will not apply to fixed income investments.
The new regime will only permit dealing commission to be used for execution or research services:
Q
'Execution' services should consist of broker services that are demonstrably linked to the arranging and conclusion of a specific transaction or a series of related transactions AND which arise between the point where an investment manager makes an investment decision and the point at which the transaction is concluded.
Q
'Research' services should be capable of adding value by providing new insights, and should represent original thought, not repeating or repackaging what has been presented before. Research should involve analysis or manipulation of data to reach a meaningful conclusion, and it should be directly relevant to and used to assist in the management of investments for customers.
Any goods or services not deemed to be sufficiently connected with particular investment management decisions or transactions will not be able to be acquired with dealing commission.
The changes to the COB Rules are only half of the new regime. The Investment
Management Association ("IMA"),
London Investment Banking
Association ("LIBA") and National
Association of Pension Funds ("NAPF") have, in parallel with the FSA's changes, revised the IMA/NAPF code of best practice for brokers, to include the use of a standard form of disclosure to clients and information about the investment manager's approach to using commission to acquire execution and research services; as well as a new LIBA
'Statement of Good Practice' for brokers to identify the execution and research component of dealing commission.
The amended Disclosure Code will require firms to disclose two levels of disclosure. 'Level 1' is to be disclosed annually - descriptions of investment managers' policies, processes and procedures in the management of costs paid on behalf of clients; and 'Level 2' is client-specific information to be disclosed semi-annually:
(a) a breakdown of trading volumes and commissions clarifying which were at full rate, other rates or net;
(b) an allocation of commission between execution and other components of the service provided;
(c) comparable firm-wide information on the pattern of trading and commission spend for clients; and
(d) comparisons between the average client commission rate against those across the firm.
The IMA expects that disclosure reports will be issued to UK pension funds by fund managers in the first quarter of 2006, and to other funds in the third quarter of 2006.
COB rule 7.18 will only be applicable to
UK investment managers when they are executing customer orders through a broker (or other third party), passing on the broker's charges to their customers, and in return for passing on the charges the investment manager receives goods or services in addition to the execution of the customer orders.
Continued on page 4
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3

Take Stock
The receipt by a UK investment manager of soft commission is prohibited unless it satisfies the execution or research tests described above. The new rules will also affect any broker that deals with UK investment managers and currently pays for additional goods or services as soft commission. The scope of such payments will be considerably reduced by the new regime, and brokers may find that they have to find new ways of incentivising investment managers to send business in their direction.
The FSA has said that it intends to further consider the territorial scope of the new regime in due course.
However, the preliminary view is that the regime will only apply to investment management carried on in the UK with the new disclosure regime being the standard for the investment managers' UK clients. It will remain to be seen whether the UK disclosure regime will apply to non-UK clients.
Breaches of the new regime will potentially result in the standard penalties open to the FSA for breach of any of the other rules in the FSA
Handbook. These penalties are public censure, fines, and at the most extreme, the FSA could revoke the investment manager's permission(s) to carry on regulated activities. If revoked, the investment manager could not lawfully conduct investment management or any other regulated activity.
In the Winter 2004 issue of "Take
Stock" we considered implementation of the Market Abuse Directive (the
"Directive"), with comments on the new offences of insider dealing and market manipulation. Since that time there has been a further delay to UK implementation, although the new regulations (Policy Statement 05/ 03) were published on 26 March 2005.
They will be enforceable from 1 July
2005, the same day as the Prospectus
Directive becomes enforceable. (See related article on page 1). Recent analysis of how the new regime will function in practice has led to new issues being identified:
Q
Uneven EU implementation
No unified approach has been taken across Europe for the implementation of the Directive, so firms acting on a cross-border basis will be likely to need to seek advice regarding each jurisdiction. The days when firms drew comfort from meeting the UK's golden standard so as to avoid infringing the rules in other EU states have passed.
Indeed, it is possible that some EU regulators in states with less-developed markets than those in the UK may regard some aspects of market conduct carried on in the UK as abusive.
Q
Insider lists
The Market Abuse Directive
Disclosure Rules (the "Disclosure
Rules") come into force on 1 July 2005.
They place an obligation upon 'issuers' to maintain lists of all those individuals who have access to inside information
(being precise information which isn't generally available, which relates to shares or the issuer of those shares, and which would have a significant effect on the share price if it were publicly available) specifying who knows what, when they know it, and why they have access to it. There is a continuing obligation to keep the lists current, so the lists will have to be updated as the parties privy to inside information
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change. The EU wants to ensure that control is exercised over the distribution of inside information.
Crucially, the Disclosure Rules' definition of 'issuer' includes principally those companies whose shares are admitted to trading on a regulated market (or are the subject of an application for admission). Since
November 2004 AIM has ceased to be classified as a regulated market (it is now an exchange-regulated market), and so in consequence AIM listed companies should be exempt from compliance with these rules, though any company listed on the main market will have to comply.
For companies listed on the main market, or any other regulated market, this is potentially an extremely onerous obligation, especially in circumstances where the issuer or its advisors change personnel, or where different people have access to different information, especially when combined with the
Directive's requirement that the list be retained for five years from the date that the list was last updated.
However, to make life a little easier for the issuer, the FSA has issued guidance to the effect that where an outside firm
(e.g. lawyers, accountants, brokers etc) is retained in connection with the issue of shares, then the issuer's list need not contain the name of every individual at those outside firms if: (1) the issuer's list contains the name of the principal contact at that firm; and (2) that firm maintains its own separate list of persons with access to the inside information; and (3) that firm can promptly provide the issuer with their list of persons, whenever requested.
On 6 April 2005 the FSA's rules on the provision of basic advice relating to stakeholder products, as well as the
FSMA 2000 (Stakeholder Products)
Regulations 2004 and associated amendments to the FSMA 2000
(Regulated Activities) Order 2001
("RAO") came into effect.
Stakeholder products include stakeholder children's trust funds, certain cash deposit accounts, stakeholder pension schemes, and certain other products introduced by the government.
firm providing customers with basic advice on stakeholder products must also give customers an initial disclosure document ("IDD") setting out which products are affected by the basic advice regime, which should ensure that customers are aware that the advice being offered is not full independent advice. The IDD must state that more comprehensive advice options exist and the adviser should make certain that the customer is happy with the limited nature of basic advice for these specific products.
Providing basic advice on such products is now a regulated activity under article 52B of the RAO and therefore to lawfully advise on such products a firm must now be regulated by the FSA and comply with all the relevant parts of the FSA Handbook. A
The FSA believes that not every consumer will want or be able to afford fully tailored advice on their saving or investment requirements, and so this regime should suit consumers who are looking for a less in-depth, and cheaper alternative to full investment advice.
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Take Stock
The Markets in Financial Instruments
Directive ("MiFID") will widen the scope of investment services requiring authorisation and widen the range of regulated investments in the EU.
MiFID is effectively a pan-EU compliance framework and will replace the existing Investment
Services Directive ("ISD"). It establishes high-level conduct of business standards and new standards for managing conflicts of interest, best execution, customer classification, and suitability requirements for customers.
It will apply to all existing FSA regulated firms and may require other firms to become regulated (although it should be noted that MiFID does not apply to insurance business).
Drafted under the Lamfalussy process, the high level rules drafted by the
European Commission have now been fleshed-out in a high degree of detail by the Committee of European
Securities Regulators ("CESR"), with their final technical implementing measures published on 30 April 2005.
Adopted by the EU on 21 April 2004,
MiFID should come into force on 30
April 2006 although the implementation date will be likely to be delayed until 30 April 2007 to give member states long enough to consult on and implement MiFID in their jurisdiction.
Some of the key changes likely to be effected as a result of MiFID are that:
Q
Firms authorised to conduct investment services (including receipt, transmission and execution of orders, dealing on own account, portfolio management, investment advice, and underwriting, amongst other activities), will also be able to conduct ancillary services (including safekeeping and administration/ custody of financial instruments, foreign exchange services connected with the provision of investment services, investment research and analysis, and underwriting services, amongst others) without needing to seek separate authorisation;
Q
Commodity derivatives will come within the scope of MiFID (they were not covered by the ISD), and will include OTC commodity derivatives as well as other derivatives including freight rates and emission allowances. This will mean that firms which deal in commodities will now be able to make use of passporting arrangements, although they will also have to comply with all the relevant regulatory requirements (a major change for some commodities dealers who are currently outside the scope of the FSA's remit);
Q
There will need to be extensive changes to the FSA Handbook to ensure that firms conduct a full suitability test on clients when they provide investment advice or portfolio management;
Q
New best execution obligations will come into force to ensure the best possible deal for clients, taking into account price, cost, speed and likelihood of execution and settlement;
Q
There will be introduced a more effective ability for investment firms to 'passport' their operations cross-border. Under the ISD investment firms conducting crossborder business had to comply with the conduct of business rules in each separate jurisdiction. Under
MiFID conduct of business rules will become harmonised across the
EU, meaning that firms will remain subject to the prudential regulation of their home state, greatly simplifying cross-border business; and
Q
Minimum standards of both pre and post trade transparency will also be introduced.
The best execution obligations in Art.
21 relate closely to the new soft commission regime (see article on page 3), which should be MiFIDcompliant as regards transparency and best execution. EU law requires that firms seek the best possible result for their clients, requiring price, cost and time considerations be taken into account. The FSA consulted on best execution in CP154 (October 2002), and it seems that the UK will be ahead of the EU with regard to implementation of these areas. The
FSA had decided not to issue draft rules on execution until after MiFID
Level 2 measures were published by
CESR. Now that CESR has published its level 2 implementing measures, the
FSA will be issuing further consultation papers on CESRproposed changes later in 2005.
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The European Commission has shown its continued commitment to the creation of integrated and efficient EU financial services markets by setting out its proposals on European financial integration for the period until 2010 in a green paper published at the start of
May 2005. economic benefits to EU industry, markets and consumers. Credit rating agencies and financial analysts will not be the subject of any new proposals, although asset management and retail financial services have been identified as policy areas where further initiatives might bring benefits to the European economy. A separate green paper on these topics will be published in the summer of 2005.
to the accumulated value at pay-out, so a cost-efficient fund industry will allow risk to be diversified more efficiently and allow investors to earn higher returns.
The Commission's focus for the next five years will be on (1) consolidating the existing legislation agreed under the
Financial Services Action Plan, rather than proposing new initiatives, (2) ensuring that EU rules are implemented and enforced in national regulation, and
(3) evaluating the effect of the financial services action plan in national markets.
The Commission is committed to act only where initiatives bring clear
Asset management is a key area for further consultation. Investment funds are likely to grow in importance as public sector pensions suffer funding pressure and occupational pension funds shift to a defined contribution basis. A small difference in the net return on investments can make a large difference
Retail financial services integration should allow consumers to purchase products cross-border, facilitating the sale of products of one domestic market throughout Europe without the need for substantial changes. The Commission also intends to look at ways to make cross-border use of bank accounts more consumer friendly and to break down barriers so that customers can shop around all over Europe for the best savings plans, mortgages, insurance and pensions, with clear information so that products can be compared.
The result of the proposed consolidation and advances in financial services policy should be the alignment of financial services legislation with other areas of
EU law and that synergies will develop with policy areas such as competition law, consumer policy, corporate governance, company law reform and other areas. Annex 2 of the green paper gives an overview of timeframes for the adoption and transposition of completed measures.
The green paper is open for public consultation until 1 August 2005. The final financial services policy programme will be presented in a white paper in
November 2005. The Green Paper is available online at: http://www.europa.eu.int/comm/internal
_market/finances/docs/actionplan/index/ green_en.pdf
SUMMER 2005
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The Money Laundering Regulations
2003 ("MLRs") provide that in determining whether a person or institution has complied with any of the requirements of the MLRs, a court may take account of any relevant guidance issued or approved by a supervisory or regulatory body. This guidance, issued by the Joint Money Laundering
Steering Group ("JMLSG"), sets out a best practice framework for dealing with potential money laundering events.
The JMLSG published its penultimate draft of a new issue of guidance notes on
14 March 2005. Entitled 'Prevention of
Money Laundering / Combating the
Financing of Terrorism: Guidance for the UK Financial Sector', the draft guidance notes ("Guidance Notes") are under public consultation until 30 June
2005.
The Guidance Notes are in 2 parts; the first part is a prerequisite for everyone who needs JMLSG guidance as to whether or not to disclose a potential money laundering act. Part II is specific to 19 different sectors of the financial services industry and includes sections for banking, credit, life-assurance, investment fund product providers, stock-brokers, asset finance, private equity and IFAs, amongst others.
The proposed changes, set out in the
JMLSG's introductory document, would change the way that money laundering/terrorist financing risk is managed in the UK, affecting the way firms operate and the way that customers are dealt with. JMLSG's proposals envisage a risk-based approach, allowing firms to focus their resources on the minority of customers who carry a higher risk, and simplify the document requirements for individuals' proof of identity, and allow greater account to be taken of identity verification carried out by other regulated firms. JMLSG also proposes that the guidance should be internetbased, and freely available.
The JMLSG's introductory document and the Guidance Notes can be viewed at http://www.jmlsg.org.uk.
The final version of the Guidance Notes will be published and submitted to the
Money Laundering Advisory
Committee for approval by the Treasury minister at approximately the end of
September 2005, and should come into legal effect around 31 March 2006.
Who to Contact
For further information contact the following
Philip Morgan pmorgan@klng.com
T: +44 (0)20 7360 8123
Neil Robson nrobson@klng.com
T: +44 (0)20 7360 8130
Kirkpatrick & Lockhart
Nicholson Graham LLP
110 Cannon Street
London EC4N 6AR www.klng.com
T: +44 (0)20 7648 9000
F: +44 (0)20 7648 9001
Kirkpatrick & Lockhart Nicholson Graham (K&LNG) has approximately 950 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 and one incorporated in England practicing from the London office.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
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