What are fund investor's rights?

Reimo Hammerberg
Partner, vandeadvokaat
Tel +372 6 400 958
saada e-mail

Jane Eespõld
Advokaat
Tel +372 6 400 900
saada e-mail

Recently, a lot has been said and written of investment funds (eg due to revaluation of fund assets, cessation of redemption of fund units, etc). Since in such case the consequences are usually undesirable for investors, the above topics have naturally caused wide discussion and emotions. At the same time little or nothing has been directly spoken either of investors' rights or violation of the rights. The talks rather concerned the non-fulfilment of expectations. Apparently, in the present-day declining economy, where the assets value goes down, we will face such situations again.

Therefore, there arises a very relevant question – what are fund investors' rights? The answer to this question depends inter alia on the fact how and through whom an investor acquired fund units.

How investor typically acquires units?

An investor may purchase fund units inter alia in the following way:

• 1) The investor purchases the units directly from a fund management company, ie the management company itself offers the units of the fund managed by it to investors.
• 2) The investor purchases the units from a distributor or reseller (eg bank teller, when the investor visits a bank to perform other transactions, eg change a credit card or open a bank account).
• 3) The investor purchases the units through his/her private banking account manager who is employed either by a bank or investment firm. Units may be purchased through an account manager either based on a corresponding request of the investor (the customer manager deals with brokerage) or the customer manager purchases the units in the course of managing the investor's securities portfolio (the customer manager deals with portfolio management).
• 4) The investor purchases units as a result of investment advice.

In the above cases, investors' rights are different. In the cases mentioned in clauses 1 and 2, the matter concerns the offer of fund units, where the investor's rights are mainly stipulated in the fund rules and the law. In the cases mentioned in clauses 3 and 4, the investor is rendered investment services, in the rendering of which the investors have supplementary rights in addition to the provisions of the fund rules.

The investor's rights primarily arise from the Investment Funds Act and fund rules. For example, the rules contain the fund's investment policies, rights and liabilities pertaining to the units, terms and conditions of the units' redemption, and the procedure of making disbursements at the expense of the fund's revenue. An interested person can find the valid fund units on the web pages of the management company and Financial Supervision Authority. If in managing the fund the referred requirements have been violated, the investor may lodge a claim to compensate the loss against the management company.

If the offer of fund units is public, it is accompanied by the obligation to prepare a prospectus. The offer of fund units is not public only in cases prescribed by the law – eg when units are offered to a limited range of investors or only to professional investors. The aim of the prospectus is to provide sufficient information in an understandable form regarding the issuer and offered securities, which is necessary to adopt an informed investment decision. As a rule, public offer prospectus shall be registered in the Financial Supervision Authority and published on the webpage of the Financial Supervision Authority, offeror or intermediary, or in other way prescribed by law.

If the prospectus contains material information from the point of view of assessing the value of fund or units, which proves different from the actual state of things, the investor shall be entitled to charge from the management company the compensation of the loss inflicted by the difference (if the management company was aware or should have been aware of the difference). Therefore, the objective of the prospectus is just to inform and not to consult. The investor should make the investment decision and conduct the risk analysis independently, using advisers when needed.

In addition, the sales material regarding the fund units must comply with the prospectus (ie correspond to reality). The offeror should also secure the notification of all investors on equal grounds. This also applies in case when the matter does not concern public offer and no prospectus should be prepared.

If the investor purchases units using the investment services (clauses 3 and 4 in the above list), the investor shall have in addition to the above the rights arising from the use of the investment service. Among other things, the investor is entitled to receive information regarding the nature of the investment service and the risks accompanying it, which provides him/her with the opportunity to make a thoroughly motivated investment decision (it is prohibited to emphasise potential gain for the investor, if at the same time no reference is made to risks).

In addition to notifying the investor, the provider of the investment service should conduct an appropriateness test or suitability test depending on whether the investor acquires the fund by way of brokerage, portfolio management or investment advice service. Appropriateness test consists in providing an assessment whether the investor has the knowledge and experience necessary for understanding the risks associated with the transaction. In framework of suitability test, in addition to appropriateness there shall be assessed also the fact whether the investor's financial position complies with the investment objectives and risks of the transaction, and whether the transaction also complies with the investor's investment objectives.

If fund units are purchased by way of brokerage service, the account manager shall conduct only the appropriateness test. The appropriateness test may be not conducted only in case account manager has clearly informed the investor that the suitability of the service or financial instrument is not assessed (including the fact that the investor's interests may be therefore less protected).

If fund units are purchased in the framework of portfolio management or investment advice service to the investor, the account manager shall conduct the suitability test, and no exemption from performing it is possible under any condition.

If the appropriateness and suitability test were not conducted appropriately or there ware violated other requirements of rendering the investment services, the investor shall not necessarily have any right of claim against the management company or offeror of units, but rather against the provider of the investment service.

It is important to mention that also in case the above-mentioned tests were properly conducted, the investment decision shall still be adopted by the investor himself/herself (either deciding on particular investment or investment policy). The conduction of the above tests does not guarantee the successfulness of investment.

It might be said as a conclusion that all fund investors have the rights arising from the Investment Funds Act and fund rules. The remaining rights already depend on whether fund units were offered publicly and whether in selling fund units the investor was provided an investment service. With the same it should be noted that the above is certainly not an exhaustive overview of the investors' rights but rather guidelines for orientation. There are rather more rights due to high regulatory requirements to the activity of fund management companies and investment firms. The exact scope of the right depends always on the particular facts of the case.

Investing is an activity that inevitably involves risks, and these risks may also be realised. It is not precluded by either profound disclosure, or conduction of appropriateness or suitability test in the framework of rendering investment services.

The investor himself/herself always has the obligation and liability to examine the investment and its risks and to adopt the investment decision using advisers in case of necessity.