Introduction

In June 2016, the Securities and Futures Commission (“SFC”) updated the Frequently Asked Question regarding “‘Offers of Investments’ under the Securities and Futures Ordinance (“SFO”)” (the “FAQ”). An Appendix 1 has been added to the FAQ to provide guidance on collective investment schemes (“CIS”) involving interests in real property. The updates on the FAQ are noteworthy as some examples are discussed by the SFC to illustrate the regulatory regime for this type of CIS. Nonetheless, in order to get a better understanding of the regulatory regime, such updates should also be read together with the District Court case in which the defendants operating CIS were acquitted of unlicensed dealing in securities.

Regulatory regime over CIS

The SFC has summarised the definition of CIS under the SFO into four elements:

• it must involve arrangements in respect of any property;
• investors do not have day-to-day control over the management of the property even if they have the right to be consulted or to give directions about the management of the property;
• the property is managed as a whole by or on behalf of the person operating the arrangements, and/or the contributions of the investors and the profits or income from which payments are made to them are pooled; and
• the purpose or effect of the arrangements is for the investors to participate in or receive: (i) profits, income or other returns from the acquisition, holding, management or disposal of the property, or (ii) payments or other returns from: the acquisition, holding or disposal of, the exercise of any right in, the redemption of, or the expiry of, any interest in the property.

Section 103 of the SFO prohibits issue of marketing materials which invite the public to acquire an interest in a CIS, violation of which is a criminal offence. This prohibition is however not applicable if the marketing materials are intended to be issued only to professional investors.

Further, under the SFO, CIS is a kind of “securities”, dealing of which is a regulated activity that requires a relevant licence granted by the SFC. Any person dealing in securities without such a licence commits a criminal offence under section 114 of the SFO.

In other words, if a person operates a CIS without a licence and issues advertisement to the public to promote it, he may commit two offences and risks fine and imprisonment.

CIS involving interests in real property

Under the SFO, “property” includes land and estate of land. Therefore, an arrangement of real property investments which satisfies the definition of CIS under the SFO falls under the regulatory regime over CIS.

Appendix 1 of the FAQ discusses a number of examples to illustrate what kind of arrangement is a real property CIS, summarised as follows:

• Real estate projects involving interests in hotels/holiday resorts, serviced apartments, student accommodation and shopping malls are more likely to be a CIS.
• An arrangement is likely to be a CIS if its investors own the individual units in a real estate project under which units are rented, rent is pooled and there is a manager making decisions about the renting.
• Notwithstanding the absence of pooling of rent or profits, an arrangement may still be a CIS if the property is managed as a whole by or on behalf of the person operating the arrangement.
• An arrangement is a CIS if under the arrangement some investors have day-to-day control but the others do not.
• It will depend on the facts to determine whether an arrangement is a CIS if under the arrangement investors owning different units in the same project appoint the same property agent to lease their units for them; however, if
  • the property agent carrying out administrative steps to lease out units according to the terms specified by investors under the relevant agency agreements are not managing those units; and
  • individual investors would direct and make key profit-generating decisions in respect of the units,

the arrangement is generally not a CIS.

• The following kind of arrangement is generally not a CIS:
  • a managing agent manages the project and arranges for leases to be entered into between each investor and a tenant;
  • the investor chooses the tenant and decides the lease terms;
  • the agent runs the project and relationships with tenants, including collecting rent, arranging repairs and insurance, cleaning and security; and
  • the individual investor receives the rent attributable to his individual unit.
• An arrangement under which the managing agent decides things like cleaning and maintenance of common areas, which contribute indirectly to profit, or can get block discounts for all investors for insurance, is generally not a CIS.

The SFC also makes clear that any authorization for a real property CIS will only be granted if all the applicable requirements under the Code on Real Estate Investment Trusts have been complied with, including:

• the CIS must be listed on The Stock Exchange of Hong Kong Limited;
• the CIS manager must be SFC licensed or be licensed by the regulator of an overseas regime acceptable to the SFC;
• there must be a trustee; and
• the assets of the CIS must be segregated and held in trust.

The District Court prosecution and its implications

Notwithstanding the regulatory regime over real property CIS, two defendants who operated unauthorized CIS were acquitted in April this year. The case is HKSAR v IPFUND Asset Management Limited and Sin Chung Yin DCCC 23/2015. The first defendant is a Hong Kong company and the second defendant is its director. They operated real property investment projects through inviting investors to subscribe shares in private Hong Kong shell companies, which would use the subscription money to purchase and resell real properties, and distribute profits from such purchase and resale to the investors. The defendants were charged of unlicensed dealing in securities, violating section 114 of the SFO.

The judge found the real property investment projects CISs. However, since the definition of “securities” under the SFO expressly excludes shares in Hong Kong private companies, the defendants were found not dealing in securities. The charge of unlicensed dealing in securities therefore failed.

The case seems to suggest that an unauthorized CIS carried out through investment in shares in Hong Kong private shell companies may not necessarily be prohibited under the SFO. SFC’s discussion of CIS in the updated FAQ should be read together with the implications of this case. Nonetheless, the case should not be taken too far against the CIS regulatory regime. It should be noted that the case is a District Court case, which does not constitute a binding authority; and it is still an offence under section 103 of the SFO to issue marketing materials which invite the public to acquire an interest in such CIS.

Conclusion

The updates of the FAQ provide some useful examples for our better understanding of what constitute real property CIS. Whether each investor have day-to-day control and can make key profit-generating decisions in respect of the investment arrangement are key factors which the SFC would look at. Carrying out CIS without relevant authorization and licence granted by the SFC may render commission of multiple criminal offences.

Although the regulatory regime over real property CIS should be considered together with HKSAR v IPFUND Asset Management Limited and Sin Chung Yin, a person should not operate any unauthorized real property CIS before seeking proper legal advice, as the regulations against CIS under the SFO are multifold.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.