§ 9.15 p.m.
§ Lord McIntosh of Haringey
rose to move, That the order laid before the House on 10th April be approved [14th Report from the Joint Committee].
The noble Lord said: My Lords, this modest but worthwhile order extends a degree of consumer protection to investors in limited liability partnerships (LLPs) by amending the Financial Services Act 1986. It applies only to that Act for the moment We shall, of course, take steps to ensure equivalent protection before the Financial Services and Markets Act 2000 comes into force at the date described as "N2", which we have undertaken will be before the end of November this year.
Limited liability partnerships were created under the Limited Liability Partnerships Act 2000. They are corporate bodies without a share capital. The Act came into force on 6th April. The important point for the purpose of this order is that it will be possible to structure LLPs in a way that management is separated from ownership. This means that membership of an LLP can be bought and sold separately from the underlying business and its assets. These membership interests could be traded in the way that shares of a typical company are traded. We have acted to deal with trading in pooled investment interests.
The emergence of a new investment market is a possibility and not a certainty. But there is some interest in this possible development. Without this measure any such investment market would be unregulated, given that LLPs do not fall within any of the definitions of "investments" or "investment business" in Schedule 1 to the 1986 Act. We wish to provide a degree of consumer protection to ensure that dealing in membership of an LLP is a regulated activity under the 1986 Act.
The effect of the order is that the definition of a "collective investment scheme" in the 1986 Act will he extended to include LLPs. Therefore, to the extent that they function as collective investment schemes, LLI's will become subject to the same requirements of the regulatory regime as are applicable to other existing collective investment scheme structures. In practice, this means that anyone who sets up or winds up a pooled investment LLP will generally need to be authorised under the Financial Services Act. If an LLP is a collective investment scheme, it will need to be authorised itself. As the operator of the scheme, its 989 assets will be controlled and traded by it on behalf of the underlying investors, as is the current position with an OEIC (an open-ended investment company).
An advertisement for the issue or sale of an LLP interest, which will be an investment advertisement, must be issued by or approved by an authorised person. However, the issue of an advertisement for new "partners" in a purely commercial or professional firm organised by an LLP should not be an investment advertisement.
There are restrictions on the promotion of unregulated collective investment schemes—these largely prohibit promotion to unsophisticated investors. Those prohibitions will apply to pooled investment LLPs. Firms currently engaged in setting up or operating collective investment schemes will be familiar with those requirements. Advisers will be familiar with the boundary questions that will arise in determining whether or not a firm is a collective investment scheme, as the same tests will be applied.
No additional regulatory costs are imposed on firms using the LLP structure, as opposed to other existing collective investment scheme structures used to undertake investment business. I want to emphasise that not every participation in an LLP is brought within the scope of financial services regulation by this change. That is not our intention, and it is not what the order does. The order merely provides that,limited liability partnerships are capable of being collective investment schemes".The order addresses the situation where the right to take part in an LLP is packaged and held out as an investment. The process of a partner joining or leaving a working partnership, that has chosen to take advantage of the LLP Act and is structured as an LLP, will be unaffected by this order. This is because the order only does what it says: it allows LLPs to be collective investment schemes. It does nothing more. That is why I described it as being "modest". In particular, it says nothing about the process whereby members join or leave a business. The Limited Liability Partnerships Act 2000 governs these matters.
Some people may ask whether LLPs might be able to structure themselves so that, at one at the same time, they are able, first, to trade in their membership interests; and, secondly, they do not fall within the core definition of "collective investment scheme" in Section 75 of the Financial Services Act. If they are able to do this, it is asked: are they not unregulated? Similarly, is the order before the House of no assistance? The answer to that conundrum is as follows. Any LLP that is structured in such a way that non-working partners are able to trade in their membership interests will fall within the core definition of "collective investment scheme" under Section 75 of the Financial Services Act.
Where an LLP wants to obtain investment capital, it has a number of choices, which the order does not limit. In some professions the rules of the relevant professional body may limit those choices and might preclude the creation of what I could call "investment participations"; that is, for example, the case for 990 solicitors. They can, of course, raise investment capital through the issue of debentures. But, if that is allowed, an LLP that seeks to create and market investment opportunities—that is, turning itself into an investment business—will be subject to investment regulation.
It is certainly not our intention to restrict the development of LLP businesses. We do not believe that this order will do so. However, we shall be able to keep this under review. We have a further opportunity to look at this when we legislate to bring in these protections under the Financial Services and Markets Act later this year.
It has been suggested—it was suggested in another place—that regulation akin to that of shares would be simpler. We considered that option. But in both economic and management terms LLPs are much closer to partnerships than companies with share capital, and the tax and regulatory framework generally looks to the respective partnership rules. This approach has the advantages of practicality and simplicity and of being built on an existing, widely understood regime.
The approach in the wider LLP legislation is to tax them in the same way as partnerships, and (at least in the default provisions in the LLP regulations) to set up a membership agreement which looks more like a partnership deed than articles of association of a company.
Adjusting the definition of "share"—which was what was suggested—would have the effect that every business organised as an LLP would be subject to some regulation (investment advertisements, prospectuses, advice and so on), whether or not the LLP was for investment purposes. This is the position with companies but not the position for partnerships (general and limited). This strikes us as over-regulation, given the expectations that the LLP structure is most likely to appeal to businesses currently structured as partnerships.
While it might have been possible to produce a way out of these difficulties that would have further complicated the issue. We considered the other alternatives of leaving them outside the regulatory structure altogether and creating a wholly new type of investment within the scope of the Financial Services Act (with the same result on advertising as adjusting the definition of share). I hope that I have made clear why those options were not pursued.
The benefits of the order are essentially precautionary. Without this measure there would be risks of investor difficulty or losses, but these are risks we think it is right not to expect investors to run as the sums involved could be substantial.
Of course we attach real importance to protecting investor confidence in the wider financial system (which any widespread problems undermine) and this change will contribute to that. In my view this order is compatible with the European Convention on Human Rights. I commend the order to the House.
§ Moved, That the order laid before the House on 10th April be approved [14th Report from the Joint Committee]. (Lord McIntosh of Haringey).
§ On Question, Motion agreed to.