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Erscheinung:15.01.2015 | Topic Consumer protection Dr. Jean-Pierre Bussalb, BaFin

Retail Investors Protection Act: Improved transparency on the unregulated capital market

Investors have recently suffered considerable losses on capital investments. Although the risks associated with capital investments are described in detail in the relevant prospectuses, many retail investors were not initially aware that high potential returns are also invariably associated with high risks.

In some cases, losses were however due to fraudulent practices by the offerors and the backers of the capital investments.

In response, the Federal Government announced a package of measures (see expert article from June 2014, only available in German) in May 2014 designed to improve investor protection and the transparency of offerings on the unregulated capital market (see expert article from March 2014). This package of measures is expected to be implemented in early 2015 in the form of the Retail Investors Protection Act (Kleinanlegerschutzgesetz). The Federal Government has already submitted a relevant draft to the Bundestag (only available in German).

This article looks at the main points of the planned new legislation. It will expand the prospectus requirement in accordance with the Capital Investment Act (VermögensanlagengesetzVermAnlG) and remove loopholes that have until now made it difficult for investors to properly assess the risks associated with certain capital investments. The act will also introduce additional information and notification requirements for offerors. In turn, BaFin will be given additional powers of intervention and publication.

Capital investments
The Capital Investment Act (VermögensanlagengesetzVermAnlG) defines the prospectus requirement for types of investment that are not securities within the meaning of the Securities Prospectus Act (WertpapierprospektgesetzWpPG) or investment funds within the meaning of the Investment Code (KapitalanlagesetzbuchKAGB). BaFin has published an interpretive letter (only available in German) examining in detail the differences between capital investments and investment funds. According to the VermAnlG, the prospectus requirement applies, for example, to public offerings by companies operating outside the financial sector, such as German limited partnerships in the renewable energy sector, or to the issuance of profit participation rights that do not provide for loss participation by investors, but that are subject to a qualified subordination clause that disadvantages investors (see expert article from August 2014, only available in German).

Investor responsibility

The new law thus helps investors to better assess the integrity and potential rewards of capital investments. This makes it easier for them to make a well-informed, risk-aware decision. However, investors are and will continue to be responsible for their own decisions: if a risk materialises, they must bear the consequences.

Investors must also be aware that, unlike banks or financial services institutions, offerors and issuers of capital investments are not supervised by BaFin. Prior to a public offering, offerors and issuers are only required to file a prospectus with BaFin and publish it once it has been approved by BaFin. The legislation governing prospectuses is therefore only designed to provide investors with full transparency on capital investments, their offerors and issuers. BaFin´s examining of the prospectuses will not completely prevent criminal practices by individual offerors in the future.

Prospectus requirement: key changes

  • Expanded prospectus requirement and exemptions
  • Minimum term and notice period
  • Improved topicality and accessibility
  • Advertising restrictions
  • BaFin’s powers extended

Extension of prospectus requirement

According to the draft legislation, offerors of profit participation loans and subordinated loans will also normally be required to draw up a prospectus in the future. These products have until now been offered without a prospectus in numerous market segments, such as to finance the production of furniture, animal feeds, foodstuffs and medical products, as well as to launch and operate radio stations or apps, organise concerts, or to market works of art.

All investments that are economically equivalent to the aforementioned capital investments that have been subject to the prospectus requirement to date, will also require a prospectus, in particular because they grant a claim to interest payments and principal repayments. Examples of these may include investments in overseas teak plantations or certain purchase models for shipping containers, depending on the contractual arrangements. BaFin will examine whether an offering requires a prospectus in each case.

Minimum term and notice period

The Retail Investors Protection Act will also introduce a basic minimum term of 24 months and a notice period of at least 12 months for capital investments. The protection created by this is twofold: on the one hand, the offeror of the capital investment has a stable funding basis for 24 months. On the other, the investors are now aware from the outset that the capital investment represents a business investment of a certain duration, and they cannot demand its repayment in the short term. This means that both sides will have to examine whether and to what extent interest payments and principal repayments are actually provided for with regard to the investment objectives and investment policy.

There have been cases in the past where offerors were not able to repay investors’ funds on demand at short notice and as a result, were forced to file for bankruptcy.

Topicality and accessibility of prospectuses

The topicality and accessibility of investment prospectuses will also be improved. Prospectuses will only be valid for a maximum of 12 months. If an offeror plans to offer a capital investment on the market for longer, it must update the prospectus and resubmit it to BaFin for approval. The offeror must also make the prospectus, including any supplements, available on its website.

Offerors must immediately publish all facts that could significantly affect their ability to meet payment obligations to investors, particularly after the end of the public offering period for capital investments. BaFin will also publish these facts on its website.

Advertising restrictions

Advertisements for capital investments will also be more strongly regulated. Public advertising for capital investments, for example in buses and trains, on billboards and using unaddressed mail, will no longer be allowed in future. Advertising in newspapers and magazines will still be permitted but must include a clear statement on the risk of loss. Advertising for capital investments will only be allowed in other media if these report at least occasionally on economic topics and the advertisement is placed in connection with such a report. Here, too, investors must be made aware of the fact that they risk the total loss of the invested capital.

In future, BaFin will be able to prohibit abuses in advertising for capital investments. If the offeror falsely implies that the repayment of the invested money is guaranteed, or misleadingly creates the impression of a particularly low-cost, high-yield offering, BaFin can prohibit the advertisement.

Exemptions from the prospectus requirement

Crowdfunding in the form of crowdinvesting is to be exempted from the prospectus requirement under certain conditions so as not to deter investments in innovative small and medium-sized companies.

Crowdfunding – crowdinvesting
Crowdfunding is a way for a large number of backers to provide financial support for a specific project. Funds are usually raised via an online crowdfunding platform. There are many different forms of crowdfunding platforms. In practice, a distinction is currently made between four main crowdfunding models: donation-based and rewards-based crowdfunding, which are also referred to as crowdsponsoring, loan-based crowdfunding (crowdlending) and crowdinvesting. In a crowdinvesting model, backers receive an interest in the financed project’s future profits, or equity or debt instruments if the investment involves securities. You can find an in-depth article on crowdfunding here.

According to the draft legislation, the prospectus requirement will not apply to subordinated loans and profit participation loans with which a company will raise a maximum of €1 million through crowdinvesting if this has been organised via an online platform and each investor can invest a maximum of €1,000 without any further disclosures. Investments of more than €1,000 up to €10,000 require the investor to declare that they have assets of at least €100,000 or that they are not investing more than double their average net monthly income.

The offeror must provide a capital investment information document to every investor who invests more than €250. The investor must sign and return this document.

In addition, subordinated loans and profit participation loans of up to €1 million for social and charitable projects are likewise not subject to the prospectus requirement if the loan has been issued by a micro-corporation, as defined by section 267a of the Commercial Code (Handelsgesetzbuch - HGB), whose members are registered associations with a social or charitable purpose, and if the lending rate of the loan is less than the standard market interest rate for mortgage Pfandbriefe (debentures) with the same maturity period.

Loans and profit participation loans from members of a cooperative society to their cooperative society are also exempt from the prospectus requirement if they are exclusively offered to members of the cooperative society and those members receive key information about the capital investment.

BaFin’s powers extended

In future, BaFin will be able to publish measures taken by it in response to violations of the Capital Investment Act, in particular decisions on fines, on its website to warn potential investors.

If it has significant concerns that investor protection or the functioning or integrity of the financial markets could be compromised, BaFin can restrict or prohibit the sale of certain financial products. The new statutory definition of product intervention is not directed at any specific group and thus also applies to independent intermediaries as well as direct sales of financial instruments and structured deposits, i.e. it is not limited to capital investments. Product intervention can take the form of a general administrative act, or BaFin can prohibit specific market participants by way of an individual administrative act, e.g. for certain financial practices.

Enforcement

BaFin will also be able to have the financial reports of an issuer of a capital investment reviewed by an external auditor in future if there are specific indications of a violation. This will increase the pressure on companies to prepare proper financial reports every year.

To ensure that the annual financial statements are published by the required deadline, the maximum administrative fine for violating disclosure obligations will be increased tenfold from €25,000 to €250,000.

Additional information

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