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What are the risks of non-compliance with fund marketing rules for cross-border marketing in practice?
Since 2006, Global Sales Compliance (GSC) has worked closely with AIFM/Asset Manager marketing teams to ensure compliance with cross-border marketing rules.
Many clients have asked us, “What is the worst that can happen to us in practice if we breach local laws on fund marketing?” During nearly two decades of GSC’s bespoke marketing compliance advisory we have investigated with our legal counsel network in 70+ countries numerous client queries about the risks associated with cross-border marketing.
In this blog, we identify the 5-Key Distribution Risks associated with fundraising overseas and the practical implications to AIFMs and Asset Managers.
Is cross-border marketing risk-free?
No. Marketing funds and financial services cross-border constitutes a regulated activity in each jurisdiction. This is why there are regulations in each country governing the promotion of financial products or services to investors in that country.
So fundraising cross-border (overseas) entails RISK.
We advise clients to mitigate their distribution risks as much as possible by complying with local laws and regulations on the marketing of funds or financial services to investors in each country.
What are the 5-Key Distribution Risks?
- Sanctions Risk
- The country regulator could impose sanctions for unlawful activity carried out in their jurisdiction. Many AIFMs/Asset Managers don’t realise there are criminal sanctions including imprisonment as well as administrative sanctions (fines) in many jurisdictions for breaches of fund marketing and/or licensing rules.
- For example, in several Asian jurisdictions there are criminal sanctions of 10 years imprisonment for breaches of fund private placement rules or fund prospectus registration requirements.
- In a certain Latin American jurisdiction, the country regulator imposes 15 years imprisonment for breaches of licensing regulations for cross-border marketing of funds.
- In other jurisdictions, there are large fines ($/EUR/£ MM) that could apply for breaches of local laws.
- These sanctions could apply to the entity carrying out the breach (i.e., salespersons) and/or management of the entity carrying out the breach.
- In practice, tough criminal sanctions are generally a “bellwether indicator” of the local regulator’s willingness to enforce their rules.
- Litigation Risk
- Investors can sue the AIFM/Asset Manager on the basis that the AIFM/Asset Manager broke local laws and regulations for the marketing of funds or financial services to the investor in their country.
- Clients say to us, “Investors can sue us anyway for any reason, so why is litigation risk important?”
- Our response to clients is, “Don’t give investors any reason or claim to sue you based on your (AIFM/Asset Manager’s) breaches of local fund marketing laws.”
- In practice, here’s what has been known to happen:
- investors become disgruntled (they lose money) in the AIFM/Asset Manager’s fund,
- investors can file a complaint with the local regulator claiming that the AIFM/Asset Manager breached local laws on fund marketing (and/or)
- investors can file a lawsuit in court against the AIFM/Asset Manager, claiming that the investor’s fund subscription contracts are null and void because the AIFM/Asset Manager breached local marketing regulations.
- Litigation risk can have a spillover negative impact on the AIFM/Asset Manager’s reputation and business franchise risks. High-profile litigation could reflect badly on the AIFM/Asset Manager’s reputation and business franchise.
- Investor Rescission Rights Risk
- Litigation and investor rescission rights risks frequently go together.
- When AIFMs/Asset Managers breach local marketing laws, in practice it is the equivalent of the AIFM/Asset Manager handing out free put calls (“free puts”) to the investor.
- Investors could have legitimate claims against the AIFM/Asset Manager to get their money back, requesting rescission rights if the AIFM/Asset Manager has breached local regulations on marketing the fund to the investor, effectively, a “free put”.
- “Free Puts” to the investor are so not free to the AIFM/Asset Manager; they are in fact very costly (“expensive puts”) as investor rescission rights claims could potentially:
- negatively impact the performance of the AIFM/Asset Manager’s fund
- investors could file lawsuits in court against the AIFM/Asset Manager
- AIFM/Asset Manager incurs large legal costs to defend the lawsuit
- AIFM/Asset Manager hires in-house lawyers (more headcount) to defend the lawsuit (and/or)
- the AIFM/Asset Manager’s reputation and business franchise could suffer due to bad publicity.
- Business Franchise Risk
AIFM/Asset Managers generally do not want to subject their business franchise to unnecessary risks. However, breaches of local marketing regulations can indeed subject the AIFM/Asset Manager to business franchise risk. Why would fund managers want to subject their precious and growing business franchise to excessive risk of failure? - Reputation Risk
AIFM/Asset Managers generally do not want to have an industry-wide bad reputation triggered by any of the 5-Key Distribution Risks. As part of their own RFP processes, investors actually care about the AIFM/Asset Manager’s business practices and choose to invest with AIFM/Asset Managers who have a good reputation. Reputations are hard-earned, so why would the AIFM/Asset Manager want to have a bad reputation for their own breaches of local regulations that could negatively impact their ability to fundraise from investors overseas?
Cross-border marketing does entail some risk. We advise clients to comply with cross-border marketing rules at all times to mitigate the 5-key Distribution Risks for cross-border marketing. If the AIFM/Asset Manager wants to take additional risks in the local jurisdiction (going up the risk spectrum), then we advise clients to assess these opportunities with a measured risk-benefit analysis on a case-by-case basis with backup documentation to compliance file.
It is possible to mitigate the 5-Key Distribution Risks when marketing cross-border to keep your business franchise safe.
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