Isle of Man: Commercial Update - October 2008

Financial Services Act 2008
by Simon Harding, Partner

The Isle of Man Financial Services Commission is responsible for the regulation of the majority of the financial sector, namely: banks, building societies, investment businesses and fiduciary services providers. Until now each category of financial services provider has been subject to separate, independent legislation and regulations providing for different categories of licence. The Financial Services Act 2008 consolidates the regulatory regime in respect of each of the categories under one Act, providing transparency and significant simplification. This is particularly so in the case of a financial service provider who under the current regime holds more than one type of licence. The regulation of fund vehicles in the Isle of Man has also been updated in a new Collective Investment Scheme Act 2008.

The Financial Services Act 2008 received Royal Assent in July 2008 and came into force on 1st August 2008. It was accompanied by consolidated secondary legislation and a new Rule Book. Transitional provisions provide for existing licenceholders to continue the carrying out of regulated activities under their current licences and in accordance with the previous regulatory codes until 1st January 2009 at which time new licences will be issued and the new Rule Book will fully apply. There is one significant exception to the transitional provisions, being that the new anti- money laundering rules contained in the new Rule Book apply to all licenceholders from 1st August 2008.

The new Act and Regulations have been the subject of much consultation between the FSC and licenceholders, reflecting the Government's objective to ensure that any new rules are workable and represent a practical balance between regulatory constraints and the freedom required in order to promote business growth.

The regulations themselves remain largely unchanged, with regulated activities remaining the same (except for the reclassification of banking as 'deposit-taking') and the continuation of the fit and proper test in respect of permitted persons, controllers and directors.

Despite the regime itself remaining largely unchanged, by providing most of the practical regulation of service providers through secondary legislation, the Act offers the Government ample flexibility to allow the regulations to be updated and improved in an ever changing economic environment. For instance although 'Regulated Activity' is loosely defined in the Act, provision is made for a detailed definition of what constitutes a regulated activity to be provided in accompanying regulations. Therefore, by only restricting the definition within the primary legislation to "financial services activities" "undertaken by way of business", there is scope to extend the definition beyond those activities currently regulated to any other financial service or activity. For example, it is proposed that new regulatory requirements will be imposed on electronic money transmissions in the future.

One of the more significant improvements made to the regime provides for a new intermediate power to be granted to the FSC to formally warn a director or controller who is required to be fit and proper, but whose actions are questionable. This power would be appropriate where a formal sanction is warranted, stopping short of a "not fit and proper" direction, for example, where there is insufficient evidence to make such a direction.

The new Act and Regulations have also seen removal of the reference to recommendations to be made by the FSC (the power to give directions remains) and standardisation of the FSC's powers to appoint reporting accountants, receivers, managers and the power to direct that assets be vested in a trustee, which had previously applied to only some sectors. The Act also extends the powers of the FSC in respect of investigation, inspection and their power to require information, to include, in controlled circumstances, requests made by other regulators.

Although the Isle of Man was found to be largely compliant with international standards as well as the FATF recommendations by the IMF in 2003, the new regulatory regime consolidates and simplifies the old regime. Together with improvements such as the extension of the FSC's powers in respect of inspection and investigation, and provision of information, the new regime provides a transparent and user- friendly regulatory environment which can clearly be seen by the international community to meet international standards, further promoting the Isle of Man as a leading offshore market.

In A Spin Cycle: Money Laundering Put Through The Wringer

It's been a busy few months in the world of anti-money laundering (AML) and countering the financing of terrorism (CFT), a subject that gives wide scope to those who have a penchant for bad puns. Toby Ward gives a quick overview

All Change for AML Regulations

Both of the financial services regulators on the Isle of Man (the Insurance and Pensions Authority (IPA) and the Financial Supervision Commission (FSC)) have introduced revised regulations and guidance notes for their respective areas of supervision.

The Insurance (Anti-Money Laundering) Regulations 2008 and the accompanying Guidance Notes on Anti-Money Laundering and Preventing of Terrorist Financing – for Insurers (Long Term Business) were produced by the IPA in the early part of 2008, passed by Tynwald and which came in to effect on the 1st September 2008. The Regulations and Guidance Notes are derived from the previous Anti-Money Laundering Standards but incorporate provisions relating to a more risk based approach to customer due diligence and to dealing with politically exposed persons (PEPs). The new Regulations and Guidance Notes are available at the IPA's website www.gov.im/ipa.

Similarly the FSC has been undertaking a review of the AML and CFT regulation for its licence holders as part of the CAROL (Consolidation and Review of Regulatory Legislation) Project. The output of CAROL has been a number of new acts and secondary legislation which came in to force on the 1st of August 2008 (see previous articles in this newsletter for further information). These changes have revised the regulatory landscape for all financial services entities and activities that are regulated by the FSC (essentially all entities and activities other than those relating to insurance and pensions). The new Financial Services Rule Book 2008 details the requirements relating to AML and CFT with further guidance being found in the Anti-Money Laundering and Countering the Financing of Terrorism Handbook. As with the IPA regulations and guidance, the main thrust of the new Rule Book and Hand Book has been to further develop the provisions relating to a risk based approach to customer due diligence and to PEPs in line with developments elsewhere around the globe. Again the Rule Book and Hand Book can be found at www.fsc.gov.im/aml.

Finally, to show that the legal industry is moving with the times, the Isle of Man Law Society has produced the Guidance Notes 2008 which came in to force on the 1st August 2008. The Guidance Notes provide guidance to the legal profession on the Island on compliance with the Criminal Justice (Anti Money Laundering) Code 2007. Following the implementation of the Criminal Justice (Anti Money Laundering) Code 2007 and the adoption of the Guidance Notes 2008, the position of advocates where they undertake relevant business is analogous to that applicable to solicitors in England and Wales.

Examination Time

One of the big drivers behind the flurry of activity relating to AML and CFT on the Island in the last 12 months has been the impending visit of the International Monetary Fund (IMF) in September 2008. The last visit by the IMF to the Island in 2002 concluded that there were "high levels of compliance". The Island was evaluated on 32 of the FATF 40+8 (as it was then) recommendations and found to be "compliant" on 25 and "largely compliant" on another 7. All of the relevant governmental, regulatory and industry bodies on the Island have been busy over the last 12 months putting in place measures to ensure that the next evaluation of the Isle of Man improves on that of 2002. We will provide an update on the IMF's evaluation once it is available.

Black Marks for the White Paper

In May 2008 the EU Committee on the Prevention of Money Laundering and Terrorist Financing published its draft white paper on countries with equivalent anti- money laundering controls. The white paper lists those jurisdictions which the Committee believes provide sufficient anti-money laundering controls so that EU organisations doing business with entities from the listed countries can conduct simplified due diligence rather than enhanced due diligence.

The White Paper listed 13 countries that were deemed to have equivalent AML and CFT controls, including Argentina, Brazil, the Russian federation, Switzerland, the US and South Africa. None of the offshore financial centres (OFCs) were listed, although the White Paper does make clear that the Crown Dependencies (the Isle of Man, Jersey and Guernsey) may be considered to have equivalent controls.

Rather unsurprisingly the White Paper has created a furore within the offshore world with accusations of cynical manipulation being laid against the Committee on the grounds that the 13 approved countries comprise either major trading partners of the EU (such the US, Japan and Switzerland) or developing economies with which the EU may wish to build major trading relationships (e.g. Brazil and the Russian Federation). Governments in the Crown Dependencies and further afield in the offshore world have been keen to highlight that their jurisdictions have achieved higher rates of compliance in IMF and FATF evaluations than most of the countries listed in the White Paper and, indeed, than a number of the EU countries themselves.

The White Paper is in draft form at the moment and it is hoped that with the new legislation and regulation now in place on the Island and, in due course, with the publication of the results of the IMF visit, the Island will again be judged to be at the forefront of the battle against money laundering and terrorist financing. If the Island is still not included on the White List we really will have reasons to complain that it is a politically motivated list rather than a true reflection of the achievements of the countries.

It is probably worth quickly considering the Isle of Man's record in relation to AML and CFT

• The Isle of Man has had AML and CFT legislation in place for well over a decade during which time it has been praised following each review - the Edwards Report of 1998, the FSF Report of 2000, the FATF Review of 2000 and the IMF evaluation of 2002 (the results of which are detailed above).

• The latest analysis of suspicious activity reports (SARs) for the OFCs show that the Isle of Man rates far in excess of other OFCs. Jersey is the OFC that has made the second highest number of reports but only 75% of the number of SARs as the Isle of Man despite a comparatively larger financial industry.

• With the new AML and CFT legislation now in force, the Isle of Man has regulation that would meet the requirements of the Third European Directive on Money Laundering if it applied to the Island.

• William F Baity, deputy director of US anti-money laundering agency FinCen and a former chairman of the Egmont Group (the grouping of financial crime intelligence units), recently praised the Isle of Man for the positive role that the Island has taken in combating AML.

Conflicts Of Interest And Declarations Of Interest In Transactions And Arrangements
by Camilla Neal, Advocate

As of 1 October 2008 the final phase of extensive new statutory duties for company directors, introduced by the UK Companies Act 2006 (the UK Act), came into force in England and Wales. A major area of change is in the law surrounding director's conflicts of interest and in particular the timing and method of any declaration of such an interest.

The UK Act imposes two specific strands of regulation in relation to conflicts of interest. Firstly, by Section 175 there is a specific duty for company directors to avoid conflicts of interest and where a conflict situation is unavoidable seek authorisation from the board of directors prior to that potential conflict arising. Secondly, the more familiar requirement that conflicts of interest be declared to the board of directors of a company remains under Sections 177 and 182 of the UK Act.

The duty to avoid conflicts of interest is the provision most likely to cause problems for companies as the underlying concept is a new one. In particular before the 1 October implementation date directors of UK companies should have considered if any changes were needed to their existing conflict regimes to take into account the new requirements of the UK Act. Such changes might have included the amendment of the articles of association of public companies to allow their board of directors to authorise conflicts rather than being forced to seek shareholder approval for each conflict or the undertaking of an internal audit of potential conflicts by a company with its directors. The importance for a UK company in putting everything in order before 1 October was that under the new regime the board of directors cannot give retrospective approval.

Unlike the new position in the UK, in the Isle of Man the majority of director's duties remain firmly encased in common law and have not been formally codified. Whilst the directors of an Isle of Man company must not put themselves in a position where there is a conflict (actual or potential) between their personal interests and their duties to the company there is no statutory procedure and since no uniform procedure can be implemented companies must deal with the practicality of complying with this duty on a case by case basis.

If a conflict does exist, a director is under a duty to disclose to the members of the relevant Isle of Man company in a general meeting the nature of any interest in a transaction to which the company is or is to be a party. Failure to disclose such an interest makes the contract voidable at the option of the company against any party with notice of the breach or any profit made by the director in breach recoverable by the company. However, an Isle of Man company is at liberty to waive the benefits of these equitable rules and allow a director to make a contract with, or be interested in, a contract with the company.

Invariably such a waiver is done by the inclusion of a provision in a company's articles of association releasing the directors from the requirement to disclose their interest to the company in a general meeting. However, a complete waiver by the company of the common law rules protecting the company as principal in dealings in which directors have an interest would not be in the interests of the company's shareholders. For that reason a director of an Isle of Man company incorporated under the Isle of Man Companies Acts 1931 to 2004 must comply with the requirements of section 148 of the Isle of Man Companies Act 1931 (the 1931 Act) (such provision being similar to the provisions under Section 317 of the UK Companies Act 1985) to disclose to the board of directors of a company the nature of any interest which a director might have in a contract or proposed contract as soon as they become aware of it. Interestingly, when the Isle of Man rewrote its companies legislation and brought into force the Isle of Man Companies Act 2006 (the 2006 Act) similar provisions to the existing ones under Section 148 of the 1931 Act were included and the road which the UK has gone down was not taken. The regime under the 2006 Act is similar to that under the older legislation and as such no obligation has been imposed on directors to avoid conflicts as has been taken in England. It remains to be seen whether such a change may be considered in the future once the impact and effect of the new English regime has been established and its benefits assessed but for now public and private companies incorporated in the Isle of Man will not have to change their articles of association.

Illicit Peer To Peer File Sharing And Copyright
by Claire Milne, Senior Associate

The creative industries are underpinned by the law of copyright. In the Isle of Man, the principal piece of legislation governing copyright is found in the Copyright Act 1991. This piece of legislation however, is based very much on the UK's Copyright, Designs and Patents Act 1998.

Copyright is a right that arises automatically in original literary, artistic and musical works, sound recordings and broadcasts. In law, software is regarded as a literary work and therefore is protected by copyright as are photographs, musical scores, musical recordings and films. By its very nature therefore, the Internet is arguably nothing more than a collection of copyright works. Since its inception however, the Internet has raised concerns for rights holders regarding the potential for copyright infringement on the Internet.

The issue of illegal downloading from the Internet has made news headlines on numerous occasions. A recent study conducted by Jupiter Research, commissioned by BPI (formerly known as British Phonographic Industry) estimated that 6.5 million people in the UK engaged in online music "piracy" in 2007. The same organisation that undertook this research has estimated that the cumulative cost to the music industry in the next five years of this activity will exceed £1bn.

The software that is typically used in filesharing was developed in order to allow people to make the most effective use of computer networks. A P2P computer network uses a series of ad hoc connections between participants in a network and the cumulative bandwith of network participants. The advantage of a P2P network is that all users provide resources, including bandwith, storage space and computing power. As additional users arrive and demand on the system increases, the total capacity of the system also increases. As there is no one central server to fail, P2P networks are more robust with data replicated over a number of users. Peer-to-peer use however can be legitimate and perhaps the best example of legitimate peer-to- peer use is the BBC's i-Player which, since its launch on 25 December 2007, has achieved over 3.5m downloads per week.

Rights holders are however concerned not with legal downloads from the Internet but rather with illegal P2P use; the illegal sharing of files (mostly in relation to music and film); the resulting copyright infringement and the loss of revenue to the rights holder. Various action has been taken by rights holders in the past but it is accepted that traditional court action is not always the best way to proceed.

In recognition of this, at the end of July, BPI signed an agreement with several ISPs to put in place measures to seek to reduce illegal filesharing. This agreement requires the music industry and the relevant ISPs to educate consumers and develop legal online download services. In practice, this means that ISPs will be sending thousands of educational letters to those customers who are suspected of illegal filesharing. However, how effective (and commercially attractive to ISPs) this educational exercise will be remains to be seen! The UK Department for Business, Enterprise and Regulatory Reform ("BERR") has also recognised the issues that arise from illegal filesharing and its impact on the music and other creative industries. On 21 July, BERR issued a consultation document on various options to address illicit peer-to-peer file sharing. A copy of the consultation document is available at http:\\www.berr.gov.uk\files\file47139.pdf.

The UK Government's consultation is concerned with examining the options for a statutory solution to the problem of illegal peer-to-peer file sharing of copyright material. This problem was highlighted by Andrew Gowers in his report to HM Treasury in December 2006 regarding intellectual property in the United Kingdom. The Gowers Report set out recommendations regarding intellectual property in the digital age. The Report's principal recommendations were aimed at :-

• Tackling intellectual property crime and ensuring that intellectual property rights are enforced;

• Reducing the costs and complexity of the intellectual property system in the United Kingdom; and,

• Reforming copyright law in view of the challenges of the digital age.

BERR's consultation is a response to the recommendations set out in the Gowers Review.

The UK Government's view is that there should be a self regulatory approach consisting of codes of practice agreed to by both industry and ISPs but that the self- regulatory approach would be overseen by a regulator who would have the responsibility for approving the relevant codes of practice. The UK Government recognises however, that there are alternative options and these are as follows:

• Streamlining the existing process by requiring ISPs to provide personal data relating to a given IP address to rights holders on request without them requiring to go to court;

• Require ISPs to take direct action against users who are identified by the rights holders as infringing copyright;

• Appointing a third party to consider evidence provided by rights holders and to direct ISPs to take action against individual users as required or to take action directly against individual users;

• Requiring that ISPs allow the installation of filtering equipment to block infringing content or requiring ISPs themselves to install faltering equipment that will block infringing content.

Although BERR is a body of the UK Government, its consultation is important to businesses that are involved in the creative industries and especially to ISPs on the Island. The closing date for the consultation is 30 October 2008. On Island ISPs and those with an interest in copyright on the Internet now have the opportunity to have their views heard.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.