Tuesday, October 16, 2012

AIF Regulations: Meaning of Ownership Interests and Investor Interests in a Company – Part II

[The following post is part of the series contributed by Vinod Kothari and Soma Bagaria. The authors can be reached at vinod@vinodkothari.com and soma@vinodkothari.com respectively. The first post of the series can be found here.]

As the AIF Regulations are unclear on the extent of its applicability in case of companies, guidance can be sought from other jurisdictions.

1.             United States

In the US, the Investment Company Act, 1940 (“US Act”) regulates an investment company, which has been defined as an issuer of securities that:

(a)           is, holds itself out to be, or proposes to be engaged primarily in the business of investing, reinvesting, or trading in securities;

(b)          is engaged or proposes to engage in the business of issuing face amount certificates of the instalment type, or has been engaged in this business and has such a certificate outstanding; or

(c)           is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of government securities and cash items) on an unconsolidated basis.

The Financial Accounting Standards Board (“FASB”) sets out the following criteria for determination of an ‘investment company’:[1]

1. An investment company is an entity that does both of the following:

a.    Obtains funds from an investor or investors and provides the investor(s) with professional investment management services

b.    Commits to its investor(s) that its business purpose and only substantive activities are investing the funds for returns from capital appreciation, investment income, or both.

2. An investment company and its affiliates do not obtain or have the objective of obtaining returns or benefits from their investments that are either of the following:

a.    Other than capital appreciation or investment income.

b.    Not available to noninvestors or are not normally attributable to ownership interests.” [emphasis supplied]

Of course, the above criteria are only indicative and cannot be construed as a litmus test for determination of an investment company. However, it is pertinent to note that a clear distinction has been made between the investment interest and ownership interest, the latter being excluded as an investment company.

2.             United Kingdom

Section 235 of the Financial Services and Markets Act, 2000 defines a collective investment scheme to mean:

any investment arrangements with respect to property of any description, including schemes, money, the purpose or eect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.

It has been further stated that the participants in such scheme shall not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions.

Furthermore, both of the following characteristics shall be satisfied:

(a)           the contributions of the participants, and the profits or income out of which payments are to be made to them, shall be pooled; and

(b)          the property shall be managed as a whole by or on behalf of the operator of the scheme.

Therefore, a collective investment scheme is an arrangement that enables a number of investors to pool their assets and have these professionally managed by an independent manager.[2] The segregation between management and investors, therefore, is quite clear.

3.             European Union

The Directives relating to undertakings for collective investment in transferable securities (“UCITS Directive”)[3] excludes a collective investment undertaking undertakings of the closed ended type from the purview of the UCITS Directive.[4] In other words, a closed-end vehicle, which is what all companies are, is completely excluded from the UCITS Directive.

The Directive on AIF Managers by the EU Committee of the House of Lords, AIF was defined to include hedge funds, private equity funds, venture capital firms, commodities and real estate funds.[5]

4.             Singapore

The Securities and Futures Act (Cap 289) of Singapore defines a collective investment scheme to mean:

(a) an arrangement in respect of any property —
(i) under which —
(A) the participants do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions in respect of such management; and
(B) the property is managed as a whole by or on behalf of a manager;
(ii) under which the contributions of the participants and the profits or income from which payments are to be made to them are pooled; and

but does not include —
(i)   an arrangement operated by a person otherwise than by way of business;
(ii) an arrangement under which each of the participants carries on a business other than investment business and enters into the arrangement solely incidental to that other business;
(iii)         an arrangement under which each of the participants is a related corporation of the manager;
(x) a closed-end fund constituted either as an entity or a trust;

Here again, one would notice a complete exception carved for closed-end funds, which would include all investment companies.

(to be continued)

- Vinod Kothari & Soma Bagaria

[1] See Investment Companies Summary of Decisions Reached to Date During Redeliberations as of September 5, 2012. Available at: http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175824491189&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs (last visited on October 10, 2012)
[2] http://www.hmrc.gov.uk/collective/what-is.htm (last visited on October 11, 2012)
[3] Directive 2009/65/EC of the European Parliament and of the Council. Available at: http://www.esma.europa.eu/system/files/L_302_32.pdf (last visited on October 10, 2012)
[4] Article 3(a) of the UCITS Directives.

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