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Regulators (or National Country Authorities, aka “NCAs”) across the globe are cracking down on breaches of their country’s regulations for a wide range of activities, including for the marketing and sale of financial products (funds) and services to investors in their country.

Many NCAs are tightening regulations to protect their most precious client segments. Historically, regulators have always strived to protect retail customers. Now, in many countries, the incentive for regulators is to further protect their country’s pension funds, sovereign wealth funds and private wealth management (HNWI) client segments.

When AIFMs/Asset Managers are marketing your funds cross-border into foreign jurisdictions, what do regulators expect from you?

In this blog, we explore your cross-border marketing activities from the lens of the regulator: What are they expecting from you? Do regulators apply a “form” vs. a “substance” test when considering whether AIFM/Asset Managers have complied with their jurisdiction’s regulations?

What do regulators expect from us while fundraising in their jurisdiction?

#1: There are country specific rules governing your marketing activities

Marketing funds cross-border into overseas jurisdictions constitutes a regulated activity. This means that marketers and financial service providers must comply with the local jurisdiction’s rules on the promotion of funds as well as licensing requirements. Read our blog: Cross-Border Marketing Compliance: What you Need To Know

#2: Regulators expect you to know what their country’s fund marketing laws are and to comply with these regulations for any regulated activity you undertake in their country

NCAs expect you to comply with these marketing regulations – otherwise, why would they go to the trouble to draft country marketing regulations? The point is, country fund marketing regulations are NOT optional and ignorance of the law is no defense. So before you send out any marketing collateral, organise a phone call, hold a virtual meeting or send out an email to investors in any country referencing your fund, you need to check that country’s fund marketing regulations. This must happen BEFORE you initiate any fund promotional outreach in any country.

Who wants regulatory sanctions for unlawful cross-border fund marketing activity?

No one in their right mind!

If you breach laws in foreign countries for the marketing of your fund, you could be subject to the 5-Key Distribution Risks. These are:

1. Sanctions by the Regulator
2. Lawsuits from investors
3. Rescission rights claims from investors
4. You could lose your business franchise … and
5. Your reputation could suffer.

Why would you want to trigger any of these Distribution risks?

Read our blog: 5-Key Distribution Risks for Cross-Border Marketing

How serious are regulators about enforcing their country’s fund marketing regulations?

Many NCAs are very serious about enforcement of their laws in order to protect investors in their jurisdiction and/or their “golden goose” cottage industry (i.e., HNWI, PWM client segments).

Many regulators mean business when you break their country’s fund marketing laws: a bellwether indicator of the seriousness of the NCA’s enforcement is the sanctions on the books for breaches of marketing regulations and/or the level of fines imposed for “bad actor” activity. It’s also helpful to review actual sanctions enforcement activity in practice to gauge how serious a regulator is on enforcement.

Perhaps one of the most serious indicators is prison time.

By way of example, we have identified several countries falling into the category we call, “the 10-Year Imprisonment Club” where anyone in breach of these country’s regulations could technically go to jail for 10 years – these are the regulators we label as “sharp teeth” NCAs that really mean business when it comes to enforcement of regulation breaches and investor protection.

Read more about enforcement in our blog: Punitive Fund Marketing Regulations Sanctions: Enforcement indicator?

To avoid triggering sanctions while conducting cross-border fundraising in foreign jurisdictions, in the regulator’s eyes, it’s important for AIFM/Asset Managers to understand the concepts of marketing compliance “form” vs. “substance”.

What is Marketing Compliance 'Form' vs. 'Substance'?

Marketing compliance “form” means (broadly) the books, records and evidence AIFMs/Asset Managers keep in-house to document compliance with marketing regulations in each jurisdiction where they are doing business. Compliance books and records are paramount to a robust compliance infrastructure. Because fund marketing constitutes a regulated activity, each AIFM/Asset Manager must be ready to defend their compliance status at all times when questioned by regulators and/or in the case of investor litigation. It is a proof check.

Marketing compliance “substance” means, it matters that your actual activities in any foreign jurisdiction comply with the country’s marketing rules in “real time”. In other words, you cannot claim you are compliant if your cross-border marketing activities don’t match up to that statement. It is an honesty check.

Will regulators apply a marketing compliance “Form” vs. “Substance” check on my activities in their jurisdiction?

In order for regulators to consider whether AIFMs/Asset Managers are compliant with country regulations, they’ll apply both a “substance test” (are you complying in practice with our laws on marketing your funds) AND a “form test” (you must demonstrate compliance books and records that prove your compliance with our rules).

In other words, your form MUST match substance.

You cannot fib and say, “We are compliant and here are the records to prove it,” if these records do not match up with your actual activity in any jurisdiction (“the substance of your activities”). Equally, if you have no FORM (no books and records to the file) to prove your compliance with the country’s marketing regulations, then how can you prove your actual activities are compliant?

To demonstrate the marketing compliance “form” vs. “substance” concept, let’s explore their application to the “hot topic” of Reverse Solicitation.

Marketing compliance 'Form' vs. 'Substance' in Action: Reverse solicitation

“Reverse solicitation” is a marketing scenario whereby the potential investor contacts the fund manager (AIFM/Asset Manager) and requests information on the fund manager’s fund on an unsolicited basis. This scenario was intended by regulators to be a potential example of a carve-out to local regulations on solicitation of funds so long as the contact with the investor was genuinely unsolicited by the fund manager, based on the fact set.

What regulators will expect from you in the case of reverse solicitation:

“Substance Test”: To confirm if a case of “reverse solicitation” is genuine (or not), Regulators generally apply the “initiative test”: who contacted whom first? Did the investor do their own independent research and find the fund manager to request information on the manager’s fund without any prior contact by the fund manager? Or did the fund manager make outreach first to the investor, taking the first initiative by any means (phone calls, emails, video calls, meetings, etc.)?

“Form Test”: In any case of reverse solicitation, the fund manager should document the fact set surrounding the investor’s request for information about their fund with compliance notes to the file in order to prove at all times that the fund manager did NOT solicit the investor, rather, the investor contacted the fund manager about information on the fund.

Read more about the topic in our blogs: What is Reverse Solicitation? and Reverse Solicitation: What is the Initiative Test?

By way of example and applying both tests, if you (a US hedge fund manager managing a Cayman domiciled hedge fund) have 100 Reverse Solicitation letters signed by 100 investors resident in France (signed letters claiming investors contacted you for information about your hedge fund as a reverse enquiry or “passive solicitation”), France’s AMF may likely “look through” your “form” and apply the “substance test” to your claim of Reverse Solicitation (as the reason why you have so many French investors in your hedge fund which cannot legally be marketed in France).

Here's how AMF thinks: how realistic is it that 100 French investors out of the blue, with no prior contact or solicitation by you, contacted the fund manager to request information about their hedge fund? Not very likely.

Similarly, if your fundraising in France is limited to one-off instances of “passive solicitation” (in “substance”) about your hedge fund, you should have compliance records (“the form”) to prove your operational “substance”.

Summary

Regulators are increasingly willing to crack down on breaches of their national fund marketing regimes, to protect more than just retail clients. The days of AIFM/Asset Managers ignoring country fund marketing regulations and fundraising cross-border by “flying under the radar” are over.

Ignorance of these laws is no excuse. Compliance with these laws is not optional.

To avoid triggering sanctions when fundraising overseas, AIFM/Asset Managers should mitigate their 5-Key Distribution Risks by complying with country fund marketing rules at all times in form AND substance. Put in place a cross-border marketing compliance platform and document it with robust books and records to prove it.

Regulators expect that if you say you are compliant with their fund marketing regulations, your marketing compliance “form” has to match your marketing “substance” at all times.

Be expected to prove your compliance at all times, even at the drop of a hat!

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