By Roger Blears, RW Blears LLP
Enterprise Investment Scheme (EIS) funds are structured on the basis of an investment management agreement between each investor and the manager under which the manager is appointed to make and manage investments. As such all EIS funds are potentially collective investment schemes; 'arrangements for the management of property of any description on behalf of a number of participants' (section 238 FSMA 2000).
Collective investment schemes can only be marketed on a very restricted basis, unless either of two exemptions applies:
1. Managers authorised to act for retail clients can purport to make investments on the basis that they are suitable for each individual’s personal circumstances - an arrangement referred to as an individual portfolio service. If the manager also gives investors the right to withdraw at any time then the arrangements should not amount to a collective investment scheme.
This exemption is unlikely to be suitable for managers making investments in unquoted securities which are inherently risky given the absence of control and the inability to trade shares on a market.
2. Provided investors are given the prescribed withdrawal rights (cash at any time and EIS shares after 7 years) then the fund will not be a collective investment scheme. The crucial difference is that this exemption applies even if the fund manager is only authorised to act for professional clients.
The additional benefit of this exemption is that the manager is not required to make investments on an individual basis for investors by reference to their financial circumstances. Investments must, however, be made in accordance with the investment policy described in the fund’s information memorandum because the fund may still qualify as a collective investment undertaking for the purposes of Markets in Financial Instruments Directive (MiFID) — meaning that MiFID would not apply to the promotion and management of the EIS fund.
Leading FSA counsel’s opinion has been obtained on a number of occasions to the effect that an EIS Fund is an ‘undertaking’ for the purposes of the MiFID exemption. In making his case, counsel points to the fact that the term ‘undertakings’ is widely interpreted for the purposes of UCITS IV (Undertakings for Collective Investment in Transferable Securities Directives) in determining whether an entity is an ‘undertaking for collective investment in transferable securities’, where, taking a purposive approach, its legal form is secondary to its object.
It is commercially attractive for fund managers to fall outside MiFID. This is because MiFID narrowly restricts the class of private investors (now called retail clients) one formerly treated as intermediate customers (now called professionals) to those retail clients with the expertise, experience and knowledge appropriate for EIS investments and who also satisfy certain criteria.
Thus it seems necessary to structure an EIS fund to fall outside MiFID in order to take a common sense benefit from the political will of HMG that EIS funds should be capable of being marketed to and accessible by members of the public.
Lastly, it appears HMG is likely to use the introduction of the Seed Enterprise Investment Scheme to confirm that MiFID had no effect on the exemption, which allows EIS Funds to opt out of the UK CIS regime.
This might involve amending paragraph 2 of Schedule SI 2001/1062:
1. To incorporate reference to the Enterprise Investment Scheme in its title;
2. To refer to EIS legislation as recast in ITA 2007; and
3. Such that the wording in paragraph 2(2)(b)(i) reads ‘the operator will, so far as practicable, make investments in companies which satisfy the requirements of Chapter 4, Part 5, Income Tax 2007’.
These amendments would resolve much of the market confusion, and the re-affirmation of this exemption by HMG by introducing such amendments in a post-MiFID world, would also overcome doubts that MiFID has superseded it.
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