Legal Framework for the Activities of Registered AIF Managers

CIRCULAR: 11/2016 DATE: 27.05.2016 THE CIRCULAR APPLIES TO: Managers of alternative investment funds Securities companies

FINANS TILSYNET P.O. Box 1187 Sentrum 0107 Oslo

Legal Framework for the Activities of Registered AIF Managers

Table of Contents

1. Introduction 3
2. Legal Basis 3 2.1 Requirement for either authorization or registration 3 2.2 Strengthened investor protection when marketing to non-professional investors 4 2.3 Who is a non-professional investor? 4
3. Further on the concept of marketing etc. 5 3.1 What counts as marketing? 5 3.2 Marketing by others than the registered AIF manager 6 3.3 Transactions in secondary markets 6
4. Internal procedures for marketing and documentation of customer classification 7
5. Future enforcement of breaches of the marketing prohibition 7

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1 Introduction

Alternative investment funds managed by registered AIF managers cannot be marketed to non-professional investors. The Financial Supervisory Authority has conducted an investigation to verify compliance with the marketing prohibition. Based on the experiences from the thematic supervision, the Financial Supervisory Authority sees a need to provide further information about the restrictions that apply to the activities of registered AIF managers, and what the Financial Supervisory Authority will base its supervisory practice on.

The circular provides further details on, among other things, who can be classified as a non-professional investor, and what counts as marketing. Proper compliance with the regulations is necessary to ensure that non-professional investors receive the protection that the legislation presupposes.

2 Legal Basis

2.1 Requirement for either authorization or registration

A manager of alternative investment funds must have authorizations under the AIF Act if a managed fund is to be marketed to non-professional investors, cf. Act of 20 June 2014 No. 28 on the management of alternative investment funds (the AIF Act) § 1-4 (6) and § 7-1. The manager must have a concession as an AIF manager and a specific marketing authorization for each individual fund that is to be marketed to non-professional investors. A number of organizational and operational requirements for the business must be met, and a depositary must be appointed for each individual fund.

AIF managers who manage funds with a total managed capital below certain thresholds, and who do not intend to market to non-professional investors, may instead choose to register in a register maintained by the Financial Supervisory Authority, cf. AIF Act § 1-4(1). As of 1 May 2016, there were just under 70 registered AIF managers. The AIF managers declare upon submission of the registration form that the funds managed will not be marketed to non-professional investors.

The thresholds for the requirement of a concession are set at an amount in Norwegian kroner corresponding to:

• 500 million euros when the portfolio consists of alternative investment funds that are not subject to financial leverage, and which do not have redemption rights for a period of five years from the date of the first investment in each fund, or
• 100 million euros, for other types of alternative investment funds than those mentioned above.

Footnote 1: The requirement for authorization to market alternative investment funds to non-professionals under the AIF Act does not apply when marketing alternative investment funds that are also national securities funds. Management of national securities funds requires authorization under the Act of 25 November 2011 No. 44 on securities funds.

2.2 Strengthened investor protection when marketing to non-professional investors

Alternative investment funds comprise a number of types of funds, such as various types of hedge funds, active ownership funds, and property funds. The investment area, risk, costs, and complexity of the products vary greatly, and some alternative investment funds will be unsuitable as savings alternatives for many non-professional investors. The AIF Act with regulations therefore contains strengthened investor protection when marketing alternative investment funds to non-professional investors. The requirements aim to provide non-professional investors with sufficient protection when selling such products.

When marketing to non-professional investors, the manager must, as mentioned, have authorization regardless of the size of the capital under management, and a specific authorization to market the individual fund, cf. AIF Act § 7-1. The requirement for authorization implies, among other things, that the AIF manager will be under full supervision. In addition, special requirements apply to good business practice in customer treatment, cf. AIF Act § 7-3. Suitability testing of the customer must be conducted to ensure that the investment fits the individual's investment objectives, risk tolerance, and level of knowledge. The suitability test must be conducted before the investor subscribes, and the customer treatment must be documented.

It is also required that the AIF manager prepares key information for each alternative investment fund, and that the manager is affiliated with an external complaint scheme. The detailed requirements follow from Chapter 7 of the AIF Act with regulations.

2.3 Who is a non-professional investor?

For the registered AIF managers to comply with the marketing prohibition, the managers must classify customers correctly. It is a narrow circle of investors who can be classified as professional.

A non-professional investor is, according to AIF Act § 1-2(l), an investor who cannot be classified as professional according to the Securities Regulations § 10-2, and who also cannot be treated as a professional customer according to the Securities Regulations §§ 10-4 and 10-5.

In principle, all private individuals are non-professional investors. According to the Securities Regulations § 10-2, only securities companies, credit institutions, insurance companies, pension funds, and similar institutional investors are considered professional investors. Investment companies that meet certain financial thresholds can also be considered professional, cf. § 10-2 letter (b).

Customers who do not meet the requirements for being professional according to the Securities Regulations § 10-2 can request to be treated as professional, provided the customer meets two of the following three criteria listed in the Securities Regulations § 10-4:

• has executed transactions on the relevant market on average ten times per quarter in the four preceding quarters,
• has financial portfolios of more than 500,000 Euros, and
• works or has worked in the financial sector for at least one year in a position requiring knowledge of the relevant transactions or investment services.

The manager may treat customers who meet at least two of the above criteria as professional, provided the following additional requirements in the Securities Regulations § 10-5 are met:

• the customer gives their request to be treated as professional in writing, and
• the customer receives a clear written warning about the investor protection and rights the customer waives,
• the customer declares in writing, in a document other than the customer agreement, that they understand the consequences of waiving investor protection.

The registered AIF manager must take all reasonable measures to ensure that the criteria according to § 10-4 are met, and can only comply with a request from a customer if the manager can with reasonable certainty establish that the customer has the necessary experience, knowledge, and expertise to make the relevant investment decision, and understands the risk associated with the decision.

If a registered AIF manager accepts a request from a non-professional customer to be treated as professional, the manager must be able to document that the conditions are met. If the AIF manager cannot document correct classification to the Financial Supervisory Authority, it will be assumed that the person is non-professional.

3 Further on the concept of marketing etc.

3.1 What counts as marketing?

The AIF Act contains a broad definition of marketing. Marketing is understood as a direct or indirect offer to purchase or place shares in an alternative investment fund on the manager's initiative or on behalf of the manager, cf. AIF Act § 1-2 letter h).

Non-professional investors often have limited knowledge and experience regarding complex investments, such as alternative investment funds often are, and the investments will often have significant importance for the individual. The marketing rules of the AIF Act are intended to ensure adequate investor protection. The purpose therefore also implies that the concept of marketing should be understood broadly.

Marketing in this context covers more than what is commonly considered marketing in other contexts. It is not only general marketing measures such as advertising and other publicity that are covered, but also other activities that involve inviting or encouraging investment in an alternative investment fund. This includes sales-oriented activities such as information meetings or customer interviews, and other forms of information given to potential customers prior to the customer's investment decision. In other words, it is not necessary for the marketing to be directed at the general public, or a larger circle of investors, for the activity to be considered marketing.

Offers to purchase or place shares to the manager's family or social network are also considered marketing. Similarly, offers directed to existing shareholders in the relevant fund will be considered marketing, including offers to purchase or place shares in connection with capital increases.

The Financial Supervisory Authority will, in its practice and in line with statements in the preparatory works of the AIF Act, base the assumption that the marketing prohibition will largely be the same as a subscription or sales prohibition, albeit with a narrow exception for purely passive sales.

Passive sales, or sales that occur on the customer's own initiative, also referred to as "first approach," are not considered marketing. Passive sales include sales that occur exclusively on the customer's initiative, and without the manager, or anyone acting on behalf of the manager, having marketed the fund to the customer before the customer has committed to invest. For a sale to be conducted by a registered AIF manager without conflicting with the marketing prohibition, it is a prerequisite that the entire process leading up to the sale, and not just the initial contact, occurs on the customer's initiative. Passive sales generally require no other involvement from the manager than accepting the customer's offer to subscribe to the relevant fund.

The thematic supervision revealed that some of the registered AIF managers managed funds with shareholders who were either wholly or largely classified as non-professional. Non-professional investors normally have limited knowledge and experience with alternative investment funds and complex investments. Sales that occur on the customer's own initiative will therefore be rare in practice. A business model where the registered AIF manager relies on sales to non-professional investors who subscribe on their own initiative will be difficult to implement within the framework of the regulations.

3.2 Marketing by others than the registered AIF manager

Securities companies that wish to distribute alternative investment funds must ensure that the manager has the necessary authorizations. Securities companies cannot market alternative investment funds managed by registered managers to non-professional investors.

3.3 Transactions in secondary markets

The Financial Supervisory Authority assumes that the marketing prohibition does not prevent shareholders from transferring their shares to other non-professional investors in the secondary market.

The prerequisite is that the manager, or other sales and marketing channels, does not market the shares.

4 Internal procedures for marketing and documentation of customer classification

The Financial Supervisory Authority assumes that registered AIF managers must have internal procedures to ensure compliance with the marketing prohibition, including procedures for classifying private individuals and small and medium-sized enterprises.

If a registered AIF manager accepts a request from a non-professional customer to be treated as professional, the manager must document that the conditions for the reclassification are met.

5 Future enforcement of breaches of the marketing prohibition

The Financial Supervisory Authority takes breaches of the prohibition against marketing alternative investment funds to non-professional investors seriously.

Registered AIF managers who market alternative investment funds to non-professional investors will be conducting illegal business. If violations are discovered, the Financial Supervisory Authority may order the cessation of business activities under the Financial Supervisory Authority Act § 4 letter a.

In the event of a breach of the marketing prohibition, it must be expected that the Financial Supervisory Authority will delete the manager from the register. In such a case, a new AIF manager must be appointed for the funds managed by this manager. If a fund has non-professional owners who entered the fund as a result of illegal marketing, a manager with authorization under the AIF Act must be appointed as manager for this fund. Alternatively, the fund must be liquidated.

Breaches of the prohibition will be taken into account in future suitability assessments of significant owners, board members, and management, for example when applying for a concession.

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