Illegal investment schemes, When business transactions or financial services are provided without authorisation from BaFin
Enticed by promises of incredible profits from sure-fire financial bets, consumers daily invest their money in non-licensed offers taking the form of illegal investment schemes and end up being ruined. BaFin takes action against providers operating in this segment and engaging in business operations without the required authorisation from BaFin (see info box “Record number in 2018”). In this way it protects the interests of consumers as a whole and safeguards the stability and integrity of the financial system.
At a glance Record number in 2018
In 2018, BaFin took formal action against operators of unauthorised business transactions or involved undertakings in 86 cases – more than in any year before that. In the vast majority of cases, the operators failed to recognise the authorisation requirement and discontinue their unauthorised business activity when BaFin intervenes without any formal orders and coercive measures becoming necessary.
BaFin uses supervisory measures to compel companies to observe the authorisation requirement, i.e. not to engage in gainful activities for which they would actually need authorisation from BaFin. If business is transacted without the required authorisation, BaFin may order it to be prohibited and wound up – regardless of whether a case has to be pursued under criminal law and the criminal prosecution authorities also take action. In the event of criminal prosecution, the competent BaFin Directorate for the Integrity of the Financial System (IF) works together closely with the criminal prosecution authorities. Both sides then also coordinate with each other in deciding who takes what step and when. In some cases it is sensible for BaFin to take the first step in an investigation, whereas in other cases the public prosecutor’s office is the first to take action.
Authorisation requirement, yes or no?
Anyone wishing to engage in business operations commercially or on a scale requiring a commercially organised business undertaking subject to authorisation under the relevant supervisory laws needs a written authorisation from BaFin. This is referred to as the authorisation requirement. These laws include the German Banking Act (Kreditwesengesetz – KWG), the German Insurance Supervision Act(Versicherungsaufsichtsgesetz – VAG), the German Payment Services Supervision Act(Zahlungsdiensteaufsichtsgesetz – ZAG), and the German Investment Code (Kapitalanlagegesetzbuch – KAGB).
But things need not come to that at all: providers also have the possibility of having their business project reviewed by BaFin in advance. That gives them legal certainty from the outset on whether the planned activities are subject to the authorisation requirement.
That is something the so-called “King of Germany” from the Reichsbürger movement did not do. Acting on his own initiative, he started his own “Royal Reichsbank”. He also tried his hand at health and pension insurance schemes. After BaFin had consistently intervened against the unauthorised business operations, the operator was most recently handed down a prison sentence – also for engaging in unauthorised insurance business – which he is now serving.
Currently, BaFin is closely scrutinising, among other things, more recent forms of financial services being offered over the internet.
One relevant subject concerns investments in initial coin offerings, or ICOs in short (see 1/2018 issue of BaFinPerspectives, as well as BaFinJournal of March 2018 and April 2018 – only availble in German), of which BaFin has already warned publicly. It is derived from the term initial public offering (IPO) used for stock corporations. In an ICO, the issuer issues self-created digital units (tokens or coins) which are based on distributed-ledger or blockchain technology. In almost all cases, the purchasers pay for the tokens with so-called virtual currencies, i.e. other digital non-legal means of payment. For issuing the tokens, blockchain-based programs (smart contracts) are often used. These are capable of performing actions independently and without being influenced externally, such as transfers of assets.
In many cases the issuer promises to use the income generated with the ICO to finance the further development of a product, infrastructure or service offering. At the same time, the tokens serve as a voucher or means of payment for later offers. But sometimes the issuer also advertises a traditional profit participation.
Inquiries by token issuers regarding possible authorisation requirements have increased significantly of late. The novel forms of technology that can be encountered in connection with ICOs are a particular challenge for BaFin. That is primarily due to the fact that one uniform assessment of the different ICOs cannot be made since the conditions under which the tokens are issued differ considerably. That means that BaFin always has to assess these on a time-consuming, case-by-case basis.
At a glance Illegal investment schemes versus regulated and unregulated capital markets
In BaFin’s understanding, illegal investment schemes encompass the totality of banking, financial services, investment, insurance and e-money transactions as well as payment services performed without the authorisation required under the relevant technical supervisory laws. Players dealing in illegal investment schemes want to avoid the statutory authorisation procedure and ongoing supervision by BaFin and are often found to employ criminal means for such purposes. For this reason there is no guarantee they meet the personal, professional and financial conditions required for transacting such business operations.
By contrast, the legal, regulated capital market encompasses those institutions, service providers and insurance undertakings which are authorised under the relevant supervisory laws and which are thus subject to ongoing supervision by BaFin.
The unregulated capital market, on the other hand, is where all market participants and offerings are found which are not subject to the statutory authorisation requirement, i.e. which do not require an authorisation from BaFin and therefore are not subject to its supervision (see BaFin Journal March 2014). However, they may – depending on their form – be subject to a prospectus requirement.
There are some serious providers operating on the unregulated capital market, but there are also some using abusive schemes to circumvent the authorisation requirement. Such business models can also cause considerable damage to investors and moreover undermine the trust that investors not directly affected have in the financial market.
Online trading platforms
Non-licensed internet trading platforms established for trading in financial instruments have a considerable potential for harming consumers. BaFin repeatedly warns the public of forms of highly speculative and frequently also fraudulent trading. Most recently, it issued joint statements together with the German Federal Criminal Police Office (BKA) and various criminal police offices at the federal state level (LKAs) warning of dubious online platforms.
The approach taken by the trading platforms always follows a similar pattern: on the internet online trading is advertised for example in virtual currencies, binary options and financial contracts for difference (CFDs). The customer is encouraged to register with their name, e-mail address and telephone number. The trading platform then contacts the customer, usually by phone or e-mail, requesting them to deposit money into their trading account. It is only very rarely the case that the holder of the account specified for the transfer payment is the platform or its operator. Instead it is usually a (non-licensed) payment service provider that takes the customer’s money and forwards it to its principals abroad.
The customer can then use their money on the platform for trading – in binary options or CFDs based on commodities, shares, currencies or cryptocurrencies. At first, they usually generate positive results, are reassured in their skills as traders by the telephone support provided by the platform and convinced to invest more money. But if the customer later tries to withdraw their balance, contact with the platform ends abruptly. In some cases balances on the customer account also disappear because the platform has traded with the customer’s money without permission.
Since the providers register their company headquarters under offshore mailbox addresses and such addresses – and in many cases the companies themselves – often change, the odds of recovering the money are not good.
Fighting illegal investment schemes
BaFin has extensive resources to combat unauthorised business which it uses giving due regard to the principle of proportionality.
At the beginning, BaFin usually first avails itself of its extensive rights to investigate the facts and tries to clarify the questions arising from the potentially unauthorised business. It may hear the party concerned informally and request information and documentation.
If the party concerned refuses to cooperate or their statements turn out to be incomplete or untrue, BaFin may take formal clarification measures.
Requests for information and documentation
The first measure to be mentioned in this regard is requests for information and documentation. Such requests constitute the most moderate means of formal clarification and require the party concerned to provide information and submit documentation to BaFin. BaFin often considers issuing such a request when the party concerned disputes or fails to recognise their authorisation requirement and for that reason refuses to meet their obligation to provide information and cooperate. A prerequisite for issuing a request for information and documentation is that there are facts providing reasonable grounds to assume that the party concerned or an involved undertaking (see info box, page xy) is engaging in business operations subject to authorisation under the relevant supervisory laws without having the required authorisation.
A request for information and documentation is enforceable by a penalty payment of up to 2.5 million euros.
The next step following the request for information and documentation is an audit order: it can be issued if doubts arise as to whether information provided by a party concerned is complete. An audit order gives BaFin employees the right to enter business premises even without the consent of the party concerned. However, BaFin is not allowed to inspect business records without such party’s consent. As a more moderate means compared with a search order, the audit order is considered whenever the party concerned continues to assure their willingness to provide information but doubts still exist as to whether the information provided is complete. The audit order can likewise be enforced with penalty payments.
If by this stage BaFin has still not been successful in achieving its objective of clarifying the matter of the suspected unauthorised business activities, the next possibility to be considered is a search.
A search is the most draconian means of clarifying the facts. BaFin employees may, even against the will of the party concerned, enter and search their commercial and residential premises and secure evidence there. They may also search persons, e.g. to secure any mobile data carriers. Given the encroachment on fundamental rights it involves, however, a search as a general rule requires a judicial order issued by the local court of competent jurisdiction. A judicial order may be dispensed with only in the event of imminent risk.
If it has been established that unauthorised business operations are being performed, BaFin is authorised under the relevant supervisory laws to take action against the relevant operators and the involved undertakings:
- Prohibitive order: If there is a risk of unauthorised business operations being performed or continued by the same provider also in future, BaFin may prohibit performance of such business operations.
- Resolution order: Where the unauthorised business operation has not already been terminated directly by the prohibitive order, BaFin may issue a resolution order as a further-reaching measure. Such measures are adopted in particular when the operator collects and possibly also invests customers’ funds (for example deposit business, portfolio management, principal broking services, investment business). It is only after the funds have been paid back to the investors in full and provided no new business transactions have been concluded that the unauthorised business operation is deemed to have been resolved.
- Liquidator: If the operator of an unauthorised business operation cannot ensure that the ordered resolution will be properly performed, BaFin may appoint a suitable person as liquidator. Generally such persons are specialised attorneys who have also proven themselves as insolvency administrators. The costs of the liquidator must then be borne by the operator of the unauthorised business operations. If the estate assets do not suffice to cover the priority-ranking costs of the liquidator, it is possible to refrain from appointing a liquidator so as not to further diminish the assets to the detriment of the investors. The liquidator is also entitled to file for insolvency proceedings on the assets of the operator.
At a glance Involved undertaking
An involved undertaking is an undertaking involved in the initiation, conclusion or settlement of unauthorised business transactions. Some examples are trustees and companies which are instructed with the distribution of investment products or which forward customers’ funds.
Schemes involving the payment of funds – such as the deposit, investment or money-remittance business – may result in serious losses to investors within a short time even if no fraud is involved. Unauthorised insurance business operations carry the risk of particularly drastic consequences, including the destruction of an individual’s economic existence, if a policyholder in an insured event cannot rely on a highly efficient and qualified insurance undertaking.
To ensure that customers and investors are protected from unauthorised business operations, BaFin publishes all measures taken with regard to illegal investment schemes on its website. A more precise description of the prohibited business model is intended to enable customers to draw conclusions as regards their own investment behaviour. As a result of the improved transparency, customers concerned are informed about the action taken by BaFin and potential investors are warned about entering into business with the operator acting without authorisation.