DPB Update. Index 1. DPB UPDATE 2. FINANCIAL PROMOTIONS. For firms licensed in the Designated Professional Body arrangements

DPB Update For firms licensed in the Designated Professional Body arrangements Issue 1 June 2002 1. DPB UPDATE The start of a new era. On 1 December 2001 the FSA took over the regulation of mainstream investment business and the Institute assumed its new role as a Designated Professional Body to look after those firms undertaking non-mainstream investment business. This is the first issue of the DPB Update which replaces the Investment Business Gazette. The gazette ran for 35 issues, with the first edition published in January 1988. During that time the Gazette has been used to advise firms on investment business matters. That will continue, although now directed at firms licensed under the Designated Professional Body arrangements. Index 1. DPB update 2. Financial promotions 3. Changes to money laundering regulations 4. Audit and accounting requirements for investment business 5. Numbering system for DPB firms 6. Guidance for firms on investment business 7. DPB firms and limited liability partnerships 8. Legends and letterheads - a reminder 9. Collective investment schemes 10. DPB licence fees 11. FSA Consultation Paper 121 - reforming polarisation 12. Practice assurance 13. CAIFS Seminars - helping you to serve your clients You can obtain an electronic version of the DPB Update at www.icaew.co.uk/dpb. Firms are free to make further copies, provided these carry the Institute s copyright. The new arrangements have now been in place since 1 December 2001. As time passes, more aspects of the arrangements will fall into place. This article sets out what has happened since then. Although the Institute has sent a copy of the DPB Handbook to each licensed firm, it is also available on the Institute s website. Firms can download this from www.icaew.co.uk/dpb and purchase additional printed copies from the same place. The layout of the website relating to DPB matters has been reorganised to reflect that we are now past 1 December 2001. To access this, sign onto the website as a member and then select investment business from the drop-down menu on the left of the screen. You will also find electronic versions of this newsletter at www.icaew.co.uk/dpb. The JMU will shortly start to send out DPB annual returns. Firms who are also registered for audit will receive a combined return. Those who only hold a DPB licence will receive a shorter return dealing only with DPB matters. For firms who are audit registered or previously authorised under the former IB regulations, the date of sending out the return will be as before. For newly licensed firms the return will be sent to you approximately four months after your year-end. It is then due for return by the end of the sixth month after the year-end. The first DPB returns (or combined returns including DPB questions) will be sent out to firms in early June. A copy of the DPB annual return can be found on the investment business section of the members website as described above. Monitoring visits will start later in 2002. There will be approximately 100 per year. Initially these will be stand-alone visits but this may change as practice assurance develops. 2. FINANCIAL PROMOTIONS This article updates the one in the last Investment Business Gazette (no 35) on the Financial Promotions Order following the publication of new guidance by the Financial Services Authority (FSA). The new FSA guidance will be in the form of an appendix to the FSA s Authorisation Manual. The previous article was based on information contained in the FSA s perimeter guidance that has been superseded by the new guidance that is more illustrative. FSA guidance is issued under section 157 of the Financial Services and Markets Act 2000 (the Act). While not binding on a court of law it may be persuasive if a court has to consider an issue to which it relates. New arrangements for financial promotions Since 1 December 2001 only firms authorised to conduct investment business by the FSA are allowed to issue or approve communications made in the course of business which amount to a financial promotion. There are no special arrangements for firms licensed under

the Designated Professional Body (DPB) arrangements and DPB firms will not be able to approve or issue financial promotions unless these have been approved by an authorised firm. There are a number of exclusions in the legislation of situations that do not amount to a financial promotion. Most can be used by any firm but some of these exclusions can only be used by a DPB licensed firm. These relate to communications describing the exempt regulated activities (e.g. professional work involving non- publicly tradable investments) which DPB firms are permitted to undertake under Part XX of the Act. These exclusions are described in more detail below. To assist firms, the various factors which need to be taken into account when deciding whether there is a financial promotion as defined in the legislation are shown in the attached flowchart. Financial promotions are a complex area. This article can only act as an initial guide to the various provisions. If a firm is unsure about any promotion it is making, it should seek legal advice. The legislation Section 21 of the Act sets out the general restriction on issuing or approving financial promotions made in the course of business. Failure to comply with section 21 of the Act can have serious consequences. Under section 25 of the Act, a person commits a criminal offence if he carries on activities in breach of the restriction. In addition, any agreement resulting from the promotion may not be legally enforceable. Firms should therefore treat with caution any information which they are being asked to distribute on behalf of or to clients. The Financial Services and Markets Act (Financial Promotion) Order 2001 (SI 2001 No.1335) (FPO) defines the controlled activities and controlled investments for the purposes of section 21 of the Act. It also contains a large number of exemptions but only those of particular interest to unauthorised firms (i.e. firms not authorised by the FSA) are discussed in this article. The FPO has already been amended, at the time of writing, by three further statutory instruments (noes 2001/2633, 2001/3650 and 2001/3800). Of these, the most relevant is number 2001/2633 that introduced amendments to articles 28 and 55 of the FPO. Terms used A financial promotion is defined in section 21 as being an invitation or inducement to engage in investment activity, communicated by a person in the course of business. The restriction in section 21 applies to any form of communication (solicited and unsolicited) whether written or oral. The expressions invitation and inducement are capable of a number of meanings but in terms of the FPO the FSA see the following meanings as a good indication of the status of a communication: Invitation: making a direct request or encouraging or soliciting Inducement: bringing about, prevailing upon or encouraging Examples of an invitation include direct offer financial promotions, prospectuses with application forms and internet promotions by brokers where the response by the recipient will initiate the activity. An inducement can occur where, for example, a fund manager has been successful over the years and provides contact details for further information. The FPO only seeks to apply to communications which have a promotional element The FSA has given examples of the types of communications which it believes would not amount to an invitation or inducement. These are communications which: merely inform or educate as to the mechanics or risks of an investment; contain no element of persuasion or incitement to enter into an investment agreement request someone to sign an agreement on terms which they have already agreed to. It is common for firms to be requested to provide material that has not been prepared as a financial promotion (e.g., a business plan). The FSA has said that such material will not normally amount to an inducement even if the recipient chooses to use the information to make an investment decision. Firms should nonetheless act with caution when dealing with such requests and where necessary take external advice. The FPO uses a number of terms to describe a communication. These are key to understanding the financial promotion regime and are described in the following table. Real time Non-real time Solicited Unsolicited Telephone calls, personal visits, meetings or other interactive dialogue etc All forms of written material, brochures, websites, advertisements, letters and emails etc which create a record of the communication and any communication that is not real time. A communication initiated by the recipient or that takes place in response to a request from a recipient of an earlier financial promotion. A communication made without express invitation Thus a communication can be solicited or unsolicited and then either real time or non-real time. Section 21 of the Act and the FPO are about controlled activities and controlled investments. These are effectively the regulated activities and regulated investments of the Regulated Activities Order (RAO) but without the exclusions of the RAO. Thus making a promotion about an activity or investment that is covered by an exclusion in the RAO will still be a financial promotion even though providing the service etc is not a regulated activity. For example, services offered in connection with the sale of a body corporate are in certain circumstances exempt under article 70 of the RAO (i.e. it is not a regulated activity). But any communication made in relation to this would be restricted under section 21 of the Act unless one of the exemptions in the FPO can be applied. Firms will not need to be authorised by the FSA in order to take advantage of the exemptions in the FPO although some of these will be particularly relevant to DPB licensed firms. Controlled activities and controlled investments are defined in the FPO as follows: Controlled Activities Accepting deposits Effecting and carrying out contracts of insurance Dealing in securities and contractually based investments Arranging deals in investments Managing investments Safeguarding and administering investments Advising on investments Advising on syndicates participation at Lloyd s Providing funeral plan contracts Providing qualifying credit Agreeing to carry on specified kinds of activity 2

Controlled Investments A deposit Rights under a contract of insurance Shares or share capital of any body corporate Instruments creating and acknowledging indebtedness Government and public securities Instruments giving entitlement to investments Certificates representing certain securities Units in a collective investment scheme Rights under a stakeholder pension scheme Options, futures, contracts for differences Lloyd s syndicate capacity and syndicate membership Funeral plan contracts Agreements for qualifying credit Rights to or interests in investments Exclusions specifically for DPB licensed firms There are two exemptions in the FPO which have been specifically designed for DPB firms. These are provided in articles 55 and 55A (introduced as an amendment to the FPO by SI 2001 No 2633). Article 55 allows DPB licensed firms to make solicited or unsolicited real-time communications (i.e. the firm can respond to requests or can initiate discussions about investments with clients). This is provided the communication describes a regulated activity allowed by the DPB arrangements and the communication is to someone who has already engaged the firm to provide professional services. The communication cannot be about an activity that is covered by an exclusion in the RAO unless the exclusion in article 67 of the RAO (which concerns activities that are reasonably a necessary part of professional services) applies. Also the communication can only be made directly to clients. It cannot be used for real time promotions made to a third party, even if it is information about the client. In such circumstances another exclusion in the FPO would have to be used, if available. Article 55A exempts any non-real time financial promotions (e.g. a brochure or website) where they relate to a DPB activity and contain a specified statement disclosing the firm s status under the Act. The prescribed wording is as follows: This [firm/company] is not authorised under the Financial and Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services because we are members of the [ICAEW/ICAS/ICAI]. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. This will enable the firm to issue printed brochures or material on a website without any need for approval by an authorised person. This is an important exemption for DPB firms and allows them to refer to their DPB regulated activities in advertising material. It was only achieved after lobbying by the Institute. The requirement that the statement must be in the specified terms will not prevent minor changes to the text provided this does not alter the meaning of the statement. The FSA has indicated that alterations such as replacing we with the name of the firm or because with as or (where relevant) members of with licensed by the would be acceptable. Firms should consider carefully changes of a more substantial nature and obtain clearance from the FSA where this could affect the meaning of the statement. The FSA has advised that it will not be necessary to repeat the statement whenever a DPB activity is mentioned in a brochure or other non-real time financial promotion. Firms should be aware that if the brochure advertises the financial services of a third party this will then become a financial promotion and will need to be approved by an authorised person. This is discussed in more detail under article 15 below. The scope of article 55A is slightly different to article 55. Both can only be used in relation to activities that can be carried on by a DPB licensed firm and neither can be used for transactions to which an exclusion in the RAO applies (such as the sale of a body corporate). However, article 55A cannot be used for activities that are excluded under article 67 of the RAO (which concerns activities that are reasonably a necessary part of professional services) whereas article 55 can. Licensed firms that cannot meet this exemption may still be able to make a financial promotion by using one of the other exemptions in the FPO as described below. Other exclusions As well as the exclusions mentioned above which are for DPB firms there are other exclusions in the FPO which any firm can use. The ones most likely to be relevant to DPB firms activities are discussed in this section. Firms should note that their ability to use the exemptions will depend on the type of controlled activity involved. Whilst there are some exclusions which are applicable to all controlled activities there are others which are more limited in scope and only apply to a certain controlled activities or even just one. Article 28 and 28a on one-off non-real time and solicited real time communications This is an extremely useful exclusion. It allows firms in certain situations to make one-off communications with individual clients (as compared to a mailshot to many clients). Article 28 provides that financial promotion restrictions will not apply to a one-off non-real time communication (e.g. a letter) or a solicited real time communication (e.g. a conversation initiated by a client) which is personal to the recipient and is not part of an organised marketing campaign. The FSA considers a one-off financial promotion is most likely to occur where the firm considers the individual circumstances of the recipient and tailors the financial promotion accordingly. Expressed differently, is it reasonable to expect the recipient or group of recipients to be interested in the subject matter of the promotion. So approaches made to a group of persons (e.g. a married couple, the directors of a company or members of an investment club) at the same time could be exempt. This is provided the firm is satisfied that each recipient s circumstances are such that they would be interested in the promotion and that they would act jointly in relation to the promotion. Such a communication must not amount to an organised marketing campaign which a DPB firm is not allowed to do. The FSA has not attempted to define an organised marketing campaign although this is likely to have the following characteristics: planned in advance not specifically influenced by the circumstances of the recipient part of a wider plan having a common objective. The one-off exclusion would also allow a firm to reply to a request from a client to provide the name of an authorised firm to whom the client can be introduced. Article 28A (also introduced with article 55A) provides that unsolicited real time communications can be made: if the communication is one-off; and if the firm making the promotion reasonably believes that: the recipient of the promotion understands the risks associated with engaging in the investment activity to which the promotion relates; 3

the recipient would expect to be contacted by the firm in relation to the investment activity to which the promotion relates. It will be for firms to make a judgement on the last two points. The FSA have indicated that it would be safe to assume that the person understands the risk where he is understood to be a professional or to be professionally advised in relation to the investment activity. The exclusion will benefit DPB firms, for example, when a firm needs to contact another party, or their professional advisers, to find out if they are willing to proceed with a transaction which is already under discussion. Article 14 on follow-up communications A firm can make a follow-up communication to a previous communication that was itself exempt under the FPO. This applies to any non-real time or solicited real time follow up communication. This exemption can only be used in certain circumstances: the original communication relied on an exemption that itself required particular information or statements to accompany it (e.g. articles 48 to 50, promotions to high net worth individuals, companies or sophisticated investors, each require the inclusion of various warning statements, see below); the follow-up is made within 12 months of the first communication and to the same recipient; and it is about the same subject as the first communication. Thus if a firm has made a communication to a high net worth individual (which requires additional information to be provided with the communication), it can send a follow-up communication to that same individual about the same subject. A firm could not use the exclusion if the original communication used an exemption that did not require additional information to be provided (e.g. article 28 oneoff promotions). Article 19 on communications to investment professionals For communications made under article 19 to be exempt, the communication must either be made directly to an investment professional (see below) or the person making the communication must believe on reasonable grounds that the recipient is an investment professional. If the communication has the following characteristics, it may be reasonably regarded as directed at investment professional. They are: an indication in the communication that the financial promotion is directed only at persons having professional experience in the subject matter of the communication and only such persons will make use of it; an indication in the communication that other persons should not rely on the communication; and the maker of the communication has arrangements in place designed to prevent persons other than investment professionals from engaging in the investment activity that is being promoted. The FPO states that an FSA authorised firm is an investment professional as is a person whose ordinary business involves him in carrying on the controlled activity to which the communication relates. So a communication about an investment to an organisation known to make investments would be exempt (e.g. investment trust companies or venture capital companies). With respect to firms of chartered accountants the FSA have said that a firm can be regarded as an investment professional where the communication made to it relates to a controlled activity which it may be expected to engage in under the Part XX arrangements. It would not apply if the communication invited the firm (or its partners) to make personal investments. Articles 48 on communications to high net worth individuals The exemption for high net worth individuals is designed to reflect the typical characteristics of business angels and other sources of informal capital for start up and small companies. This exemption can only be used where an individual possesses a certificate of current net worth which must include a specified statement confirming the person s eligibility to receive the promotion under the exemption. The exemption only applies to non-real time and solicited real time communications. Promotions can only be sent to such persons within twelve months of the date of the certificate being signed. For a high net worth individual the certificate must be signed by a recognised person who can be either the individual s accountant or employer who must make a declaration regarding the solvency of the individual in the preceding twelve months. This is based on the individual having had an annual income of at least 100,000 in the preceding financial year or having held net assets of not less than 250,000 throughout the preceding financial year. It is a further requirement that the high net worth individual making the investment cannot lose more than the amount invested. As the certificate covers the previous year s assets this must be renewed on an annual basis for the individual to remain eligible to receive financial promotions. The communication that takes advantage of this exemption can only be in relation to certain types of investments such as shares in unlisted companies (for the full list see article 48 (5) of the FPO). This exemption is likely to be of most use to firms acting on behalf of unlisted clients seeking venture capital from business angels. There are other conditions that have to be met when using this article and the FPO should be referred to for these. The communication must not invite the recipient to engage in investment activity concerning the particular investment to which the communication relates with the person who signed the certificate. This would not prevent a firm that had given a client a certificate discussing with that client financial promotions received from a third party. The third party would be trying to induce your client to engage in an investment activity with the third party, not the firm, so the firm can advise the client. However, there is nothing to prevent a firm from making other financial promotions to the recipient provided it uses other exclusions. Article 50 on communications to sophisticated investors The exemption for sophisticated investors is similar to the exemption for high net worth individuals (article 48 see above). It can also be used to make communications to business angels and other sources of informal capital for start up and small companies. A similar requirement as in article 48 for a certificate exists for sophisticated investors although this is not subject to a minimum solvency requirement. Only a firm authorised by the FSA can provide the certificate. The certificate must indicate the classes of investment that the individual can receive communications about and is current for a period of three years. It must also certify that the person has enough knowledge to be able to understand the risks associated with the investment. The promotion itself must also contain a warning that there is significant risk of losing all monies invested or of incurring additional liability. There are other conditions that have to be met when using this article and the FPO should be referred to for these. As for article 48, the communication must not invite the recipient to engage in investment activity concerning the particular investment to which the communication relates with the person who signed the certificate. This would not prevent a firm that had given a client a certificate discussing with that client financial promotions received from a third party. The third party would be trying to induce your client to engage in an investment activity with the third party, not the firm, so the firm can advise the client. However, there is nothing 4

to prevent a firm from making other financial promotions to the recipient provided it uses other exclusions. Article 49 on communications to high net worth companies, trusts etc Article 49 deals with high net worth companies, unincorporated associations or trusts. There is no need for a certificate and it applies to any communication. The person making the promotion must believe on reasonable grounds that the recipients are high net worth companies etc. These are defined in the FPO (which should be referred to for the full definition) as: Corporate body: if there are more than 20 members then called up share capital or net assets must exceed 500,000; if it is a subsidiary of another company which has more than 20 members then called up share capital or net assets must exceed 500,000; in any other case called up share capital or net assets are more than 5m; Unincorporated associations or partnerships: net assets of more than 5m; Trusts: the value of the cash or investments which form part of the trust assets must exceed 10m. Although there are no restrictions on the types of investments etc, there are a number of conditions attached to the exemption for high net worth companies etc. The communication must indicate the persons to whom (i.e. those above) it is directed and that others should not act on the communication. Also the person making the communication should have systems in place to prevent recipients other than the persons listed above (such as the directors of the company acting in a personal capacity) engaging in the activity described in the communication. If a firm would be prevented from making a communication under the terms of article 49 it may be able to use another exclusion in the FPO. Article 15 on introductions This exemption applies to any real time communications made with a view to introducing the recipient to an authorised person or exempt person provided: the authorised or exempt person is not a close relative of or part of the same group as the firm; the professional firm does not receive any form of payment except from the client; and the recipient has not sought investment advice from the firm. The FSA has confirmed that if the client agrees to the firm keeping the commission received from the authorised person or exempt person then this constitutes a payment from the client, not the third party. This exemption cannot be used to make a real time introduction (e.g. during a discussion) to a group company. However, the one-off exclusion (article 28) would allow a firm to reply to a request from a client to provide the name of an authorised firm to whom the client can be introduced. The name of the group company can then be given. If the introduction is non-real time (e.g.. in a brochure) this exemption cannot be used if it identifies a specific authorised firm. However this should not in practice cause many difficulties. Where the reference to the introduction is fairly basic the authorised firm can approve the promotion on a straightforward and simple basis, provided it contains no more than the information allowed by paragraph 3.2.5 (5) of the FSA s Conduct of Business Sourcebook. If this applies then, under paragraph 3.2.4 (2) the authorised firm merely has to ensure that the promotion is fair, clear and not misleading. No approval statement is needed on the brochure and there is no record-keeping requirement for the authorised firm approving the promotion. The FSA has confirmed that a letter sent to a client providing the name of a firm to whom business can be introduced will be covered under article 28, one-off financial promotions. If a firm wishes to make a general statement in its promotional literature that it can make introductions it would probably be more appropriate to use the generic promotions exemption described below. Article 62 on the sale of a body corporate This exemption covers communications relating to the sale of a company made on behalf of a body corporate, a partnership, a single individual or a group of individuals. This means that firms will be able to take advantage of the exemption when the communication relates to a transaction where: the shares consist of or include 50% or more of the voting shares in the body corporate (or together with any shares already held by the person acquiring them, consist of or include at least 50% of such shares); and the acquirer is either a body corporate, a partnership, a single individual or a group of connected individuals and so is the seller, but they need not be the same type. If the above conditions are not met the exemption can still be used if the object of the transaction may reasonably be regarded as being the acquisition of day to day control of the affairs of the body corporate by the buyer. The identity of the seller(s) is then not relevant. This terms of this exclusion are similar to those in article 70 of the Regulated Activities Order. (The Treasury is giving further consideration to the scope of the exclusion and firms will be informed of any decision to amend this.) Article 17 on generic promotions This excludes promotions which do not identify (directly or indirectly): a person who provides the controlled investment to which the financial promotion relates; or a person who carries on a controlled activity in relation to that investment. Where a document indicates that the professional firm can refer the client to another firm for the provision of investment services or activities, but does not identify the other firm or the specific activities, then article 17 can be used by the firm and the statement is not a promotion. A suitable wording would be: We are able in certain circumstances to offer a limited range of investment services. If you need more complex advice on investments we may have to refer you to someone who is authorised by the Financial Services Authority as we are not. If the brochure or document refers to specific types of investments, such as pensions, article 17 may not be met and approval would therefore be needed. If the client then asks for an introduction, article 28 (on one-off financial promotions) will apply and the name of the other party can be provided. Other matters Engagement letters Some of the above exemptions will only apply where a real time solicited communication is made, i.e. the client initiates the communication or the firm responds to a request from the client. An example is a follow up communication (article 14) where the firm has made a financial promotion but cannot discuss the matter unless the client so requests. Also, for the firm to provide a proper service to the client it may be necessary to contact the client without specific permission. In these cases the FSA considers it advisable for the 5

engagement letter to draw specific attention to the possibility of the firm making an unsolicited real-time financial promotion. The firm should obtain the client s specific acceptance of this. A suitable paragraph for the engagement letter would be: To enable us to provide you with a proper service there may be occasions when we will need to contact you without your express permission concerning investment business matters. For example it may be in your interests to sell a particular investment and we would wish to inform you of this. We may therefore contact you in such circumstances. [We would however only do so in our office hours of...]. We shall of course comply with any restrictions you may wish to impose which you notify to us in writing. Where the client signs the engagement letter there should be a specific reference back to the above paragraph. Insolvency practitioners Insolvency practitioners are exempt persons under the Act. This means that when acting within the meaning of section 388 of the Insolvency Act 1986 they are not stopped by the general prohibition under the Act from conducting regulated activities. Similarly, article 16 of the FPO allows such an insolvency practitioner to make non-real time communications or solicited real time communications in the course of carrying out insolvency work. Summary There are a large number of exclusions within the FPO that should allow firms to undertake a range of communications without needing authorisation. But financial promotions are a complex area and firms should be careful that they do not stray beyond the limits of any exclusion. If the firm had previously (i.e. before 1 December 2001) received the client s permission then this will still be valid. Is it a financial promotion? Is the firm making a communication or causing a communication to be made? NO YES Is it an invitation or inducement? NO YES Is the invitation or inducement relate to a controlled investment? NO YES This is not a financial promotion Is the invitation or inducement to engage in investment activity? YES NO Is it made in the course of business? YES Does the communication fall within one of the exclusions in Part IV & VI of the Financial Promotions Order? YES This is not a financial promotion NO NO Part IV - All controlled activities. Article. 14. Follow up communication 15. Introductions 16. Exempt persons 17. Genetic promotions 19. Investment professionals This is a financial promotion and will require approval from an authorised person Part VI - Certain types of controlled activities. Article. 48. Certified HNW individuals 49. HNW companies 50. Sophisticated investors 55 & 55a. Communications by profess 62. Sale of a bodycorporate 6

3. CHANGES TO MONEY LAUNDERING REGULATIONS One of the consequences of N2 is that the Money Laundering Regulations 1993 (the Regulations), SI 1993/1933, needed updating. This is to take account of two principal changes - the superseding of the Financial Services Act 1986 by the Financial Services and Markets Act 2000, and the creation of the Designated Professional Body (DPB) licensing arrangements. It is these Regulations that introduce a number of procedural requirements on firms conducting relevant financial business. Such firms need to have identification and record keeping procedures, appoint a Money Laundering Reporting Officer and train and educate their staff in the firm s procedures against money laundering and tipping off. The updating of the Regulations has been made through The Financial Services and Markets Act 2000 (Consequential Amendments and Repeals) Order 2001, SI 2001/3649. This has the effect that: relevant financial business is now based on those activities in the Regulated Activities Order 2001, SI 2001/544; firms, whether authorised or licensed, will be bound by the Regulations if they are carrying on Regulated Activities. Firms that carry on relevant financial business (ie Regulated Activities) need to follow the procedures imposed by the updated Regulations. This encompasses both DPB-licensed firms and firms authorised by the Financial Services Authority (FSA). Firms licensed under the DPB arrangements by the Institute and firms authorised by the FSA are under different obligations when it comes to the procedures that they need to adopt to help prevent money laundering. Firms licensed under DPB The updated Regulations apply to these firms insofar as they conduct Regulated Activities. Part XX of the Financial Services and Markets Act 2000 confines DPB-licensed firms to a limited range of Regulated Activities referred to as Exempt Regulated Activities. Any Exempt Regulated Activities carried on by DPB-licensed firms need to be conducted in an incidental manner, arising out of the firms other professional services. Strictly speaking, these other professional services are outside the scope of the updated Regulations. Nevertheless, it is likely that: it will be easier to obtain identification material from clients at the commencement of a business relationship as one does not know when a client will want a service comprising relevant financial business. It is awkward to suspend acting for a client who has joined the firm since 1 April 1994 pending the satisfactory completion of identification checks; the Second EU Money Laundering Directive, expected to be adopted shortly and implemented within eighteen months, will extend legislation to firms of accountants as a whole, not just those which are authorised or licensed; and the Proceeds of Crime Bill extends the range of offences that will be covered by the money laundering registration. Consequently, now is a good time to review your current identification procedures and consider whether to apply them to all clients. The Institute s current guidance is Statement 1.304 in the Members Handbook. Firms authorised by the FSA In addition to the foregoing, the FSA has issued its Money Laundering Sourcebook. This needs to be read in conjunction with the updated Regulations and the Guidance Notes issued by the Joint Money Laundering Steering Group. The Money Laundering Reporting Officer ( MLRO ) needs to be an approved person. The FSA s Sourcebook brings in an additional requirement for the MLRO to make an annual report to senior management and to be aware of Money Laundering pronouncements on the FSA s web site. All firms As well as their obligations arising from the Regulations, firms should note two further sets of requirements. Firstly, all firms, be they authorised, licensed or not, are under a statutory duty to report suspected drug trafficking and terrorism. Secondly, all firms should be complying with the Charter of the European Professional Associations in supporting the fight against organised crime, signed on 27 July 1999 on behalf of, inter alia, CCAB bodies. The Charter requires firms to verify the identity of clients when handling clients money, whether or not it is handled in connection with relevant financial business. This should be seen as adding little to what any practice management arrangements would require. Advice can be obtained from the Institute s Technical Department or ask for the Institute s MLRO. 4. AUDIT AND ACCOUNTING REQUIREMENTS FOR INVESTMENT BUSINESS Under the legislation in force before 1 December 2001, a firm that was constituted as a company and authorised for investment business by the Institute could not use the audit or accounts disclosure exemptions in the Companies Act 1985 (CA85). The Financial Services and Markets Act 2000 (Consequential Amendments and Repeals) Order 2001, Statutory Instrument (SI) 2001 No. 3649 has recently been passed. While the changes made by this SI, in the main, reflect the new terminology used under the Financial Services and Markets Act 2000 they do amend the audit and accounting requirements for limited companies conducting investment business. Section 14 of the SI changes the definition in section 249B of the CA85 of companies that cannot use the audit exemptions. All limited companies that are authorised by the Financial Services Authority (FSA) will require an audit under the Companies Act 1985, regardless of size. Exemptions in respect of small companies (as defined) do not apply for FSA authorised companies. The legislation does not extend the audit requirements to those companies that are licensed under the new designated professional body (DPB) arrangements. The audit exemptions for small companies under the Companies Act do apply to DPB licensed firms. This will be a change for small companies who were previously authorised by the Institute as a recognised professional body but are now DPB licensed. They will no longer need an audit. Similarly section 11 of the SI changes the definition in section 247A of the CA85 of companies that cannot use the accounting exemptions. The change is the same as for the audit exemption. An FSA authorised company cannot use the exemptions whereas a DPB licensed company, if it qualifies as small or medium can. 5. NUMBERING SYSTEM FOR DPB FIRMS Following the changed arrangements for investment business regulation from 1 December 2001, the Institute has become aware that some insurers will not always accept business introduced from DPB licensed firms. On the part of some of those authorised firms this is a policy decision. Other authorised firms are taking this approach mainly because they cannot easily identify DPB licensed firms on a public register. 7

To deal with both points the Institute has been in discussions with the major insurers and life offices and also the FSA. It is hoped that in the long term the FSA will incorporate DPB licensed firms on its public register of regulated firms. This is made available to the large insurers to incorporate in their own systems. As an interim measure the Institute will be providing the major insurers with a list of our DPB licensed firms. This will include a unique identifying number. For most firms who were authorised by the Institute under the previous arrangements, this number is the firm s old SIB/FSA number. For firms newly licensed, the Institute will issue a new number. These numbers can then be used when communicating with insurers, etc. However, this is not a guarantee that a particular insurer will wish to deal with a DPB licensed firm. To assist firms if they need to explain the current position to insurers a standard note has been prepared. This was developed in conjunction with the FSA and the major insurers and can be downloaded from the members web-site at www.icaew.co.uk and selecting the option for investment business from the left-hand menu. If you have forgotten your number, a full list of all DPB licensed firms can be viewed at www.icaew.co.uk/listofdpbfirms. 6. GUIDANCE FOR FIRMS ON INVESTMENT BUSINESS The Institute has now updated its guidance leaflet Investment Business from 1 December 2001 - Guidance for firms to incorporate material contained in the Designated Professional Body Handbook. It now includes a flowchart, linked to detailed supporting schedules, which have been developed to provide guidance to firms as to whether they can carry on a particular investment business activity. Further information regarding authorisation from the Financial Services Authority and more detailed guidance on corporate finance activity have also been included in the leaflet. The new version replaces that issued in July 2001 and is on the Institute website at www.icaew.co.uk. Log on as a member and then click on investment business in the take me to menu on the left-hand side. 7. DPB FIRMS AND LIMITED LIABILITY PARTNERSHIPS What is an LLP? A limited liability partnership (LLP) is a new type of business vehicle that has been available since April 2001. The objective of creating this new type of vehicle was to have the flexibility of a partnership but with a limitation on the liability of the principals. An LLP is legally a body corporate although it does not have any share capital. Those who participate in an LLP are called members, as opposed to partners or shareholders. The members govern the LLP in the same way that partners in a partnership or directors in a company would. Is membership of an LLP an investment? At first sight it might seem that taking a stake in an LLP is not a regulated investment under the Financial Services and Markets Act (the Act). It is not a shareholding in the accepted sense of a company (which is an investment under the Act). Similarly, as a share in a partnership is not a regulated investment why should a share in an LLP be? However, membership of an LLP can constitute an investment in a collective investment scheme which is a regulated investment. Although the article on collective investment schemes in this newsletter indicates that generally a body corporate is not a collective investment scheme (CIS), an LLP may be. If it is a CIS, an individual will be acquiring (or selling) a regulated investment. Whether or not the LLP constitutes a CIS will depend on the facts of the case. If the LLP has one or more of the following attributes, given by section 235 of the Financial Services and Markets Act, it is likely to be a CIS: The members do not have day to day control over the management of the LLP. Either or both of the following apply: The members capital and income and profits are pooled. The property is managed as a whole or on behalf of the members by an operator of the scheme. If the LLP is a CIS then a share in the LLP is a regulated investment. Where an individual joins the LLP or sells his share in the LLP then any third party advising on or arranging that investment will be undertaking a regulated investment business activity. If the LLP does not meet these criteria, then it is not a CIS. So if the LLP is a professional partnership and the member is a participant in that business who is involved in the day to day control of the LLP, then it is not a CIS. What advice can be given on acquisitions by the DPB licensed firms? If the LLP is a CIS, then the article in this newsletter on CISs applies. The units in the CIS are a security and whether or not a DPB licensed firm can advise on an acquisition will depend on the issues discussed more fully in the article in CISs. In summary these are: If the units in the CIS are publicly tradable a firm wishing to advise on the purchase of units will need FSA authorisation. Where the units are not publicly tradable, a DPB firm may also be prevented from advising on the acquisition of units in a scheme from an operator as this would constitute a purchase from someone whose business is the selling etc of such an investment. Advice can be given on the sale of a stake in a LLP under a DPB licence even if it is a CIS. If the LLP is not a CIS then there are no restrictions on giving advice to a potential member. 8. LEGENDS AND LETTERHEADS - A REMINDER Firms have asked for a reminder of the requirements for letterheads and legends from 1 December 2001 so here it is. Firm is licensed under the Designated Professional Body arrangements The FSA will not allow a firm, which is not authorised by the FSA to use the former legend after 1 December 2001. This is because it uses the word authorised that is now only allowed to a FSA authorised firm. So from that date DPB firms will have to change their notepaper. Existing letterhead can be used if the current IB legend is overtyped. As an alternative the following legend can be used: Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. The combined wording to include audit registration is: Registered to carry on audit work and regulated for a range of investment business activities by the Institute of Chartered Accountants in England and Wales. 8

There is no requirement for DPB firms to include any legend on their notepaper but firms can use the above. The above words are not mandatory but they have the advantage that the FSA are aware of them! Firm is authorised by the FSA The existing legend can continue in use after 1 December 2001, despite the referral to the Institute as the authorising body, provided this was printed before that date. However, under the transitional arrangements, such stocks cannot be used beyond 30 November 2002. The FSA has not provided any mandatory letterhead legend for use going forward. It intends to publish a consultation paper about this sometime in 2002. Before any final requirements are introduced, firms are required to comply with the provisions in the FSA s Conduct of Business Sourcebook (COB) which are summarised below. Chapters 3, 4, 5 of the COB require firms to disclose their regulatory status in direct-offer financial promotions, stationery and terms of business letters (including customer agreements). In particular, COB 5.5.3 requires a firm to take reasonable steps to ensure that a private customer is given adequate information that the firm is authorised by the FSA. COB 5.5.4E and COB 5.5.5E provide that the reasonable steps should include a statement on relevant documentation, including business stationery, that the firm is regulated or authorised by the FSA or the Financial Services Authority. To assist firms the following has been agreed as acceptable to the FSA: Authorised by the Financial Services Authority for investment business. If your firm is also audit registered then the following can be used as a combined legend: Registered to carry on audit work by the Institute of Chartered Accountants in England & Wales and authorised by the Financial Services Authority for investment business. Any final disclosure requirement will not be know until after the FSA s consultation. So firms should avoid printing too much stationery but it will still be possible to use unused stock once the new legend is agreed as there will be a further transitional period. 9. COLLECTIVE INVESTMENT SCHEMES This article sets out the background to advice that can be given on collective investment schemes under the Designated Professional Body arrangements. What is a collective investment scheme? A collective investment scheme (CIS) is defined in section 235 of the Financial Services and Markets Act 2000 (the Act). Section 235 gives the following attributes for a CIS: The members do not have day to day control over the management of the CIS. Either or both of the following apply: The members capital and income and profits are pooled. The property is managed as a whole or on behalf of the members by an operator of the scheme. Article 81 of the Regulated Activities Order specifies that units in a CIS are regulated investments under the Act. Units are defined in section 237 of the Act as the rights or interests (however described) of the participants in a CIS. The Non-exempt Activities Order (SI 2001/1227) sets out various activities that a DPB licensed firm cannot do. Under article 4(d) of this Order, a DPB licensed firm cannot establish, operate or wind up a CIS nor act as trustee to an authorised unit trust scheme. Arrangements which are not treated as collective investment schemes. Under the Collective Investment Schemes Order 2001 (SI 2001/1062), the Treasury has designated certain arrangements as not constituting CISs. The arrangements that are covered by this Order are: individual investment management arrangements enterprise initiative schemes pure deposit based schemes (this would include cash deposit ISAs) schemes not operated by way of business certain debt issues, such as debentures, bonds and loan stock amounts held by participators in common accounts certain funds relating to leasehold property certain employee share schemes schemes entered into for commercial purposes related to existing business group schemes, where each participant is a body corporate in the same group as the operator franchise arrangements trading schemes (basically those which reward participants for introducing new members to the scheme, which is managed by the scheme operator) timeshare schemes other schemes relating to the use or enjoyment of property schemes involving the use of certificates representing certain securities (see article 80 of the Regulated Activities Order) provision of clearing services contracts of insurance funeral plan contracts individual pension accounts occupational and personal pension schemes certain bodies corporate (mainly building societies, industrial and provident societies, registered friendly societies and other bodies corporate except open-ended investment companies). The Order should be referred to for more detail on the precise definitions of these schemes. What can a DPB licensed firm do? Where the legislation provides that schemes are not a CIS, firms that are unauthorised or have a DPB licence, may be able to establish, operate or wind up such a scheme. However, other parts of the legislation stop an unauthorised or DPB licensed firm from acting in respect of some of these arrangements, such as contracts of insurance, funeral plan contracts and pension schemes which are regulated investments in their own right. What advice can be given on acquisitions by DPB licensed firms? When considering whether a DPB firm can advise on the purchase of units in a CIS, the decision does not rest solely on whether the scheme is constituted as a CIS or is included within the Statutory Instrument referred to above. The legislation does not use this terminology when preventing DPB licensed firms from giving advice on the purchase of investments. The Non-exempt Activities Order (NEAO) prohibits DPB licensed firms from advising individuals to buy or subscribe for a security, such as a share or contractually based investment and the transaction to which the advice relates would be madei) with a person whose business is buying, selling, subscribing for or underwriting the relevant investment, whether as principal or agent; 9