Financial Services

Unauthorised collective investment schemes and misleading statements | High Court warning for operators and participants

Published on 14th Jun 2018


A recent case provides a stark warning of the risks to operators and participants of schemes if those schemes are later found to be collective investment schemes.  Along with providing clarity on what will constitute a CIS, the decision establishes that the court will take a broad interpretation of who should be considered to be 'knowingly involved' in the CIS.

The case also confirms that, while taking professional advice may be a prudent step, it will not provide a defence against the strict application of the law and its consequences.

Background: regulation of collective investment schemes

Section 235 of FSMA 2000 defines a collective investment scheme (CIS) as an arrangement that enables participants to receive profits or income arising out of the acquisition, holding, management or disposal of any property. The participants must not exercise day-to-day control over the management of the property and the arrangements must have one or both of the following features: (i) the contributions of the participants and the profits and income out of which payments are to be made to them must be pooled; and/or (ii) the property is managed as a whole by or on behalf of an operator of the scheme.


The establishment, operation and winding up of a CIS (including the related activities of promoting and making arrangements for investors to invest) are 'regulated activities' and therefore fall within the general prohibition under section 19 of FSMA unless authorised by the FCA.  Doing so without FCA authorisation is a criminal offence under section 23 of FSMA.  Further, section 382 of FSMA enables the courts to require persons who have contravened FSMA, or been knowingly concerned in a contravention, to make appropriate restitution to investors who have suffered loss.  Finally, making false or misleading statements that may induce investors to invest is a criminal offence under s89 Financial Services Act 2012 (or section 397 of FSMA as it was at the relevant time).


The rationale for the CIS prohibition is that, where there is pooling of contributions and income / profits and collective management of property, the operator is not (or may not be) considering the characteristics and needs of each individual investor, or each individual investor's appetite for risk / need for income or capital, but considering only the interest of the scheme, and the assets forming part of it, as a whole.

Court of Appeal: determination of CISs

In March 2015, the Court of Appeal (in The Financial Conduct Authority v Capital Alternatives Limited & Others) considered whether four investment schemes constituted CISs pursuant to section 235 of FSMA. Of the four schemes, one was an African Land Scheme (offering investments in rice harvests in Sierra Leone) and the others were Carbon Credit Schemes (offering investments in carbon credits generated from land in Sierra Leone, Brazil and Australia). In total, 2,021 investors invested in the schemes between 2009 and 2013, with a total investment of £16.9m and all of their capital was lost.

The Court of Appeal (as the High Court had done before it) determined that the four investment schemes constituted CISs.

In respect of the African Land Scheme and one of the Carbon Credit Schemes, they were not caught by the first limb of the CIS test (set out above).  This was because, whilst the investors' contributions were pooled to allow the initial investment in the land, there was no pooling of income or profits: the individual investors were only paid for the amount of rice harvested on / carbon credits related to their own individual plots (by contrast, the other two Carbon Credit Schemes involved a pooling of income / profits).

However, the Court upheld the determination in respect of all four investments schemes that the second limb of the CIS test was satisfied: the individual plots were not managed individually but were managed as a whole.  This was notwithstanding the fact that the individual investors received a return based on the rents generated by their own individual plots. To avoid being a CIS, it was not necessary for each investor to be involved in each and every decision taken in respect of the land, but it was necessary for at least some decisions in respect of the individual plots of land to be taken by the individual investor or on the individual investor's behalf.

This is further higher court authority on the proper interpretation of section 235 of FSMA, in particular as to what is meant by being "managed as a whole", following on from the Supreme Court's decision in Asset Land Investment Plc v The Financial Conduct Authority (see our previous update on this case here).

Back to the High Court

The FCA initially brought the case in the High Court, seeking restitution orders against the participants in the schemes, including their promotors, administrators and operators and individual directors and shareholders of the schemes. Following the Court of Appeal's ruling on the preliminary CIS issue, the case was referred back to the High Court for judgment on the questions of:

  • whether the schemes were promoted on the basis of false and misleading statements in contravention of s.397 FSMA;
  • the extent to which the defendants were in contravention of FSMA by promoting the schemes and/or by establishing, arranging and operating them;
  • the extent to which the defendants were knowingly concerned in contraventions of FSMA by others; and
  • the appropriate relief, if any, to be granted.

High Court decision: restitution orders

The Court held that breaches of both sections 19 and 397 of FSMA were breaches of a 'relevant requirement' for the purposes of section 382 of FSMA. '

The Court also favoured a broad interpretation of 'knowingly concerned', and held that it would not make sense if this only applied to those who actually "got their hands dirty…". It therefore also applied to those who instruct others to get their hands dirty, and this included those running the various participants in the scheme. The Court confirmed that a fact-sensitive inquiry would be needed, "to determine whether a person is knowingly concerned in the contravention of a relevant requirement of FSMA by others".

However, the concepts of 'making arrangements', 'involvement' and 'concern' are broad and extend beyond those individuals who are the "moving light", "directing mind" or "architect". This can include low-level involvement and administrative back office functions if they "bring about" the transaction or are "events without which investments would not have been made". This could be the opening of a relevant bank account, dealing with completed application forms, processing investment payments or dealing with the carbon credit accreditation process, if those activities are performed with the necessary knowledge.  It could also include subsequent involvement by someone who was in a position to prevent ongoing contravention, but did not do so.

The Court also held that 'knowledge' in the civil context must be proved only on the balance of probabilities. This differs from a criminal prosecution for making false and misleading statements, where knowledge must be proved beyond reasonable doubt, although it can include wilful blindness and recklessness. The Court, further, applied the Court of Appeal's test in SIB v Scandex Capital Management that, if an individual knows of the facts on which the contravention depends (i.e., the elements of the scheme that made it a CIS), it is irrelevant whether or not that individual knows that such facts actually constitute a CIS and, therefore, a contravention.  Thus, the findings of the Court were not that the relevant people knew that the schemes were unauthorised CISs or knew even that there was a significant risk that the schemes were unauthorised CISs, but that they were knowingly concerned in the management and operation of the schemes themselves, which were in fact unauthorised CISs.

The High Court accordingly made restitution orders for various amounts against the remaining defendants (including individuals, of which one was a solicitor) for their roles in the schemes, which the Court held were unlawfully promoted to the public by false, misleading and deceptive statements that had induced investment. The amounts ordered were calculated based on the estimated amount of losses suffered by those investors in the schemes in which the particular defendants were involved.  This meant that, for those entities and individuals involved in all four schemes, the restitution orders were imposed in the minimum amount of £16.9m (subsequently increased to £17.9m following a further application by the FCA to take into account further losses).  The FCA is also seeking injunctions to restrain the assets of some of the defendants.

The Court noted that its discretion to make a restitution order was "extremely wide" and justified the amount of the orders by stating that the law aims to protect the investing public. The public interest must be balanced against the culpability of the contravener. The default position is therefore that a restitution order will extend to the losses sustained by the investors, and can be made against those with a lack of means, even if it makes them bankrupt, and those who have not actually made any money from the CIS.

Arguments that neither the investment property nor the scheme investors were based in the UK were unsuccessful in circumstances where the establishment and operation of the schemes and the arrangements made for the investors to invest took place in the UK.  Finally, unlike in the context of a criminal prosecution for breach of the general prohibition, it is no defence to the civil claim for restitution under section 382 that the defendant took all reasonable precautions and exercised all due diligence to avoid the contravention (which, in any event, the court found not to have occurred on the facts).


This case is a warning to operators who structure their schemes in order to avoid regulation, even if they do so in good faith: the Court has proved willing to make restitution orders against a wide range of both corporate and individual contraveners on a broad interpretation of 'involvement' and on the basis that the requisite knowledge is of the underlying facts, rather than the regulatory breach.  Even taking all due care to avoid the CIS regime, for example, by taking professional advice, will not protect schemes from a strict application of the law and its consequences.  As the Court said "reliance on advice, whilst potentially relevant to whether a restitution order is made or the amount of any such order, does not provide a defence to the claims under S382 FSMA".  This is also the first case in which the Court has made restitution orders against persons who have been found to be knowingly concerned in false and misleading statements in breach of what was then section 397 FSMA.

On the surface, the decision might seem somewhat harsh. The scheme operators had received some general non-binding guidance from the FCA (albeit in respect of different proposals).  On one reading, this could have given them some comfort that they were on the right side of the regulatory line, at least so far as the general prohibition was concerned.  But both the High Court and the Court of Appeal made it clear (as the FCA does) that the proper interpretation of the statutory regime is a matter for the courts, unfettered by any expressions of view or informal guidance given by the regulator or any industry-held view.

As Mark Steward, Executive Director at the FCA Enforcement and Market Oversight Division, said, "This judgment should send a clear message to all of those who use corporate facades to sell dubious investments. We will do what it takes to hold them to account for their misconduct."

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* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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