All of these headlines have one thing in common, i.e. a fundamental misunderstanding of BaFin's responsibilities. It is a widely spread misconception that BaFin is responsible for ensuring the airtight monitoring of the capital markets and for protecting consumers from all unsound and risky business practices – quasi through quality control. However, BaFin does not have the legal authorisation for this type of all-encompassing quality control. Furthermore, comprehensive regulation of the financial markets would contradict free market principles and the basic premise that citizens are competent and free to decide for themselves.

Therefore, except in cases of business operations requiring authorisation or activities prohibited under supervisory law, BaFin cannot take action. This includes all investment offers available on the unregulated capital market, regardless of how suspect these business opportunities from (dubious) providers appear to be, or in fact are.

The legal capital market versus illegal investment schemes

But for which types of transactions must the provider have authorisation? Or to phrase it differently, where are the boundaries that separate the legal from the unregulated from the illegal capital market? And what is BaFin's role in 'patrolling' these boundaries?

If a business venture encompasses an authorisation requirement which has been laid down within the relevant supervisory laws, and if this business venture is commercially organised, or operated on a scale which requires a commercially organised business undertaking, then, as a rule, authorisation is required. The provider will be allowed to conduct such business only if BaFin has granted it authorisation. The supervisory laws define which businesses and activities require authorisation.

Credit institutions, financial services providers, payment services providers, German management companies (Kapitalverwaltungsgesellschaften) and insurance undertakings operating with the authorisation of BaFin are active in the legal capital market. They are subject to ongoing supervision by BaFin.

Providers transacting business requiring authorisation despite BaFin having denied them that authorisation, or having not applied for authorisation in the first place, are involved in illegal investment schemes.

BaFin’s regulatory powers over illegal investment schemes

If circumstances give rise to the assumption (or if it is certain) that business activities requiring authorisation are being conducted or offered without the legally required authorisation and/or that prohibited business activities are being conducted or offered, then BaFin is authorised to demand information and documentation pertaining to all such business matters - of the company in question or one of its employees, as well as from any company that is or was involved in the initiation, conclusion or settlement of these business activities. If the suspicion is confirmed, then BaFin can order the company and the members of its governing bodies to cease business operations immediately and to liquidate the business without delay. Moreover, it can issue binding directives for liquidation and appoint an appropriate liquidator.

BaFin's requests for information and documentation, and to an even greater degree, its discontinuance and liquidation orders, are ‘burdening’ administrative acts affecting the constitutional fundamental rights of the individual. They require a formal legal basis pursuant to Article 19 of Germany's Basic Law (Grundgesetz). Therefore, BaFin may only intervene in cases where it has the legal basis authorising it to do so.

Such powers of authorisation can be found in the applicable supervisory laws, for example in section 37 (1) sentence 1 of the Banking Act (Kreditwesengesetz – KWG). Accordingly, BaFin is authorised to take action against the provision of banking and financial services businesses when these are operated or being offered without the necessary authorisation required under section 32 (1) sentence 1 of the KWG.

The unregulated capital market

Business activities not subject to authorisation requirements are part of the unregulated capital market. The unregulated capital market is the sum total of market participants and offers not subject to BaFin's authorisation and hence also not subject to its supervision.

Here, interplay with the legal capital market can be seen: the more strictly regulated the legal capital market, the more frequently providers switch to investment products which they consider not to require authorisation. The goal of many providers is to develop their business model along the border of the limits to authorisation requirement in order to avoid BaFin supervision. In this way, they move away from the legal capital market or illegal investment schemes, into the unregulated capital market.

In particular cases, individual providers operating within the unregulated capital market may be subject to the supervision of trade offices, chambers of industry and commerce, or other state authorities. They themselves are responsible for verifying this. BaFin cannot determine which provider falls under the supervision of which of the above mentioned authorities.

Case-by-case decisions

The supervisory laws contain numerous 'indefinite legal concepts', i.e. concepts which are not conclusively defined in the law and for which the legal application must be established on a case-by-case basis. This is due to the broad scope of issues to be covered and, most importantly, to the ceaseless and swift developments within the financial sector. As a result of this indeterminacy the application of the individual rules, i.e. the subsumption of each individual case under the statutory constituent elements, must always take place on a case-by-case basis. Therefore, it is usually not possible to make a generally valid statement regarding the authorisation requirements for specific investment models. Instead, the relevant documents must be examined in detail in order to determine if an obligation to obtain authorisation exists or not. General statements are further hindered by the creativity and ingenuity providers display in constructing their business models so as to avoid the authorisation requirement.

For example, entering into contracts for the purchase and storage of physical gold is not subject to the authorisation requirement. However, if the provider obligates himself through the contract to later buy the gold back from the investor at a guaranteed price equal to at least that of the original purchase price (in some cases even including the promise of a return on investment), then the investment offer, depending on the content of the contract, could be classified as deposit business within the meaning of section 1 (1) sentence 2 no. 1 of the KWG.

On its website, BaFin regularly publishes updated guidance notices and interpretative decisions regarding activities requiring authorisation in order to inform providers and consumers of the current administrative practice applicable to the interpretation of the individual cases and the limits of the authorisation requirements for individual business activities.

Changing market boundaries

The interplay between the legal and unregulated capital markets and illegal investment schemes is constantly shifting due to the passing of new laws or changes to existing ones, or due to the interpretation of indefinite legal concepts and the resultant administrative practice.

Regulation of the legal capital market has an immediate impact on the boundaries of the unregulated capital market and illegal investment schemes. Hence, it is impossible to draw sharp divisions between the three areas.

Guidelines for Consumers

As previously mentioned, it is impossible to assign specific investment models to general categories such as "subject to authorisation" or "no authorisation required". It should be noted that even with such categorisations, consumers would not be able to draw any conclusions about the risk of loss associated with a specific investment.

As an administrative authority, BaFin is not permitted to advise investors or provide support in the pursuit of civil claims. Consumers should therefore carefully check offers presented to them and, if necessary, acquire legal expertise. In particular, when providers promise high returns with very low or no risk of loss, then consumers should be especially wary. The decision to invest in an offer should not be made until all parts of the contract have been fully understood. After all, if someone is not paying attention, it is that much easier to pull the wool over their eyes.

Footnotes

¹ Examples from Handelsblatt online (4 February 2014), Süddeutsche.de (5 February 2014) and manager magazin online (15 August 2013).

² Judgement from 29 September 1992, ref. no. 1 A 26/91.