Financial services and regulation - Identification of specif...

Learning Outcomes

This article explains specified investments and regulated activities under the Financial Services and Markets Act 2000 (FSMA) and the Regulated Activities Order (RAO), including:

• The statutory “general prohibition” in s 19 FSMA and its practical application
• Distinctions between specific investment advice and generic guidance
• The scope of common regulated activities (dealing, arranging, managing, safeguarding and advising)
• Triggers for, and circumstances requiring, FCA authorisation
• Key RAO exclusions and the professional firms exemption in s 327 FSMA
• The SRA Scope and Conduct of Business (COB) Rules, including status disclosure, best execution and record keeping
• The impact of insurance distribution and credit-related activities
• The framework for financial promotions (s 21 FSMA and the Financial Promotion Order)
• Practical applications in legal practice, including conveyancing, probate, corporate acquisitions, and introductions to authorised advisers

SQE1 Syllabus

For SQE1, you are required to understand the identification and scope of specified investments and regulated activities under FSMA and the RAO, with a focus on the following syllabus points:

• the definition and categories of specified investments under FSMA and the RAO
• the meaning of regulated activities and how they interact with specified investments
• when FCA authorisation is required and the consequences of unauthorised activity
• key exclusions and exemptions, including the professional firms exemption
• how to apply these rules to practical scenarios involving legal practice.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following is a specified investment under the Regulated Activities Order?
   1. Shares in a private company
   2. Freehold land
   3. Physical gold bullion
   4. A standard residential mortgage
2. Which of the following activities would generally require FCA authorisation?
   1. Advising a client on the purchase of shares in a listed company
   2. Arranging a loan between two companies within the same group
   3. Acting as a trustee and managing trust investments
   4. Introducing a client to an authorised financial adviser, with no further involvement

3. True or false? A solicitor giving incidental investment advice as part of a conveyancing transaction always requires FCA authorisation.

Introduction

The regulation of financial services in England and Wales is centred on the Financial Services and Markets Act 2000 (FSMA) and the Regulated Activities Order 2001 (RAO). For SQE1, you must be able to identify when an investment is "specified" and when an activity is "regulated," as these determine whether FCA authorisation is required. This analysis is driven by the “general prohibition” in FSMA and the legal definition of a regulated activity in s 22 FSMA, which turns on four linked questions: whether the person is acting “by way of business,” whether the activity relates to a specified investment (or certain other matters such as benchmark administration), whether the activity itself is specified, and whether any exclusion or exemption applies.

Key Term: general prohibition
FSMA s 19 states that no person may carry on a regulated activity in the UK unless authorised or exempt. Breach is a criminal offence and may affect the enforceability of agreements.

Key Term: Regulated Activities Order (RAO)
A statutory instrument that lists the types of investments and activities regulated under FSMA.

Key Term: Financial Conduct Authority (FCA)
The main regulator for financial services and markets in the UK, responsible for authorising and supervising firms and individuals.

Specified Investments

The FSMA and RAO define "specified investments"—financial products and instruments that fall within the regulatory perimeter. Only activities involving specified investments are regulated. Where the base asset is not a specified investment (for example, most interests in land), activities that would otherwise be regulated will generally fall outside the scope of FSMA.

Key Term: specified investment
A financial product or instrument listed in the RAO that, when combined with a regulated activity, brings the activity within the scope of FCA regulation.

The main categories of specified investments include:

• shares (equity in companies). Shares in a body corporate are specified, but the share capital of certain bodies (e.g. a UK building society or an OEIC) may be treated differently in the RAO
• debentures and loan stock (corporate debt instruments)
• government and public securities (e.g. gilts)
• units in collective investment schemes (including unit trusts and OEICs)
• contracts of insurance (life, general and annuities)
• options, futures, and contracts for differences (derivatives)
• regulated mortgage contracts (loans secured by a first legal mortgage on land where at least 40% is used as the borrower’s home)
• home reversion plans and home purchase plans (home finance arrangements)
• deposits (e.g. money held in bank accounts; the regulated activity is usually “accepting deposits”)
• certain “other” categories introduced by amendments to the RAO (e.g. operating an electronic system in relation to lending).

Some assets are not specified investments, such as freehold land, physical goods, or most intellectual property rights. Activities in relation to those assets will not be regulated under FSMA unless a distinct regulated activity is engaged.

Key Term: regulated mortgage contract
A loan secured on land by a first legal charge where at least 40% of the land is used as or in connection with the borrower’s home.

Key Term: collective investment scheme (CIS)
An arrangement pooling contributions from multiple investors to acquire, manage or operate assets on their behalf.

Key Term: home reversion/home purchase plan
Home finance arrangements enabling homeowners to realise value or purchase property in a manner compliant with particular legal or religious requirements.

Regulated Activities

A "regulated activity" is an activity of a specified kind, carried on by way of business, that relates to a specified investment or certain other matters (such as administering a benchmark). The RAO lists the principal activities and their scope. In practice, whether the person is acting “by way of business” is a factual question; practitioners advising clients in a legal practice will usually meet this test.

Key Term: regulated activity
An activity listed in the RAO that, when carried out by way of business and involving a specified investment, requires FCA authorisation unless an exclusion or exemption applies.

Common regulated activities include:

• dealing in investments as principal or agent (buying/selling for oneself or others)
• arranging deals in investments, and “making arrangements with a view to” transactions
• managing investments (discretionary management of client assets)
• safeguarding and administering investments (custody services)
• advising on investments (giving a personal recommendation about the merits of buying or selling a particular investment)
• operating a collective investment scheme
• accepting deposits (banking)
• entering into and administering regulated mortgage contracts
• taking up or pursuing insurance distribution (subject to the Insurance Distribution regime)
• certain consumer credit activities (e.g. credit broking and debt administration).

The scope of “advising” is important. Generic financial information is not advice; a personal recommendation tailored to a particular investment for a named client is. Similarly, “arranging” covers bringing about transactions and making arrangements with a view to an investor purchasing, selling, or subscribing for a specified investment.

The Four-Stage Test

To determine if an activity is regulated, apply the following test:

1. Is the person acting "by way of business"?
2. Is there a specified investment involved (or is the activity about information on a person’s financial standing or administering a benchmark)?
3. Is the activity a specified regulated activity?
4. Does any exclusion or exemption apply?

If the answer to all but the last is "yes," FCA authorisation is required unless an exclusion or exemption applies.

Key Term: authorised third person (ATP)
An FCA-authorised person who provides advice or conducts the investment activity; involvement of an ATP can switch off certain arranging/dealing activities done by a non-authorised professional.

Key Term: execution-only client
A client who is not seeking, and has not sought, advice from the solicitor about the merits of entering into the transaction. The solicitor acts only to execute the client’s instructions.

Key Term: designated professional body (DPB)
An approved professional regulator (e.g. the SRA via the Law Society) through which professional firms may rely on the s 327 FSMA “professional firms exemption.”

Worked Example 1.1

A solicitor is advising a client on whether to invest in shares of a listed company as part of a business sale. The solicitor gives specific advice about the merits of the investment.

Answer:
Advising on investments (shares) is a regulated activity involving a specified investment. Unless an exclusion or exemption applies, FCA authorisation is required.

Exclusions

The RAO provides for exclusions—circumstances where an activity that would otherwise be regulated is not treated as such. Exclusions are activity-specific and can be narrow in scope. Practitioners should check whether an exclusion applies to the exact activity being performed and whether it is disapplied for insurance distribution.

• Introducing: Simply introducing a client to an authorised person (ATP), with no further involvement, is excluded from regulation for arranging. Any ongoing role (e.g. passing messages or chasing the transaction) defeats the exclusion. It does not apply to introductions relating to contracts of insurance.

• Authorised third person (ATP): Where a transaction is entered into on the advice of an ATP, an unregulated professional may be able to rely on the ATP exclusion for dealing as agent and arranging, provided all commission or benefits from third parties are accounted to the client. This exclusion does not apply to insurance contracts.

• Execution-only client: If the client is not seeking and has not sought advice about the merits of the transaction (or the solicitor has declined to advise and has recommended the client seek advice from an authorised person), the dealing-as-agent or arranging activity may be excluded. As with ATP, it is not available where the transaction relates to insurance contracts.

• Trustee/personal representative: Acting as a trustee or personal representative may exclude arranging, managing, safeguarding and advising fellow trustees/beneficiaries, as well as lending money on, or administering, a regulated mortgage contract—subject to conditions (including no separate or additional remuneration, except ordinary time-based fees). The exclusion does not apply to insurance distribution.

• Professional/necessary: Activities performed in the course of carrying on a profession or business that may reasonably be regarded as necessary to the professional services provided (e.g. arranging the sale of estate assets in probate, or making arrangements for a share acquisition when acting on a corporate purchase). This exclusion is unavailable where the activity is separately remunerated, or the activity consists of insurance distribution.

• Takeover exclusion (body corporate): Advising, dealing as agent or arranging is excluded where the transaction is to acquire or dispose of shares in a body corporate (other than an OEIC) and:

  • the shares consist of, or include, 50% or more of the voting shares; or
  • although less than 50% is being acquired, the object can reasonably be regarded as day-to-day control of the body corporate.
    The parties must be a body corporate, partnership, single individual or a group of connected individuals. The exclusion does not apply to insurance contracts.

Key Term: exclusion
A provision in the RAO that removes certain activities from the scope of regulation, even if they would otherwise be regulated.

Worked Example 1.2

A solicitor acting in a probate matter arranges for the sale of shares held by the estate. The solicitor receives a commission from the broker and does not inform the client.

Answer:
The solicitor may rely on the professional/necessary exclusion only if the commission is accounted to the client or fully disclosed in line with professional rules. Failure to disclose breaches both the exclusion and SRA rules.

Key Term: execution-only client
A client who instructs the solicitor to execute a transaction without seeking advice on its merits; execution-only can switch off “dealing/arranging” regulation for certain investments (but not insurance).

Key Term: Financial Promotion Order (FPO)
The order that sets out exemptions to the s 21 FSMA financial promotion restriction, including real-time/non-real-time, one-off communications and introducer exemptions.

Exemptions

Some professional firms, such as solicitors regulated by the SRA, may rely on the "professional firms exemption" (s 327 FSMA), often called the designated professional body exemption. This allows them to carry out certain regulated activities that are incidental to their legal work, provided strict conditions are met:

• arise out of or be ancillary to professional services provided to a particular client
• incidental to the provision of those professional services (not held out as a separate service and not a major part of the firm’s activities)
• no commission or other third-party advantage retained unless accounted to the client or fully disclosed in line with SRA rules
• only permitted activities under the SRA Financial Services (Scope) Rules are undertaken
• the activity is not prohibited by Treasury order (FSMA (Professions) (Non-Exempt Activities) Order) or by FCA direction
• the firm is not otherwise carrying on regulated activities (i.e. is not FCA-authorised for mainstream financial services).

Key Term: exemption
A statutory provision allowing certain persons or firms to carry on regulated activities without FCA authorisation, subject to conditions (e.g. s 327 FSMA professional firms exemption).

In practice, reliance on s 327 requires compliance with the SRA Financial Services (Scope) Rules and the SRA Financial Services (Conduct of Business) Rules (COB Rules). Key COB requirements include:

• Status disclosure: inform clients that the firm is not authorised by the FCA and that s 327 is being used; explain complaint/redress via the SRA and the Legal Ombudsman. Communications must be clear, fair and not misleading.
• Best execution: act in the client’s best interests and carry out transactions promptly unless delay is in the client’s best interest.
• Record-keeping: keep records of instructions to carry out transactions and of instructions issued to third parties to execute them; keep records of commissions received and how they were dealt with.
• Execution-only clients: if the investment is a retail investment product (e.g. certain life policies, unit trusts), send a letter confirming the client is not relying on the firm’s advice and retain a copy.
• Insurance distribution activities: enhanced requirements apply, including disclosure on the nature of remuneration and clear, fair, not misleading communication. Firms engaging in insurance distribution must be recorded on the Financial Services Register (even when relying on s 327) and appoint an insurance distribution officer.

Worked Example 1.3

A solicitor introduces a client to an authorised financial adviser and has no further involvement. The adviser pays the solicitor a referral fee, which is disclosed to the client.

Answer:
The introduction exclusion applies to arranging, provided the solicitor’s role ends at the introduction. Disclosure of the referral fee is required under SRA rules. If the solicitor assists further with the transaction, the exclusion may no longer apply.

Key Term: designated professional body (DPB)
A professional regulator designated under FSMA (e.g. the SRA via the Law Society) whose regulated firms may rely on the s 327 exemption subject to conditions.

Consequences of Unauthorised Activity

Carrying out a regulated activity without FCA authorisation (and without a valid exclusion or exemption) is a criminal offence under FSMA. The consequences include:

• Criminal liability: fines and/or imprisonment.
• Contractual consequences: agreements made by unauthorised persons in breach of the general prohibition may be unenforceable, subject to statutory provisions allowing courts to order restitution or adjustments to protect consumers.
• Regulatory discipline: where solicitors are involved, SRA enforcement action is likely given the seriousness of breaching the law and professional standards.

Exam Warning

Carrying on regulated activities without FCA authorisation is a strict liability offence. Always check for exclusions and exemptions before advising or acting.

Practical Application: Legal Practice Scenarios

• Advising on land: Land is not a specified investment. Advising purely on the purchase or sale of land does not amount to a regulated activity.
• Arranging a mortgage: Most residential mortgages are specified investments. Advising on or arranging a regulated mortgage contract is a regulated activity unless an exclusion (e.g. trustee/PR) or s 327 exemption properly applies.
• Incidental investment actions in probate: Selling estate securities may be covered by the trustee/PR exclusion or the professional/necessary exclusion, provided no separate remuneration is taken.
• Corporate takeovers: A share acquisition designed to secure day-to-day control of a company generally falls within the takeover exclusion (advising/arranging/dealing as agent), even if less than 50% voting shares are acquired.
• Introductions to authorised persons: If the firm’s role ends at the introduction, the introduction exclusion can switch off arranging; if the firm remains involved, consider the ATP or execution-only exclusions (subject to restrictions for insurance).
• Insurance distribution: Activities involving contracts of insurance require special caution—many RAO exclusions are disapplied for insurance distribution. If insurance distribution is undertaken under s 327, ensure Financial Services Register registration and compliance with COB Part 3.

Worked Example 1.4

A corporate solicitor is instructed on a share sale in which a client will acquire 45% of the voting shares of Target Ltd, but with rights to appoint the majority of directors and assume day-to-day control post-completion. The solicitor will advise on and arrange the transaction.

Answer:
The takeover exclusion can apply because the object is reasonably regarded as acquiring day-to-day control of the body corporate, even though less than 50% of voting shares are acquired. The exclusion covers advising, arranging and dealing as agent but does not apply to insurance contracts.

Worked Example 1.5

A private client solicitor is asked to arrange a client’s purchase of a retail investment product that is a life policy. The client insists they do not want advice; the solicitor will act as execution-only.

Answer:
Execution-only exclusions for arranging/dealing do not apply to contracts of insurance. The firm may rely on the s 327 exemption for insurance distribution only if registered on the Financial Services Register and if COB Part 3 requirements are met (including disclosure on remuneration and record-keeping). The firm must send an execution-only letter where applicable and comply with all insurance distribution rules.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• Specified investments are defined in the RAO and include shares, bonds, insurance contracts, mortgages, home finance plans, and more.
• Regulated activities are listed in the RAO and include dealing, arranging, managing, safeguarding, advising, operating CIS, accepting deposits, mortgage activity and insurance distribution.
• Use the four-stage test: business test, specified investment, specified activity, and any exclusion/exemption.
• Common exclusions include introducing, ATP, execution-only, acting as trustee/PR, professional/necessary, and the takeover exclusion (subject to insurance distribution restrictions).
• Solicitors may rely on the professional firms exemption (s 327 FSMA) for incidental regulated activities, subject to SRA Scope Rules and COB Rules (including status disclosure, best execution, record-keeping and insurance distribution requirements).
• Carrying on regulated activities without authorisation is a criminal offence and may render agreements unenforceable; always consider exclusions and exemptions first.

Key Terms and Concepts

• specified investment
• Regulated Activities Order (RAO)
• regulated activity
• Financial Conduct Authority (FCA)
• general prohibition
• exclusion
• exemption
• authorised third person (ATP)
• execution-only client
• designated professional body (DPB)
• Financial Promotion Order (FPO)
• regulated mortgage contract
• collective investment scheme (CIS)
• home reversion/home purchase plan