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What is the meaning of the “10-Year Imprisonment Sanctions Club”?

Many clients have asked us over the past two decades, “What is the worst that can happen to us in practice if we breach local country laws on fund marketing?” Clients frequently are surprised to learn that some country regulators have criminal sanctions including imprisonment time on the books for breaches of their country’s fund marketing regulations and/or licensing rules.   

What do punitive sanctions including imprisonment penalties for breaches of country marketing regulations mean to the AIFM/Asset Manager and its sales teams? We have surveyed our 57 country SRMO Sales Road Map© database and have some insights on the “10+ year Imprisonment Sanctions Club”, which, of course, is one club you don’t want to join….

In this Blog, we raise awareness about potential penalties for breaches of country fund marketing regulations and licensing rules. We also explore the logic of regulators’ severe sanctions and how this translates to potential enforcement action.   

Is cross-border fund marketing risk-free?   

No. “Marketing” funds cross-border constitutes a regulated activity in each jurisdiction. This is why there are regulations in each country – most of which are different to each other – governing the promotion of funds to investors in that country.

So if you are marketing or soliciting your fund cross-border into another country, this activity entails RISK. Read our blog, Cross-Border Marketing Compliance: What you Need to Know.

What are our 5-Key Distribution Risks? 

There are 5-Key Distribution Risks involved with cross-border marketing of your fund into other jurisdictions. These comprise the following 5-Key Risks:

1. Sanctions Risk. Regulators in each jurisdiction have different sanctions on their books for breaches of their country’s fund marketing regulations and/or licensing rules. These sanctions can comprise criminal sanctions (imprisonment), administrative sanctions (fines) and/or warnings, bad-actor notifications and more.
2. Litigation Risk. Investors can sue the AIFM/Asset Manager and/or the fund distributor that marketed the fund to them in breach of local country fund marketing or licensing regulations. Some clients say to us, “Well, investors can sue us (the AIFM/Asset Manager) for any reason, so litigation risk is not really an issue for us.”

Our response: You don’t want to give investors legitimate rights to pursue litigation in court because you (the AIFM/Asset Manager) marketed and sold your fund to the investor in breach of local fund marketing or licensing regulations. Litigation risk as part of the 5-Key Distribution Risks can be mitigated by compliance with fund marketing & licensing regulations. Don’t give the investor an extra “free argument” to take you to court.

3. Investor Rescission Rights Risk. Investors can execute their right to request rescission (refund) to get their money back if the fund was marketed and sold to them in breach of local fund marketing regulations. This is like a “free put”, which can be executed at any time by the investor. This so-called “free put” is free to the investor but not-so-free to the fund manager. Investor rescission rights claims are particularly painful to closed-end Limited Partnership GPs. You’re counting on that limited partner to commit capital to your LP for years, and if the capital commitment must be returned because you broke the laws in that jurisdiction, then this could negatively impact the performance of your LP.      
4. 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 subject your precious and growing business franchise to excessive risk of failure?
5. Reputation Risk: AIFM/Asset Managers generally do not want to have a negative industry-wide reputation triggered by any of the 5-Key Distribution Risks. As part of their own RFP processes, investors care about the AIFM/Asset Manager’s business practices and actively choose to invest with AIFM/Asset Managers who have sterling reputations. Those reputations are hard-earned, so why would the AIFM/Asset Manager want to get a bad reputation for breaches of local regulations that could negatively impact their ability to fundraise in the future from investors overseas?

We advise clients to comply with cross-border fund marketing rules at all times to mitigate the 5-Key Distribution Risks. Read our Blog, 5-Key Distribution Risks for Cross-Border Marketing.

Criminal Sanctions: Which countries are in the “10+-Year Imprisonment Sanctions Club”? 

Believe it or not, there are criminal sanctions – including imprisonment - on the books of several jurisdictions if you breach the local fund marketing or licensing regulations for the marketing of your fund to investors in that country. (Scroll down to see to whom these sanctions could potentially apply.)

We conducted a survey of the 57 jurisdictions in the SRMO Sales Road Map© database to confirm which countries have 10 years imprisonment time or longer as part of criminal sanctions for breaches of their country’s fund marketing regulations and/or licensing rules.  We omitted countries that have “imprisonment” (as a general category), for which specific number of years imprisonment was not available.

These imprisonment sanctions could be imposed for breaches of various types of activities under the local (country specific) fund marketing and/or licensing regulations.

Criminal Sanctions: Which countries are in the “10-Year Imprisonment Sanctions Club” for breaches of local fund marketing and/or licensing regulations?

1. Japan
2. Australia
3. South Africa
4. Malaysia
5. Chile
6. Taiwan

Which country has the highest imprisonment sanctions for breaches of local fund marketing licensing regulations? 

1. Mexico: 15 years imprisonment

Which countries have greater than 5 years’ imprisonment sanctions for breaches of local fund marketing and/or licensing regulations?

1. Peru (8)
2. Brazil (8)
3. Italy (8)
4. Hong Kong (7)

To whom do Criminal Sanctions apply?

Counsels confirm that anyone who breaches country fund marketing or licensing regulations is potentially liable for sanctions under local rules, including – for some jurisdictions – criminal sanctions of  imprisonment. Sanctions could apply to anyone conducting the breach, including the following entities (depending on each country’s regulations):

• AIFM/Asset Manager sales teams conducting the marketing activity
• Management of the AIFM/Asset Manager
• Third party distributor sales teams conducting the marketing activity
• Anyone in a supervisory capacity supervising the salespeople conducting the marketing activity

Punitive Criminal Sanctions: What do they mean?

Many AIFM/Asset Managers are surprised (even shocked) to learn that there are criminal sanctions including imprisonment if they breach local country fund marketing or licensing regulations. “Are we really going to prison for breaches of country fund marketing rules?” they ask.

Counsels’ response is: It is not possible to confirm if imprisonment sanctions are actually enforced, as this information is typically not made public. However, punitive criminal sanctions including lengthy imprisonment time under the country fund marketing regulations is a bellwether indicator of the Regulator’s willingness to enforce its laws. So AIFM/Asset Managers can translate 5 to 10+ years imprisonment on the books as: “This regulator means business”.

The reason regulators enforce these laws is because they want to protect their own investors,  namely, retail clients as well as their pension funds and/or sovereign wealth funds. Another reason could be the regulator does not want “capital flight” from its pension fund or sovereign wealth fund investors to leave the country for investment in foreign funds. It’s a protectionist motive. Each of the 7 countries in the “10+ year imprisonment club” has a different history as the foundation (and motive) for extremely punitive criminal sanctions.    

Summary: There are criminal sanctions including 10+ years’ imprisonment on the books for breaches of some country’s fund marketing and/or licensing regulations – and they can apply to all manner of people in the fund marketing process, from AIFM/Asset Manager management to salespeople to supervisors, third party distributors and more. These extreme criminal sanctions mean the regulator is likely to enforce its own regulations if you break their laws. Keep it safe and comply with these rules. Who wants to go to prison?         

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