Author: | Published: 9 Nov 2000
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The commercial opportunities and the regulatory challenges which pertain to business conducted via the internet can be summarized by stating that the internet gives any online individual in the world access to its global content, not by geography, but by subject-matter. Anything placed on the World Wide Web has a global audience. With the advent of the internet the assumption can no longer be made that commercial interests will be limited by the geographical location of the product. This is even more the case for financial services products, which do not require physical delivery to the purchaser.

Suppliers of financial services and products are in the vanguard in taking advantage of the internet. The surge in banks and investment companies offering online capabilities is a testament to that fact.

But, in adding or moving to an electronic platform in order to sell their products and services, financial services providers need to address the legal and regulatory issues which result from having a global audience and dealing with customers through this new medium. This article looks at some of the online services on offer, the legal and regulatory issues which arise from them and strategies to minimize the associated legal and regulatory risk.

Marketing funds online

In principle, the ability to put information onto a website which can be accessed by potential investors all over the globe through search engines is highly attractive. Funds which have a consistently good performance and which meet investors' needs in terms of philosophy, investment style, geographical location etc are more easily identified through an internet search than through traditional means. Also, because traditional selling methods involve the use of expensive advertising and/or the need to pay not insignificant fees to intermediaries, selling costs (and charges) are high. If all marketing could be conducted via the internet, costs and charges would be significantly reduced.

However, regulators in the EU, the US and many other countries have stated that the mere availability and accessibility of a website's contents by their residents constitutes financial promotion and, if not authorized, unlawful financial promotion. Thus, the UK's Financial Services Authority (FSA) has issued guidance on the question of promotion of financial services on the internet and has stated that an advertisement of financial services products which can be accessed on a computer screen by a person in the UK will be considered to have been "issued" in the UK. Unless there is an applicable exemption, the advertisement must have been issued in the UK by a person authorized under the Financial Services Act 1986. Contravention of this requirement is a criminal offence.

This follows from the fact that putting information on a website which is accessible globally is tantamount to putting an investment advertisement in public newspapers circulating in every jurisdiction in the world. It is no more possible legally to advertise in this manner (ie via a website) than it would be to place such advertisements in those newspapers. In practice this would only be possible if such funds were registered for public marketing in every country in the world. This is, of course, a practical impossibility.

As a result, it is necessary to go through the time-honoured process of identifying in which countries the promoters want to make the fund available to the public and to go through a local registration process. In addition, promoters often sell the fund on a private placement basis and in compliance with local private placement rules in other countries. Because of local taxation issues and the complexity of complying with different local regulations it is not practicable to structure funds which are appropriate for large numbers of people in multiple jurisdictions. Typically, therefore, promoters have sought to market funds to the public in only one or a very limited number of countries and to market the funds on a private placement basis to a limited number of institutions or intermediaries in other countries.

Certain EU funds which are regulated in one member state of the EU can be marketed in any of the EU member states pursuant to EC Council Directive 85/611. However, even in the case of UCITS, both the regulator of the home state (ie the state where the fund was initially set up) and the regulator of the host state (ie the state in which the foreign UCITS wishes to be marketed) must be notified and confirm the fund has complied with the relevant requirements. Notwithstanding the UCITS Directive, the marketing of the fund will still be subject to local marketing regulations and registration with the host state regulators involves approval of the proposed marketing methods. For example, in the UK, there are restrictions on the form and content of fund advertisements and the marketing to the public must, in practice, be conducted through a UK authorized firm under the Financial Services Act 1986.

EU funds which do not fall within the UCITS Directive and funds which are formed in a country outside the EU will not have the benefit of the UCITS Directive and will face the full weight of the host state regulations. In order to be marketed to the public, they are likely to need to be registered and therefore approved locally. Whether this is possible depends on where such funds are established, the degree of regulation to which they are subject and the existence and detailed requirements of the target country. Funds established in offshore financial centres are often unable to comply with local registration requirements in more sophisticated onshore jurisdictions.

This does not, however, mean that website advertising is impossible. The Securities and Exchange Commission (SEC) has stated that if financial services providers "implement measures which are reasonably designed to guard against sales or the provision of services to US persons", they will be deemed not to have targeted persons in the US.

Similarly the UK authorities state that in order that a website avoids being deemed to be targeting UK persons both a disclaimer and procedures that contain "positive steps to limit access to the site" must be put in place. Both the US and UK authorities have issued detailed guidance on the types of disclaimers and procedures they would expect to see.

Fund supermarkets

The supermarket concept typically involves offering a large number of funds advised by a number of competing advisers. For a fee, the fund will generally receive two services from the supermarket's sponsoring broker-dealer. First, accounting and shareholder servicing duties which would otherwise be performed by the fund's transfer agent. Second, the supermarket will either take on or supplement the distribution and marketing activities. Investors who purchase funds through a fund supermarket typically set up accounts with the broker-dealer sponsoring the supermarket and have no direct contact with the funds in which they invest.

For a third party such as a broker to offer a supermarket of funds there is therefore a problem. That is, whatever the broker may want, it is the fund promoter who needs to register the relevant funds and the broker has no control over this. Equally, if the fund promoter decides not to renew a registration (so that it ceases to be publicly marketable) in a country the broker would have to remove it from its list of funds available to potential retail investors in that country. So, for practical purposes, a broker or other third party offering other parties funds via a supermarket will need a marketing or other agreement with the fund promoter including obligations to give advance warning of this and other changes. Such an agreement is likely to be needed, of course, for other reasons - eg fee arrangements, responsibility for breach of local marketing rules, misrepresentation etc.


The means whereby internet sites attempt to screen out those persons accessing the site who are not permitted to view their financial services products are referred to as "filters".

The guidance issued by both the FSA and the SEC refer to the use of filters as a method of restricting access to a website. There are, however, several types of filters and their effectiveness warrants further examination.

The first type of filter is the posted warning. This takes the form of a warning that the products sold on the internet site are not being offered to persons in certain identified countries and that individuals resident in those countries should not continue further into the website and that any applications received from those persons for financial services products will not be considered. In this fashion, the website can discourage persons from certain countries from viewing the contents of the website. By itself, this type of filter is unlikely to be sufficient to satisfy a regulator that the financial services products were not being sold to residents of their country since it does not prevent the resident accessing the information.

The second type of filter is that which is imposed prior to an order being made by the customer. This type of filter takes the form of portals which the purchaser must pass through prior to placing an order for the products. These can include (a) being forced to indicate agreement to the posted conditions of sale which excludes their country, (b) being forced to indicate their country of residence, and (c) being forced to provide home and/or work contact details. The latter two would provide information to the product provider which would serve to exclude those who ignored the posted warning.

However, there is always the possibility that investors will wish to access the financial services products on offer, even if their residency prohibits the financial services products from being offered to them through the website and/or provide erroneous information. Therefore, a third level of filter, which requires greater vigilance on the part of the financial services product provider, is suggested and recommended. Once an order is placed, the product provider should be aware of any indicators that would put the issuer on notice that the residency of the purchaser was not what was originally thought. These indicators can include banking details, taxpayer identification, social insurance or social assistance details, or any comments made by the purchaser which contradict earlier information received as to the purchaser's state of residence. This last level of filter is specifically mentioned in the SEC 1998 interpretation of the use of internet websites (SEC Internal Series Release No. 1125 – 23 March 1998).


With a push of a button and a click of the mouse, investors are able to log into and browse their fund's website. Will they have access to any greater information than was traditionally available? Yes and no. Despite the ease at which information can be provided to investors on the internet, companies are reluctant to disclose the content of their portfolio. This policy is justified by fund managers on the grounds that revealing a fund's holdings and returns would place the fund at a competitive disadvantage in the marketplace.

In the US, many fund managers nevertheless provide a list of their holdings dated by three to six months. Information that is this old does not present much help to the investor, except as historical interest. Several funds in the US have now begun to place information about their funds' trades on the internet within two weeks of the trades having taken place. Others have even begun to provide real-time information. A few – albeit very few – fund managers have even started to justify important trade decisions to their investors – via e-mail.

The justification for keeping the investor better informed is that surveys have shown that there is a strong desire on the part of the public to know what is being done with their money, and why. So far, the move to this type of extreme transparency has not caught on with the bigger fund managers nor with funds outside the US. The idea has not proved popular with larger funds and their justification is expressed by a concern that the market may be distorted if everyone is able to follow the minute-to-minute or day-to-day movement of larger funds. Concern has also been raised that as large funds' investment decisions are the result of intense and costly research, there is a natural desire to protect the end result of that research, the investment decision, from being copied for free, by anyone who has access to the internet. Finally, the delay on releasing a fund's trades to the public prevents investment decisions based on emotional reactions to marketplace action or to the movement of a fund and encourages a sober review of the fund's trades, placed in the perspective afforded by the passage of time.

The regulators do not appear to be forcing any increased reporting of portfolio holdings. On the contrary, the SEC is considering a proposal to reduce the information which funds must provide to their investors. Opposing this proposal are investor groups who argue for greater detail in reports to investors and more frequent fund-holding disclosure.

It is difficult to predict a trend on this issue. The large funds will want to limit disclosure while the consumer will desire a greater amount of information. The general trend in society is towards greater transparency and if consumers begin to choose investment products based on their level of transparency, the law of the market may eventually result in all funds moving to meet the demands of the consumer for greater transparency.

Contracting online

Contracting online raises its own peculiar issues. It is always essential to know that contracts are validly executed and binding and, especially in the financial services arena, precisely when they are effective. In the case of default or dispute it can be important to know what law governs.

Different countries have different rules concerning the making of contracts. Many have rules requiring contracts to be "in writing" or by deed or for signatures to be witnessed, legalised or notarized.

Many potential problems can be resolved or at least minimized by making specific provision in the contract but one runs the risk that local rules overrides. So there is no substitute for taking local advice.

Within the EU, the Digital Signatures Directive will ensure, subject to detailed requirements, that digital signatures are recognised. Of even greater significance, the Electronic Commerce Directive is designed to provide additional certainty with regard to various aspects of e-commerce.

Areas covered by the directive include:

  • ensuring all providers of Information Society Services (ISSPs) can market and provide services throughout the EU;
  • compliance by ISSPs with certain minimum host state requirements;
  • rules for establishing how and when online contracts are made; and
  • the liabilities of online ISSPs for content.

However, attention needs to be paid to the detailed rules. For example, the Directive lays down a four-stage process for concluding online contracts. Not only must there be the usual offer and acceptance, but the offeror must communicate receipt of acceptance and the offeree must communicate receipt of that acknowledgement. Only then does a valid online contract come into existence. The rules can be overridden and for obvious reason many fund managers will wish to do so.

Chat rooms and liability for website content

In theory, the same rules apply to website content and online contracts as with traditional media. In practice some of the services being provided and the nature of real time communication and interface with customers raise novel issues.

One extreme example is the technology itself. Some search engines and access protocols (eg WAP phones) select only what they deem "essential" information to save time or because of limited viewing and storage capability. So a potential customer might not see carefully crafted risk disclosures and limitation of liability clauses unless the manager ensures all relevant sections are appropriately linked and has tested different forms of access, including how they print onto a page to ensure relevant sections are prominent in hard copy as well as on screen.

To be effective, risk disclosures and limitation of liability clauses must be adequately drawn to a customer's attention. A manager needs to ensure customers have seen and read these sections and cannot skip them.

Chat rooms pose their own problems in that customers can input their own information onto the provider's site. There have already been cases holding providers liable. The E-Commerce Directive proposes to lay down some ground rules but it seems inevitable that providers will bear significant risk in providing the services and will need to establish vetting and monitoring procedures and control content so far as they are able.

Distance selling directive

Like many EU Directives in the financial services arena, this Directive helps create a single market (by making it unlawful for host states not to allow contracts to be made at a distance – eg via the internet) but at the same time lays down rules which must be applied at the home state level.

So there are provisions for cooling-off periods and unsolicited communications (eg by e-mail).


The internet clearly offers an exciting new marketing and service delivery medium to fund managers. But the rules and regulations governing the operation of such services have not been adapted significantly to allow the internet full capabilities to be exploited and there is little sign of any cordinated international effort to achieve either a uniform set of rules specifically for the internet or mutual recognition of each other's rules on a bilateral basis.

The EU has sought to ensure there are no fundamental barriers to conducting e-commerce but in no way is the EU seeking to change the existing ground rules which apply to fund managers selling their products and services. For the foreseeable future fund managers will therefore find their ability to harness the opportunity presented by the internet will be frustrated by the need to continue to comply with local marketing rules.

This is not to say fund managers will not be able to develop internet-based products and services – many already have – but the present rules and regulations are likely to permit development only within audiences fund managers could have targeted through more traditional means.


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