Chapter Six Client Protection PDF

Chapter Six Client Protection 1. Suitability Standards 145 2. Appropriateness Standards 147 3. Client Assets Accepted Practice 149 4. Client Communication...

Chapter Six Client Protection 1. Suitability Standards 145 2. Appropriateness Standards 147 3. Client Assets Accepted Practice 149 4. Client Communications, Reporting, Financial Promotions and Advertising 151 5. Promoters and Introducers 153 6. Regulations for Special Purpose Acquisition Companies 158 This syllabus area will provide approximately 10 of the 100 examination questions 144  Client Protection 1. Suitability Standards 1.1 Introduction The rationale for categorising clients is so that those clients can be given the right level of protection under the law and regulations. A good example of this expectation is drawn from Decision 05 of 2020 of the Securities and Commodities Authority (SCA or the Authority) entitled Suitability and Appropriateness Standards. These standards relate to what are described as ‘complex’ financial products – in other words, financial products that have complications over and above those found in the usual shares, bonds or units in mutual funds. A reasonable example 6 might be a bond with the right to convert into shares, or other characteristics that make them difficult to value, or include conditions or risks that might not be fully understood by the less sophisticated retail investor. 1.1.1 Suitability Standards Learning Objective 6.1.1 Know the suitability standards (Article 3) Article 3 of The SCA’s Decision No. 05 of 2020 requires licensed firms either recommending or executing transactions in a ‘financial complex product’, carefully considering the suitability in relation to the client using three parameters: 1. The client’s experience – this should be measured by assessing the types of financial services, activities or investments that the client has been involved in, the nature, size and frequency of transactions undertaken by the client and the client’s level of education and professional experience. 2. The client’s financial circumstances – for this, the firm is expected to look at the source and amount of the client’s regular income, their regular expenses and other financial obligations, and the client’s assets, properties and investments. Together this will enable the firm to assess the extent to which the client can bear losses and face risks. 145 3. The client’s investment objectives – the firm must consider whether the product is of the type preferred by that client, and whether it meets the client’s investment in terms of period and value. 1.2 Suitability Report Learning Objective 6.1.2 Know the content required in a suitability report (Article 4) The SCA requires full details to be recorded and maintained. Specifically, Article 4 of Decision No. 05 of 2020 requires the licensed entity to prepare a suitability report that must include the following: 1. Evidence of the client’s knowledge plus the client’s awareness of the need to provide the licensed entity with up-to-date, accurate and correct information. This information should be coordinated and arranged in a manner that guarantees its accuracy and correctness and ensures the understanding of the questions addressed to the client. 2. Evidence that a correct and reliable assessment of the client’s knowledge, experience and ability to bear risks and losses has been performed. 3. Statement of the mechanisms and tools used in assessment and its suitability. 4. A detailed statement on the recommendation submitted to the client or the standards that the licensed entity depended on to consider the financial product that the client wanted was a complex product, indicating the nature, characteristics and risks of that financial product. 5. A statement of the reasons behind the suitability or non-suitability of the recommendation or the financial product transaction to the client, indicating the method of meeting the client’s goals, the client’s position towards the risks and the client’s ability to bear the risks and losses. 6. Evidence of the periodical updating and revision of the standards relating to the suitability of the financially complex product to the client. 146  Client Protection 1.3 Obligations for Licensed Entities Learning Objective 6.1.3 Know obligations for licensed entities (Article 5) Article 5 of the SCA’s Decision No. 5 of 2020 details and reinforces the obligations that are placed on licensed entities regarding suitability of financially complex products for retail customers. It requires the licensed entities to: 1. Take the necessary procedures and measures to ensure that the information received from the client is correct, complete and updated, and that the recommendation or the financially complex product is suitable to the client and does not conflict with the result of the firm’s suitability assessment. 2. Refrain from recommending or implementing deals in financially complex products to clients in the 6 event of not receiving sufficient information to assess its suitability, and notifying the client. 3. Provide the client with sufficient information necessary to assess features, costs and risks of the financial product, and indicating any potential risks that its interests may face. 4. Notify the client regarding the suitability or non-suitability of investment using the financially complex product, including the extent of meeting the suitability standards. This notice must be retained. 5. Comply with the client’s orders in the event of its insistence on the investment in the financially complex product despite notifying the client that it is not suitable. Evidence on the client insistence must be retained. 6. Obtain an annual undertaking from the client regarding data about them and updating any data that have changed. In all cases, the report must be updated every three years. All undertakings and updates must be retained. 7. Retain the suitability reports of the clients and provide the SCA with the reports on request. 8. Update the internal procedures to ensure compliance with suitability standards. 2. Appropriateness Standards 2.1 Appropriateness Learning Objective 6.2.1 Know the appropriateness standards (Article 6) When a licensed entity’s role is limited to implementation of transactions (excluding the financially complex products) without providing recommendation to the client, they must meet certain appropriateness standards that are detailed in Article 6 of the SCA Decision No 05 of 2020. This type of business is often described as ‘execution-only’ business. 147 The appropriateness standards are similar to the suitability standards used to assess complex products. They consider the following factors: The client’s knowledge and awareness of the financial services, activities and investments. The nature, size and frequency of client transactions in related financial services and investments. The client’s level of education, current and previous profession. The appropriateness of the financial products for the client in light of the data obtained from the client. The appropriateness of the financial markets that the client is targeting investment in, again in the light of the data obtained from the client. 2.2 Appropriateness Reports Learning Objective 6.2.2 Know the content required in an appropriateness report (Article 7) As with suitability, an appropriateness assessment must be supported by, and documented in, an appropriateness report. These must be prepared by the licensed entity undertaking the execution only services and include: details of the financial products or services to be implemented for the client the result of the appropriateness assessment statement of the reason behind appropriateness (or non-appropriateness) of implementation for the client. 2.3 Appropriateness Obligations Learning Objective 6.2.3 Know obligations for licensed entities (Article 8) In relation to appropriateness, each licensed entity must satisfy the following obligations: To exercise due diligence in increasing the level of client understanding of the financial service, activity, or financial product by providing the necessary information to the client. To notify the client regarding the appropriateness (or non-appropriateness) of the requested implementation, along with the extent of meeting the appropriateness standards. This notice must be retained. To refrain from implementation for the client in the event of not receiving sufficient information to assess its appropriateness, and to notify the client. To comply with the client’s orders in the event of its insistence on implementation in spite of notifying the client that it is not appropriate. Evidence of the client insistence to go ahead must be retained. To retain the appropriateness reports of clients and provide them to the SCA on request. To update the internal procedures to ensure compliance with appropriateness standards. 148  Client Protection 3. Client Assets Accepted Practice 3.1 Introduction Learning Objective 6.3.1 Understand the purpose of the client money and custody rules including the requirement for segregation and that it is held in trust: holding client assets and client money; protection; organisational arrangements; registration and recording of legal title; statutory trust Accepted practice is that financial services firms must, when holding money or other assets (such as investments) that belong to clients, make adequate organisational arrangements to protect and safeguard those assets. If it is client money, the adequate arrangements must prevent the firm from using the money for its own account, and minimise the risk of loss due to misuse, fraud, poor 6 administration, inadequate record keeping or negligence. In terms of client money, the main objective is to ensure that it is segregated from the firm’s own money. Usually this is done by ensuring that client money is placed promptly in a separately designated client money account with a bank, and ensuring that the bank treats the client money as separate from the firm’s money. If the clients’ assets are not money, the adequate arrangements are typically referred to as custody rules and must safeguard clients’ ownership rights, especially in the event of the firm’s insolvency, and prevent the use of the clients’ assets, except with the clients’ express consent. For registered investment, the registered title is typically required to be either in the name of the client, or in the name of a nominee or trust company holding the investments for the benefit of the client. 3.2 Reconciliation Requirements Learning Objective 6.3.2 Know the requirements for reconciling client assets and client money including the timing and identification of discrepancies: assets and money held by the firm; assets and money held by third parties; frequency; discrepancies; notification to the SCA Firms must perform internal reconciliations of the financial instruments held for each client with the financial instruments held by the firm and those held with third parties. Broadly, accepted practice is that reconciliations should be made as ‘often as is necessary’ to ensure the accuracy of a firm’s records and accounts. Where possible, they should be done by someone who has not been involved in the production or maintenance of the records being reconciled. If the reconciliation shows a discrepancy, the firm must make good (or provide the equivalent of) any shortfall for which it is responsible. Where another person is responsible, the firm should take reasonable steps to resolve the position with that person. 149 Firms must inform the regulator without delay of any failure to comply with the reconciliation requirements. Accepted practice for the reconciliation of client money is that firms perform internal and external reconciliations. 3.2.1 Internal Reconciliations Performing an internal reconciliation means cross-checking the records showing each client’s entitlement to client money against the records of client money the firm holds in client bank accounts and client transaction accounts. Firms can choose how often they perform internal reconciliations, subject to the requirement that they do so ‘as often as is necessary’ – and as soon as is reasonably practicable after the date to which the reconciliation relates. Where a reconciliation shows a discrepancy, the firm must investigate to identify the reason for the discrepancy and ensure that either any shortfall is paid into the client bank account or any excess is withdrawn from the client bank account by close of business on the day the reconciliation is performed. 3.2.2 External Reconciliations This means cross-checking the internal client money accounts against the records of third parties (banks) with whom client money is held. Firms must perform external reconciliations as often as is necessary and as soon as reasonably practicable after the date to which the reconciliation relates. If there is a discrepancy, the firm must investigate and correct it as soon as possible. Where it cannot do so and the firm should be holding a greater amount of client money, it must pay its own money into the client bank account pending resolution of the discrepancy. If a firm has not complied with these requirements, or is for some reason unable to comply in a material aspect with a particular requirement, it must inform the regulator in writing. An adequate method of reconciling client money balances with external records is as follows: A reconciliation of a client bank account as recorded by the firm with the statement issued by the bank (or other form of confirmation issued by the bank). A reconciliation of the balance on each client transaction account as recorded by the firm, with the balance of that account as set out in the statement (or other form of confirmation) issued by the person with whom the account is held. 150  Client Protection 4. Client Communications, Reporting, Financial Promotions and Advertising 4.1 Introduction Learning Objective 6.4.1 Understand the rules relating to communications with clients It is accepted practice for developed markets to have rules in relation to the way firms communicate with clients regarding their investment business and communicating or approving financial promotions. The majority of these rules do not apply when the client is an eligible counterparty. 6 4.2 Clear, Fair and Not Misleading Learning Objective 6.4.2 Know the rules relating to fair, clear and not misleading communications and financial promotions Generally, there is a requirement for firms to ensure that any communication with a client is fair, clear and not misleading. The fair, clear and not misleading rule applies in a way that is appropriate and proportionate, taking into account the means of communication and the information that the communication is intended to convey. So a communication addressed to a professional client may not need to include the same information, or be presented in the same way, as a communication addressed to a retail client. Examples of communicating in a clear, fair and not misleading manner include: a promotion relating to a product or service that places a client’s capital at risk makes this clear a promotion that quotes a yield figure gives a balanced impression of both the short- and long-term prospects for the investment. 4.3 Client Reporting Requirements Learning Objective 6.4.3 Know the general client reporting and occasional reporting requirements Generally, firms are required to ensure that clients receive adequate reports on the services they provide to them. These must include any associated costs. 151 Where a firm carries out an order for a client it must: provide them with the essential information on it, promptly and in a durable medium for retail clients, send a notice confirming the deal details as soon as possible (but no later than on the next business day). Where the confirmation is received from a third party, the firm must pass the details on no later than the business day following receipt provide clients with information about the status of their orders on request. However, a firm need not provide transaction details if the same details are already being sent to the client by another person. 4.4 Periodic Reporting Learning Objective 6.4.4 Know the rules on periodic reporting; the additional requirements regarding contingent liability transactions; the exceptions and record keeping requirements Firms providing investment management services must also provide periodic statements, unless these are provided by another party. For retail clients, this must be at least six-monthly, with the following exceptions: the client may request statements three-monthly instead if they receive deal-by-deal confirmations, and certain higher-risk investments are excluded, the statement may be sent every 12 months, and where the client has authorised that their portfolio be leveraged, the statement must be provided monthly. Firms must advise their retail clients of their right to request quarterly statements. Where firms manage investments for clients, or operate certain types of account for them which include uncovered open positions, they must report any losses over a pre-agreed limit to the client. They must do so by the end of the business day on which the limit is breached (if this happens on a non-business day, by the end of the next business day). 4.5 Financial Promotion Rules Learning Objective 6.4.5 Understand the purpose and application of the financial promotion rules The purpose of the financial promotion rules is to ensure that such promotions are identified as such, and that they are fair, clear and not misleading. 152  Client Protection The rules are consistent with the need for firms to pay due regard to the interests of its customers and treat them fairly and to pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading. 4.6 Appointed Representatives and the Financial Promotion Rules Learning Objective 6.4.6 Know the firm’s responsibilities under the financial promotion rules regarding the use of appointed representatives An appointed representative is a self-employed individual, or a firm, that is contracted to sell the products of a particular financial services firm. The representative is generally exempt from obtaining their own authorisation, and so the regulator’s rules do not directly apply to them. However, there is 6 typically a requirement that firms make sure their appointed representatives comply with the rules, particularly when they communicate financial promotions via their appointed representatives. 5. Promoters and Introducers 5.1 Promoter Obligations Learning Objective 6.5.1 Know obligations of the promoter relating to: financial product promotion (Article 9); promotion material (Article 10); ongoing-obligations (Article 11); promotion of foreign funds (Article 12) SCA Decision No. 3 of 2017 is titled ‘The Organization of Promotion and Introduction’. It puts regulations in place over the promotion of financial products, including funds as well as detailing the obligations faced by the introducers of financial products. Chapter 3 details the obligations of promoters. 5.1.1 Notification Requirements The promoter is required to: Notify the SCA in advance of the promotion of any financial product. The SCA may then, within ten days of the date of such notice, stop all promotion operations where it is in the public interest. For units in investment funds, the notification to the SCA is on an application form specifically designed for this purpose and the SCA may approve or reject the application within 15 days of the date of submitting the application. 153  The notice or application submitted to the SCA must enclose all documents and data and these will include: the type and quantity of financial products whether the financial products to be promoted are registered with the SCA or not. If not registered, the promoter must register such products after paying the requisite registration fees to the SCA a written approval from the peer regulator in the promoter’s jurisdiction in the event that foreign securities are to be promoted in the UAE a disclosure of the relationship between the promoter and the promoted products or their issuer during the 12 months preceding the promotion a copy of the IPO prospectus, or prospectus of the issuer or foreign issuer, if any, and the investment policy for investment funds a statement of the methods of promotion a copy of the promotional material in a clear language that is understandable to the investors. 5.1.2 Promotional Materials The promotional material referred to above must include the following: 1. The name, address and contact details of the promoter. 2. Type and place of issue of the financial products to be promoted, as well as the number of issued products, currency of issue and all related information. 3. A statement whether the promoted financial products are listed or not, and a list of the markets where they are listed. 4. Data contained in the prospectus or offer document and any amendments thereto. 5. Minimum limit for subscription or purchase, and any ban or restriction on the investor, its trading or subscription. 6. Mechanisms of dividends distribution and redemption as well as maturity dates. 154  Client Protection 7. Specifying the investor type that is eligible to invest, particular whether such investors are only required to be ‘regular’ rather than ‘qualified’. 8. The investment risks associated with the financial products to be promoted. 9. A statement identifying the major shareholders of the issuer and/or the foreign issuer who own 10% or more of the shares. 10. The method of communication used by the entities concerned with the subscription, selling and purchasing of the promoted financial products. 11. Specify the Shariah Supervisory Board whose function is to ensure conformity of the promoted financial products with Shariah. 12. The mechanisms and means for disclosing data and information. 5.1.3 Promoter’s Ongoing Obligations Article 11 of SCA Decision No. 3 of 2017 also places certain ongoing obligations on the promoter. These specify that the promoter must: 6 1. Not also act as an agent or representative of a client in dealing with the issuer or foreign issuer. 2. Use easy, clear, honest, correct and non-misleading promotional materials written in a language easy to understand by the investors, and without using any fraudulent or deceptive means. 3. Not publish, promote or use any incorrect or misleading data or information on the financial products and the issuer, including the foreign issuer or the market where they are listed, if any. 4. Abstain from providing any financial consultations or analysis relating to the financial product subject of promotion, unless it is licensed to do so. 5. Alert the clients of the possibility that the exchange rate may influence the value of any promoted foreign financial securities. 6. Alert the clients that the past performance of the promoted financial products is not necessarily an indicator or proof of the future performance. 7. Withdraw promotional material immediately upon becoming aware that the issuer breaches any legislative provisions or regulatory procedures or conditions, or becoming aware of any potential damage that the investors may sustain. 8. Enable its clients to review the material disclosures and information, reports and approved financial statements and all relevant information on a timely basis. 9. Instantly disclose, through the mechanisms and means specified in the promotional materials, the prices of the promoted financial products and any risks or any related material information, as well as the sources relied on in preparing the comparisons, provided that such sources are correct, recent and reliable and do not include any projections of future prices, or selective information. 10. Abstain from owning any promoted financial products on behalf of clients, or receiving any funds from them in this regard except after obtaining the SCA’s approval. 11. Abstain from promoting the shares of the foreign issuer intended to be offered in initial public offering (IPO) except after the issue of the SCA’s approval of the offering. 12. In case of contracting with the issuer or foreign issuer, the following conditions must be observed: show the type and number of financial products to be promoted ensure that the signed agreement between the parties does not violate any legislation in force in the UAE and that it includes a statement of the rights, duties and responsibilities of each party, the mechanism for the termination, expiry or amendment of the agreement and the means of communication between the parties 155  not to contract with an issuer or foreign issuer with whom a promotion agreement was terminated in the past for reasons related to violation of its obligations or breaching the legislation in force in the UAE, and provide the SCA with a copy of the agreement (including any alteration or amendment, or subsequent termination). 13. Ensure the suitability of the financial product to be promoted for the risk level that the local investor may tolerate, after studying the investor’s financial position and officially informing the investor of the outcome of the risk appetite study and specifying the types of financial products that suit that risk appetite. 5.1.4 Promoting Units in Foreign Funds Article 12 of Decision No. 3 of 2017 adds some additional obligations for promoters of foreign funds in the UAE. When promoting foreign funds the promoter is required to: 1. Ensure that any foreign fund subject to a public offering meets the following conditions: the fund must be subject to the supervision of a regulator similar to the SCA the fund must be either incorporated outside the UAE, or incorporated in the UAE in a free zone or financial free zone. the fund must be licensed in its jurisdiction for public offering. 2. In a private offering, the foreign fund promotion must be limited to qualified investors. 3. Ensure that any foreign fund subject to a private offering meets the following conditions: the fund must be either incorporated outside the UAE, or incorporated in the UAE in a free zone or financial free zone the fund must be and is subject to a regulator similar to the SCA the fund must be licensed in its jurisdiction for the promotion of a public or private offering. 4. Ensure that the foreign fund is not exempted from any regulatory or supervision rules or the regulations for preparing and issuing periodic reports at its domicile of incorporation. 5. Ensure that all mechanisms that enable the foreign fund whose units are promoted to meet all functions and obligations towards the holders of the promoted units in the UAE, in accordance with the public offering document. 6. Exert the due diligence of the careful person when examining and selecting the foreign investment fund to be promoted in the UAE and in monitoring the performance of such fund after the promotion process in order to guarantee the protection of the investors’ assets and ensure that the fund actually exists, and its legal position is sound at its domicile of incorporation. 7. Keep a register for the foreign fund units distributed through it. The register must include the following data: for individuals – the names, addresses, ID card or passport numbers of the unit owners as well as the number of units owned by each for companies – the names, address of the headquarters and commercial registration numbers and the number of units owned by each the dates the individuals or companies were added to the register any other data related to the unit owners. 8. Ensure that the investor in a foreign fund obtains a copy of the public offering document of the fund’s units whether the offering is public or private, before the investor subscribes for the foreign fund units. 9. Ensure that a daily price of the fund’s units is available, or as stipulated in the offering document, or each unit’s net asset value and providing suitable access to the investors in the UAE. 156  Client Protection 10. Provide the subscribing clients with a proof of their subscriptions in the fund, the units allocated/ purchased for them and the document that guarantees their exercise of all their rights as owners of such units. 11. Assume the duties of dividend distribution to the unit owners and/or redeem the units for the owners who so wish according to the announced price and in line with the foreign fund’s offering document unless the foreign fund founder assigns these two functions to another entity in the UAE. 12. The promotion means for a foreign fund approved by the SCA for promotion in the UAE in a private offering must be limited to direct contact with previously specified persons. 13. The minimum limit for subscription by a single investor in a foreign fund approved by the SCA for promotion in the UAE in a public offering must be included in the offering document. 14. The minimum limit for subscription by a single investor in a foreign fund approved by the SCA for promotion in the UAE in a private offering is the limit detailed in the offering document provided that it may not be less than AED 500,000, with the exception of a fund incorporated outside the UAE in a free zone or financial free zone, in which case the minimum limit for subscription by a single investor will be the minimum limit detailed in the offering document provided that it may not be less than AED 1 million. 6 5.2 Introducer Obligations Learning Objective 6.5.2 Know obligations of the introducer (Chapter IV) Broadly speaking, an introducer is a corporate entity that has been given approval by the SCA to provide potential clients for financial services firms. In order to gain the SCA’s approval to act as an introducer, the following conditions must be met: Firstly, the person must either be: licensed by the SCA to engage in financial activities or services licensed by a similar regulator engage in any financial activities or services, or be a licensed bank or insurance company (from within or outside the UAE). Secondly, the SCA’s application form must be submitted, including the required supporting documents, and specifying the type of financial activities or services to be introduced. The SCA will issue its decision approving or rejecting the application within a period of no longer than 15 days from the date of submitting the complete application. Once approved, the introducer has to comply with certain regulatory obligations. The six obligations are detailed in Article 14 of SCA Decision No. 3 of 2017: 1. The introduction must be related to financial activities and services intended to deal in financial products. 2. The introducer must disclose to the investor both the introduction procedures and any commissions to be received by the introducer. 157 3. The introducer must disclose to the parties to the introduction the relationship that links the introducer to each party. 4. The introducer must abstain from providing any financial consultation or financial analysis, unless licensed to do so. 5. The introducer is not permitted to receive any funds, assets, orders or requests from the client, directly or indirectly, except for the disclosed commissions. 6. To obtain the approval of the SCA to conduct any introduction business outside the UAE. 6. Regulations for Special Purpose Acquisition Companies A special purpose acquisition company (SPAC) is alternatively referred to as a ‘blank check company’. It is formed with the sole purpose of effecting a ‘merger’ - to raise money through an initial public offering (IPO) so that it can buy another company. At the initial public offering stage, SPACs do not have business operations or stated targets for acquisition. Subsequently, an existing operating company can merge with (be acquired by) the publicly traded SPAC and become a listed company. The SPAC essentially removes the need for the operating company to execute its own IPO. Sponsors set up the SPAC and invest enough cash to cover the initial operating expenses. In return for the investment the sponsors get ‘founder shares’ which will often be around 20% of the SPAC. These sponsors will typically bring together a credible and experienced board of directors for the SPAC and the team assembled by the sponsors will raise capital from investors. The capital raised is usually in the form of shares with warrants. The warrants typically enable further shares to be purchased at a small premium to the share IPO price. SPACs have a limited lifespan (typically two years) and if there is no merger consummated in the time span of the SPAC, this investment will be redeemed. In early 2022, the Authority published regulations for Special Purpose Acquisition Companies (SPACs) in Resolution No 1/Chairman of 2022. These regulations are summarised in the subsections that follow. 6.1 Permitted Activities, Classification and Exemptions Learning Objective 6.6.1 Know permitted activities for Special Purpose Acquisition Companies (Article 3); classification of Special Purpose Acquisition Companies (Article 4); exemptions to the commercial companies law (Article 5) Under Article 3 of the Special Purpose Acquisition Company regulations, a SPAC is prohibited from practising any economic activity, except for the following: a. To offer, issue and list its shares and/or warrants. b. To search for a target entity to acquire/merge with. c. Other business related to achieving its objectives. 158  Client Protection To be classified as a SPAC, the founder(s) must apply to the Authority on the required form. The Authority will then either accept the application and grant the classification, or reject the application. For acceptance the following conditions must be met: a. The issued capital of the proposed company, immediately after the public offering, shall not be less than AED 100 million. b. The founders must not have announced or disclosed any acquisition target entity or potential acquisition target entity to any person other than the sponsors. c. All proposed sponsors must meet the following requirements: 1. The value of their assets (excluding the value of the main residence) exceeds their financial obligations, and that no decision has been issued against any of them to declare bankruptcy or insolvency anywhere in the world. 2. They have sufficient experience to manage the SPAC, as determined by the Authority. 3. None of them has been previously convicted of a penalty or a crime against honour, unless rehabilitated. 4. No judicial judgment has been rendered against any of them for dismissal as a member of the 6 board of directors of a joint stock company listed in the financial market. 5. Their professional record is free from administrative penalties issued by the Authority. 6. The absence of lawsuits, reports or investigations prosecuting any of them in relation to honesty and integrity. d. The objectives of the proposed company specified in the articles of association must not conflict with the objectives that the company is permitted to conduct. e. The articles of association of the proposed company must specify the initial issued capital of the SPAC, which represents the number of the sponsors’ shares that the company will issue at the nominal value of each share determined by the articles of association. The issued capital upon incorporation may not be less than AED 100,000. f. Sponsors must have clear business goals that they will strive to achieve. g. The sponsors must be aware of the potential returns to the investors and the risks that investors may face if they purchase shares or warrants, and the sponsors must prepare proposals to reduce this risk. h. The managers must have sufficient experience to achieve the business objectives of the proposed company in accordance with the regulations issued by the Authority. Companies classified as SPACs are exempt from many provisions of Commercial Companies Law including: The need to invite the public to subscription. The need to appoint an underwriter. Priority rights to subscribe for new shares. Restrictions on trading the founders’ shares. The SPAC can offer shares and warrants to the sponsors and investors without the need to comply with the usual listing requirements. This includes potentially issuing different classes of shares according to what is specified in its articles of association, including one class for the sponsors’ shares and another class of subsequent investors’ shares. 159 6.2 Public Subscription Procedures Learning Objective 6.6.2 Know public subscription procedures for Special Purpose Acquisition Companies: public subscription procedures (Article 7); public subscription of the Special Purpose Acquisition Company (Article 8) Article (7) of the Resolution details certain requirements that need to be fulfilled prior to making shares in the SPAC available to the public. These include: 1. The SPAC must submit a request for approval of the public subscription in shares and warrants that will be issued by the Authority. 2. The request must be submitted to the Authority no later than 30 business days from the date of issue of the company’s commercial licence. 3. The request must be accompanied by a draft prospectus that includes: a. Information on the shares and warrants that will be issued by the SPAC including the price of both of shares and warrants, the description of every class of shares issued by that company and the shareholders’ rights associated with every one of the share classes. b. The factors that make investment in the SPAC different from investment in other companies, and the particular risks associated with investment in the SPAC, including the limited usage of the public subscription proceeds and the investors’ limited ability to recover those proceeds. c. The recovery rights available for investors. d. Any sectors or industries suggested by the SPAC as areas of focus for entities targeted by acquisition. e. The time period during which the SPAC suggests to complete business consolidation, and any extension suggested by the company. f. The previous experience of the sponsors and managers in companies similar to the SPAC, inside or outside the State. g. The rights of sponsors and managers in managing the SPAC that exceed or may exceed the investors’ rights, including particularly the extent of the power of sponsors and managers to specify the entity targeted by acquisition and approval on business consolidation. h. Any potential conflict of interests among sponsors, managers and investors, including any conflict associated with other commercial activities and how to deal with any potential conflict, particularly concerning the following: i. Any financial incentives for the sponsoring entities and managers. ii. Any losses that may be incurred by the sponsoring entities in the event that the SPAC fails to complete business consolidation. iii. Any plans for getting additional finance after listing and the extent of difference between the provisions of securities that are issued or that will be issued in the special offering and the securities issued in the public subscription. iv. The conditions of any offer that includes post-dated purchase agreements that allow investors to invest in the SPAC upon completion of business consolidation. 4. The founders and the board of directors shall sign the request to the Authority and will be responsible for validity of the data included in that request. 160  Client Protection 5. The listing consultant licensed by the Authority and all the parties to the public subscription process or their representatives must provide due diligence. 6. The Authority must study the public subscription request, and it may request any documents, information, data or amendments and notify the founders thereof. The founders shall meet the requirements within five business days from the date of being notified. 7. The Authority will send a written notice to the SPAC approving or dismissing the request and the prospectus within ten business days from the date of submitting the request to the Authority. 8. If the Authority does not receive the request, or if the Authority dismisses the submitted request for any reason, or if the request is deemed as waived, the board of directors of the SPAC must within thirty business days from the date on which it is required to submit the request, or from the date on which the Authority issues its decision of dismissing the request, or on the date on which the request is considered as waived of, appoint one or more liquidators to liquidate the company voluntarily according to the provisions of the Commercial Companies Law. Article (8) of the Resolution adds some further requirements, including: 6 The unissued shares must be offered as follows: a. For the sponsors, as additional shares to be issued concurrently with the public subscription, provided that the total shares of the sponsors shall not be less than 3% and shall not exceed 20% of the issued capital of the SPAC and any additional shares that will be issued via warrants in the public subscription. b. For investors, as investor’s shares in a public offering at a subscription price detailed in the prospectus. The SPAC must appoint a listing consultant and a financial consultant along with one or more entities to receive the public subscriptions. The SPAC must deposit the prospectus with the Authority and provide a copy thereof for free to the public, at least three business days before the subscription commences. The SPAC, within one business day of depositing the prospectus with the Authority, must publish the call for public subscription by announcement (including summary of the prospectus) in two daily local newspapers, and one of them shall be published in Arabic language. Shares and warrants shall be offered to the professional investors category or the retail investors category or to both of the categories. The prospectus shall specify the minimum and maximum limits that both of the categories may subscribe according to which in the public subscription. The investors must pay the full value of the shares and warrants upon subscription. Subscription must remain open for a period of not less than five business days and not more than thirty business days. If the subscription is not completely covered in the offered shares or warrants within the specified period, the SPAC must submit a request to the Authority to approve extending the subscription period for additional period not exceeding ten business days. If the additional period expires without covering all the shares offered for public subscription, the entire public subscription will be deemed as null, and the SPAC may not list its shares in the market. 161 6.3 Allotment, Issue, Registration and Listing Learning Objective 6.6.3 Know requirements for: allotment (Article 9); certificate issue and registration (Article 10); listing (Article 11) In an IPO of a SPAC, the shares and warrants must be allocated for investors according to the allocation mechanism specified in the prospectus. The allocation must take place within five business days from the day the subscription closed. Following this, any excess paid by subscribers for which no shares or warrants were allocated, should be returned no later than five business days from the date of allocation. Furthermore, the board of directors of the SPAC must, within five business days from the date of allocating the shares and warrants, submit a request to the Authority on the required form to issue a certificate registering the company. The request must be accompanied by the following: a. An audited balance sheet of the subscription accounts including the subscription by the sponsors. b. An acknowledgment signed by the founders of the completion of subscription on all offered shares and warrants, including the subscribers’ names and nationalities and the number of shares and warrant allocated. c. An acknowledgment signed by the founders of the completion of issuance of the shares of the sponsors and that those shares represent a percentage of not less than 3% and not more than 20% of the issued capital of the SPAC and any additional shares that will be issued concerning the warrants. d. A statement evidencing depositing the proceeds of the public subscription. e. The names of the members of the board of directors of the SPAC. 162  Client Protection After completing the above-mentioned procedures and payment of the registration fee, the Authority will issue the registration certificate of the SPAC. Within three business days from the date of the registration certificate issued by the Authority, the SPAC must submit a request to the market to list the shares and warrants issued by it, according to the listing rules. Immediately after being listed, the SPAC must comply with the Authority’s governance regulations for listed public joint-stock companies. 6.4 Public Subscription Proceeds Learning Objective 6.6.4 Know requirements for Special Purpose Acquisition Companies in relation to: public 6 subscription proceeds (Article 12); offering shares and warrants after listing (Article 13) The SPAC must deposit not less than 90% of the public subscription proceeds (or any higher percentage specified by the Authority) within two business days of receipt. The deposit must be into escrow or other suitable account that makes it possible to separate the proceeds from the other money of the SPAC, and the proceeds can only be used for one or more of the following purposes: a. To finance a business combination (merger). b. To meet recovery requests by the investors. c. To return the public subscription proceeds to the investors after a failure event (detailed in the following section). d. To pay any fees for maintaining the account or any other purposes associated with the A to C above. After listing and obtaining the approval of the Authority and a majority of shareholders, the SPAC may perform any of the following actions: a. Receive money from any person against issuance of shares or warrants by special offer to complete the business combination. New shares may be issued with an issuance price less than the purchase price paid by the investors. b. Receive money from sponsors in a special offer against warrants issuance. The money collected from A or B above will not be deemed to be included within the public subscription proceeds. 163 6.5 Business Consolidation and Redemption Learning Objective 6.6.5 Know requirements for Special Purpose Acquisition Companies in relation to: business consolidation (Articles 14,15,17 and 18); redemption (Article 16) A SPAC is normally obliged to complete a business combination/merger within the earlier of the time period proposed in its prospectus and two years from the date of listing. However, the SPAC may seek an extension which cannot go beyond three years from the date of listing. Any extension requires a majority vote from the shareholders and the approval of the Authority. The SPAC cannot implement any business combination/merger until after providing the Authority and the shareholders with all of the related information (including, but not limited to: information about the acquisition target entity, its value, the consideration or price, the necessary amendments to the company’s articles of association of the Special Purpose Acquisition Company and its capital structure after completing the business consolidation process) and submitting an application to the Authority to obtain its approval, and to obtain the approval of shareholders representing not less than 75% of the shares represented in the general assembly meeting of the SPAC. The SPAC cannot complete any merger unless the fair market value of the acquisition target entity or entities have been determined by an independent adviser approved by the Authority, and this value as at the closing date is equal to or more than 80% of the value of the deposited funds in the account (minus the fees of the underwriters determined by the prospectus and the taxes payable on any interest that may accrue on the funds deposited in the account). Furthermore, the SPAC cannot complete any merger unless it has funds enabling it to complete the business combination on the closing date and taking into account any refunds paid or scheduled to be paid before the closing date. The members of the SPAC board must notify the shareholders in a timely manner of the proposed business combination process at least 15 business days before the proposed closing date. The SPAC must also adhere to certain post-business combination procedures. These include: The board of directors must invite the company’s shareholders to meet in a general assembly to discuss and take appropriate decisions regarding the following issues: Amending the company’s articles of association to reflect that it will no longer be considered a SPAC and include its new purposes. Amending any of the rights attached to the shares so that all the shares in the company are equal in rights and duties. Electing a new board of directors for the company, and any of the current board members may be elected. The SPAC, as of the day following the closing date, will be subject to all of the provisions and requirements of the issuance regulation and the listing rules which apply to the public joint stock companies that are not classified as SPACs. The SPAC must notify the Authority and the market as soon as the business combination is completed. 164  Client Protection In the event that a SPAC fails to complete a business combination, its board must: Notify the Authority and the market in writing of the failure on the date of the failure. Take the necessary measures to return the funds to the investors in proportion to their ownership within ten business days of the failure date. Appoint one or more liquidators under the provisions of the Commercial Companies Law to initiate the voluntary liquidation process, within thirty business days of the date of the failure. Sponsors must not participate in any distributions made during the liquidation process with respect to any sponsor shares, including any shares subject to warrants, that have been issued prior to the listing date. The relevant market will suspend all trading in shares and warrants as of the date of failure and commencement of the procedures for cancelling the listing of the shares and warrants of the SPAC. Article 16 lays down expectations in terms of redeeming investors’ shares. It specifies that any investor has the right to request the SPAC to redeem that investor’s shares in the following cases: 6 Where the general assembly decided to extend the time period during which the SPAC may complete a business combination and the investor did not agree on the decision of the General Assembly. The investor must notify the SPAC at least five business days prior to the date on which that investor wishes to redeem. The redemption will then take place on the date specified in the notice or the next business day. Where the general assembly of the SPAC decided to approve a merger. The investor must notify the SPAC immediately upon the issuance of the decision approving the business combination of the desire to redeem. Redemption will be made on the date specified in the notice or the next business day. The amount paid on redemption will be calculated on a pro-rata basis from the proceeds of the public subscription deposited in the account, along with any interest or profits realised on this account. 165