The FCA vs Capital Alternatives

Intelligent Partnership director Daniel Kiernan has been following the FCA vs Capital Alternatives court case very closely, here is a short overview of the case as things stand.

In July 2013, the FCA issued proceedings against Capital Alternatives and 14 other parties alleging that two investment schemes, African Land and Reforestation Projects (known as Capital Carbon Credits), were operating illegally as collective investment schemes (CIS). Operating a CIS in the UK without authorisation is a criminal offence. Capital Alternatives argued that the schemes were direct purchases of property and therefore not collectives.

African Land consisted of a rice farm called Yoni Farm. Investors purchased sub-leases on plots of land and would receive profits from the rice cultivated on them. Investors in Carbon Capital Credits purchased sub-leases on plots of forestry expecting to receive accreditation for tradable carbon credits that could then be sold at a profit. Both schemes were promoted by Capital Alternatives and had raised investment approaching £17m in total, from over 200 investors.

The case began in October 2013 and was concluded in favour of the FCA in February 2014.

The legal framework

An investment scheme will be classed as a CIS only if participants in the scheme do not exercise day-to-day control over the management of the investment property and one or both of the following criteria is satisfied: (i) the contributions to and profits or income from the investment scheme are pooled together by the scheme operator; or (ii) the investment property “as a whole” is managed by the scheme operator.

When is a Collective not a Collective?

The arguments really come down to what makes a scheme ‘collective’, which really depends upon three key issues: day-to-day control, pooling and management of the ‘whole property’.

Since Brown Vs Innovator, it has been clear that when considering the issue of day-to-day control, what matters is whether investors can exercise effective day-to-day control – the unexercised contractual right to appoint different management companies is irrelevant. The court found that day-to-day control of the schemes rested with the operators.

The court found in favour of the operators when it came to pooling. Investments were pooled for the purposes of purchasing land and running the farms, but income and profits were not – on Yoni farm the rice was harvested separately and investors received returns commensurate with the amount of rice grown on their land.

However, this was the only activity that was undertaken on an individual basis – other collective elements such as construction, drainage, roads, bridges and irrigation were considerable and were carried out as whole for the benefit of the entire farm and all investors.

Overall, the court found that the two schemes were collectives. The division of the property into separate plots to generate individual returns was simply an attempt to avoid the scheme being classed as a regulated activity that did not benefit investors.

Alarming Facts

Some alarming facts came out during the case. African Land, which was to be based around rice farming, had sold more land to investors then it owned – purchasers of some 4,300 acres have received no return and most of them have had no land allocated to them. In addition, Capital Alternatives took a 50% commission paid from each new investment, meaning that the land would have to double in value for investors to recover their principal when they exited.

Reactions

FCA director of enforcement and financial crime Tracey McDermott said:

“This ruling shows that even if operators have deliberately tried to structure their scheme to avoid regulation, the court will still look at whether those operating the scheme should in fact be regulated for consumer protection.”

However Capital Alternatives and African Land will be appealing the decision. Capital Alternatives said in a statement:

“The FCA only won this preliminary issue trial on the basis of a narrow legal interpretation of the Financial Services and Markets Act. The FCA lost on every significant issue of fact.”

African Land said in a statement on its website: “At the outset, it is worth noting that the landscape of the FCA’s complaints… has changed considerably since the FCA launched these proceedings without ever having been to the farm [customers invested in].

At the July hearing, the FCA’s case against African Land was, in effect, presented as a fraud case where the farm and its operation was a mirage. It was alleged that the scheme was not being operated in accordance with the way in which it was marketed to investors (i.e. separate harvesting of investor plots) and the underlying implication and tone of the FCA’s case was that the scheme was a sham.”

According to African Land, the FCA made three accusations: that the individual investor acres were not separated; that the individual investment returns were pooled; and that the investment was managed as a whole.

African Land claims that only the third point stood up under the scrutiny of the High Court and led to the farm technically being classed as a collective investment scheme.

In the meantime, the injunctions placed by the FCA on the firms last July remain in place, meaning the schemes’ major assets remain frozen and the firms are prohibited from further promotion of the schemes.

What happens next?

Alternative investment operators will have been watching this case closely. A number of the defendants had relied on guidance given to them on various similar projects by teams at the FSA. The court stated that such informal guidance could not be relied upon and that the onus was very much on the scheme operators themselves to satisfy themselves as to the legality of their schemes.

Although the FCA did not escape censure from the court themselves in this case, it is a significant win and surely signals the end of investments that try to side step the regulations by structuring as a direct property purchase. The contractual right to exercise day-to-day control and even earning returns from the crops grown on an individual plot of land are not enough to overcome the reality that these schemes require managing as a whole.

Further Information

Intelligent Partnership have produced a more in-depth summary of this case which is available to subscribers. To gain access to the detailed summary register for free here.