Clients and prospective clients quite often ask us about setting up pooled investment vehicles in the Isle of Man. Their assumption is generally that any such vehicle is going to be complex, highly regulated and expensive and that it will most likely involve an army of lawyers together with a fund administrator, a licensed custodian, a regulated investment manager and possibly an FSA licence.
While it is certainly true that some investment companies require all of these things – it is not invariably the case. Sometimes, life can turn out be to be a good deal simpler (and cheaper) than might originally have been assumed.
“open-ended investment companies” v’s “closed-ended investment companies”
Under Isle of Man law there is a distinction between “open-ended investment companies” and “closed-ended investment companies”.
An open-ended investment company provides investors with a right of exit – typically by a redemption of their shares whereas investors in a closed ended investment company can only liquidate their investment by selling their shares (eg on a stock market if it is listed) or by way of an action of the Company which may choose to return capital to shareholders – by way of a dividend or another mechanism.
Generally speaking investment companies which invest in illiquid assets tend to be organised as closed ended companies; typical examples would include – venture capital funds & property funds whereas those investing in liquid assets – such as cash funds or investments in other funds would be open-ended.
This is because it’s easy for investment companies with liquid assets to realise the value and return cash to shareholders when asked but very difficult if those assets are illiquid.
Regulation of Investment Companies in the Isle of Man.
Open and Closed ended companies are subject to completely different regulatory regimes in the Isle of Man.
Open ended investment companies are subject to the Collective Investment Schemes Act 2008 (“the Act”). The Act provides for a range of categories of funds but generally speaking open-ended funds are ‘well’ regulated – which is another way of saying that they fall into the “complex, highly regulated and expensive category involving an army of lawyers together with a fund administrator, a licensed custodian, a regulated investment manager and possibly an FSA licence” that was mentioned in the first paragraph.
In November 2017, the Collective Investments Schemes (Definition) Order 2017 came into force. Under this legislation, certain closed ended investment companies fall outside the definition of a collective investment scheme under Manx legislation and therefore they are outside the scope of the Collective Investment Schemes Act 2008.
The Order is complex and it requires careful case by case analysis but there two principal exceptions are for Closed ended investment companies where:
(a) The documents constituting the company prohibit offers to the
public or any section of it and the number of participants is
limited to a maximum of 49; or
(b) there is a minimum initial investment level for its units of at least
US$ 100,000 for each participant,
Arrangements meeting these criteria should not need a custodian, a regulated investment manager or a fund administrator – although, of course, they are free to engage any or all of the above functionaries at the option of their board of directors.
Does a closed ended investment fund require a licence from the Regulator ?
With the exception of Insurance and Pensions business, the Financial Services Act 2008 governs which financial services activities are regulated and licensable in the Isle of Man. The Financial Services Authority in the Isle of Man is responsible for issuing Financial Services licences.
The Regulated Activities Order 2011 sets out the categories of regulated activity and persons wishing to undertake any of those activities are required to apply to the Financial Services Authority for a licence before undertaking any such activity.
Regulated activities are categorised into classes 1 to 8 and include Banking, Trustee Services, Fund Administration and Investment Management.
Class 2 covers “Investment Business”. Regulated Investment activities are broadly defined and include but are not limited to, dealing in investments, arranging deals in investment, advising on investments, managing investment and more.
However, the exclusion 2(b) provides that the issue by a Company of its own shares or debentures is not a regulated activity and exclusion & 2 (l) allows parties to arrange deals in investments where they are a party to the investment.
As a result, a closed ended investment company is free to issue its own shares to third parties and also arrange its own investment deals without requiring a licence from the FSA.
How does the Companies Act Regulate Closed Ended Investment Companies ?
There are three main pieces of legislation in the Isle of Man under which companies can be established. These are the Limited Liability Companies Act 1996, the Isle of Man Companies Acts 1931-2004 and the Isle of Man Companies Act 2006.
This article focuses on Companies incorporated under the Companies Act 2006 (2006 Act) as the flexibility of this modern legislation makes it extremely suitable for forming a Closed-ended investment company. You can find an overview of the 2006 Act companies here and more detailed information about the legislation here.
Under the 2006 Act, there is no distinction between public and private companies; therefore there is no 50 shareholder threshold, the provisions regarding share capital are simple and most importantly the rules governing the offer of shares are straightforward and easy to understand.
An Overview of 2006 Act rules regarding the offer of shares to the Public.
Section 45 of the 2006 Act contains the provision relating to the offer of shares to the public; it is worth reading. Any Closed Ended 2006 Act Company must comply with this section.
The key section says…
…directors shall ensure that any offering document issued in relation to such company shall
(a) contain all material information relating to the offer or invitation contained therein —
(i) that the intended recipients would reasonably expect to be included therein in order to enable them to make an informed decision as to whether or not to accept the offer or make the application referred to therein; and
(ii) of which the directors or proposed directors (as the case may be) were aware at the time of issue of the offering document, or of which they would have been aware had they made such enquiries as would have been reasonable in all the circumstances; and
(b) set out such information fairly and accurately.
This is mercifully straightforward and easy to understand although it does place a weighty responsibility on the directors who are responsible for the accuracy any offer document issued.
The commentary above outlines the regulatory provision which apply to Closed ended investment companies in the Isle of Man. However, it is important to note that non Isle of Man rules and regulations may well apply to any arrangement with investors that are outside the Island. Within the EU the offer of securities are subject to the Prospectus Directive which in the UK was implemented via the Prospectus Regulations 2005.
From an EU perspective the Alternative Fund Managers Directive may also be relevant. If US investors are involved it will be necessary to comply with US law and registration with the SEC may also be required. Listing rules will also apply where the Company is listed.
For this reason, it is vital to take legal advice in every jurisdiction where investors or prospective investors are resident.
Possibly slightly counter intuitively – closed ended investment funds are straightforward and relatively inexpensive to set up in the Isle of Man and are not subject to regulation by the Financial Services Authority. However it is important to ensure that overseas legislation is considered in every jurisdiction where the Company will offer its securities.