A company with passive shareholders is a fund by shape, whatever it is called.

The definition of a collective investment fund in both centres does not mention funds. It describes an arrangement. There is property of any description. There are participants whose money bought into it, or who are otherwise entitled to participate in it. The arrangements exist so that the participants receive profits or income arising from the acquisition, holding, management or disposal of that property, or sums paid out of such profits or income. And the participants do not have day-to-day control over the management of the property, whether or not they have a right to be consulted or to give directions. Any arrangement with that shape is a fund under the centre's financial services law, and the regime attaches to it: authorisation or notification, a manager holding the permission to operate it, a tier, and every duty that goes with all three.

The definition was written that way on purpose, and both centres' drafters took it from regimes elsewhere that had learned the lesson. A regime that attached only to vehicles called funds would attach to nothing a determined manager chose to call something else, and the history of collective investment regulation is a history of names invented to avoid it. The shape test catches the substance, and in practice it catches structures built by people who did not know they were building a fund, which is a larger class than the people who did.

This note sets out the four elements of the definition and how each is read, the exclusions the rules provide and their limits, the holding-company platform that is a fund, the control defence and its four failures, what being a fund costs and what being found to be one costs more, the exempt tier as the answer for most registers, a comparison of the structures that sit on either side of the line, a club drafted to stay outside, cases, what each party holds, the sequence, questions, terms and what to read.

The four elements, read

Property. Anything: shares in an operating company, a parcel of land, a loan book, a single building, units in another fund. The element is never in doubt, and it is the reason the definition reaches holding companies, joint ventures and co-investment vehicles as readily as it reaches things called funds.

Participation. Persons who contributed money or who are entitled to share in the property's profits or income. A company's shareholders participate; a partnership's limited partners participate; the lenders under a profit-participating loan may participate. The element asks whether the persons are in it for the return on the property, which they almost always are.

Pooling or collective management. The arrangements exist so that the participants share in the profits or income from the property as a whole, managed on their behalf. One centre's definition expresses this as pooling of contributions and profits; the other as property managed as a whole by or on behalf of the operator. Either way, a vehicle in which several persons' money is applied to one property under one manager has the element.

Absence of day-to-day control. The participants do not control the management of the property from day to day, whether or not they have a right to be consulted or to give directions. This is the element on which every argument turns, and the definition has pre-empted the commonest argument by saying that consultation and direction rights are not control.

The four are read together, and an arrangement with all four is a fund. It does not matter that it was formed under the companies statute rather than the collective investment regime, that its memorandum calls it a joint venture, or that its holders are sophisticated.

The exclusions and their limits

Both centres' rules exclude certain arrangements from the definition, and the exclusions are specific: bodies corporate that are not formed for investment, certain employee arrangements, certain group structures, certain single-investor arrangements, and others the rules list. A manager reads the list for the exclusion it hopes applies, and usually finds that it does not, because the exclusions were drafted for ordinary commercial companies and not for investment vehicles with several passive holders. A holding company with twelve institutional shareholders who do not manage it is not an ordinary commercial company by any reading the rules intend, and the exclusion for bodies corporate carrying on a business does not reach a body corporate whose business is holding an investment for its shareholders.

The single-investor exclusion is the one most often relied on and most often wrongly. An arrangement with one participant is not collective; an arrangement with one participant that is itself a vehicle for several persons is read through by the rules where the vehicle exists to make the arrangement look like a single investor.

The platform that is a fund

The holding-company platform is the structure most often built without noticing the shape. A company in one of the centres. Its shareholders a handful of institutions, a family office, perhaps the manager's own balance sheet. A shareholders' agreement. A board the manager appoints, or on which the manager's people sit. An asset or a portfolio beneath it: a building, a company, a set of parcels. It is called a platform, a club, a joint venture, a co-investment vehicle, a special purpose company. If its holders do not control its assets day to day, the name is not the test, and the company has been a fund since the day it admitted a passive holder.

The consequence is not theoretical. A company that is a fund by shape and has not been authorised or notified is in breach of the centre's financial services law. So is anybody who operated it, because operating a fund is a regulated activity that requires a permission. So is anybody who marketed its shares, because offering units in a fund is a financial promotion that requires its own permission or an exemption. And the holders, who subscribed to a company, hold units in an unauthorised fund with none of the protections the tier would have given them and every consequence the regulator attaches to the finding.

The regulator's first question at a thematic review is who sold the shares, to whom, and under what permission; whether the label was wrong comes later. The answer reaches the manager's own licence, because a manager that operated an unauthorised fund has breached its permission, and a manager without a permission has carried on a regulated activity without one.

The control defence

The usual defence is control. The holders sit on the board, approve every acquisition, and therefore have day-to-day control of the property. The defence is tested against the documents and the minutes, and it fails in four familiar ways.

A board that does not sit, or sits to ratify what the manager has done, has not controlled anything day to day. Minutes that show a quarterly meeting approving a list of transactions already completed are minutes of ratification, and ratification is the absence of control recorded.

A quorum the manager's appointees can make alone is a board the holders do not control. A board of five with three of the manager's people and a quorum of three is the manager's board.

A reserved-matters list that leaves acquisition, disposal, financing and the business plan to the manager is a list of the things the holders do not control, drafted by the holders themselves. A list that reserves only the sale of the whole and changes to the constitution has reserved the two decisions that are not day-to-day management.

A right to be consulted, or to give directions, is named in the definition itself as not being control, and a shareholders' agreement that gives the holders those rights has given them the rights the definition says do not count.

The defence succeeds where it is true. A genuine club of three institutions whose own investment committees take every decision, whose representatives sit on the board with a quorum they make, whose reserved matters include acquisition, disposal, financing and the business plan, and whose minutes show deliberation and decision rather than ratification, controls the property day to day, and the company is a company.

What being a fund costs, and what being found to be one costs more

Being a fund, on the exempt tier, costs a notification, a manager with a permission, a constitution in the tier's form, a memorandum with the required statements, a classification record for each holder, an administrator, an auditor, a custodian where the tier requires one, periodic reports and annual accounts. The duties are light against the alternative, and a careful manager would have discharged most of them anyway: it would have classified its holders, kept a register, struck a valuation and reported.

Being found to be a fund costs a regulatory finding against the manager, a review of its permission, a requirement to regularise the vehicle by notification or authorisation with the holders' consent, a review of every placement of its shares in every state where a holder sits, a lender whose representation about the borrower's regulatory status is untrue, and holders whose counsel read the finding as a breach of the manager's duties to them. The cost of the second is a multiple of the cost of the first, and the first was available at formation for a form.

The definition in the onshore states

The onshore states have their own definitions, and a vehicle that is a fund in a centre may be a fund there too, with different consequences. The Kingdom's investment funds regulations define a fund by reference to a collective investment scheme managed by a capital market institution, and a foreign vehicle's securities offered in the Kingdom are read as securities of a foreign fund for the distributor rule whether or not the vehicle's home regime calls it one. Kuwait's module defines a collective investment scheme widely and attaches its permission requirement to the marketing of any such scheme. Qatar's funds law makes founding a fund without the central bank's authorisation an offence, and its definition reaches arrangements that pool money for investment in Qatari assets. A holding-company platform whose shares were offered to holders in the three states has been offered as a fund's securities in each, under each state's definition, and the answer to the centre's question is not the answer to theirs.

What the holders lose

A holder in a company that is in fact an unauthorised fund has none of what the tier would have given it. No classification, so no record that it was treated as professional and no notice of what it gave up. No memorandum in the tier's form, so no required statements about risks, conflicts and the regulator's role. No prescribed valuation, no periodic report in the prescribed form, no investors' committee the constitution obliges, no related-party regime beyond the companies statute's directors' duties. And no standing to complain to the regulator as a holder in a regulated fund, because there is no regulated fund. A holder's counsel who discovers the position reads it as a failure by the manager of a duty the manager owed by operating the vehicle, and the remedy is sought from the manager.

The lender's and the buyer's readings

A lender to the platform takes a representation that the borrower is not a collective investment fund, or is one and is authorised, and prices the facility on it. A finding that the representation was false is an event of default and a repricing. A buyer at exit, whether of the asset or of the platform, reads the platform's regulatory status in diligence, and a platform found to have been an unauthorised fund is a platform whose every share issue and every dealing can be questioned; the buyer prices the risk or requires regularisation before completion, which takes a quarter the buyer's timetable did not have.

Where it surfaces

At the regulator's review, which asks for the permission under which the vehicle is operated and the record of the placement of its shares.

At the lender's diligence, which asks for the representation and the opinion behind it.

At the buyer's diligence, which asks for the regulatory status and finds a company whose holders do not control it.

At a holder's complaint, when the holder discovers that the protections it assumed were never there.

At the manager's own licence renewal, when the regulator asks which vehicles the manager operates.

The exempt tier as the answer

The exempt tier in both centres exists for this register: a small number of professional investors, a manager with a permission, a constitution notified rather than approved, and duties that are light against the consequence of being found to be a fund without having been one. A manager who builds a platform for a dozen institutions and wants them passive has described an exempt fund, and the cheaper course is to form it as one.

The form can still be a company. Both centres permit an investment company as the legal form of a fund, and a holding-company platform can be constituted as an investment company at the exempt tier, with a board the manager appoints, a shareholders' agreement recast as a constitution in the tier's form, and the holders as unitholders rather than shareholders. The holders keep their shares; the manager keeps its permission; the regulator records a notification; and the structure is what it always was, with the label corrected.

By structure · by test	Control in fact	Control in documents	Read as
Club of three institutions	Investment committees decide; board quorum is theirs	Reserved matters include acquisition, disposal, financing, business plan	A company, if the minutes show it
Platform of twelve holders, manager's board	Manager decides; board ratifies	Reserved matters: sale of the whole, constitutional changes	A fund by shape
Joint venture of two parties, each managing	Both decide jointly	Joint control in the agreement	Not collective; a company
Co-investment vehicle alongside a fund, manager-run	Manager decides	Holders consulted	A fund by shape
Single sovereign's holding company	The sovereign decides	The sovereign's own governance	Not collective; a company

A club drafted to stay outside

A club of three institutions holding one asset through a centre company can be drafted to stay outside the definition, and the drafting is specific. Each institution's own investment committee approves each acquisition, disposal, financing and business plan before the board meets, and the approval is in the board's papers. The board has one seat per institution, a quorum of all three, and no seat for the manager, who attends by invitation. The reserved matters are the day-to-day management decisions, listed. The manager's agreement is an advisory and administrative agreement under which the manager recommends and the board decides, and the manager has no authority to bind the company. The minutes show deliberation and decision at each meeting. The structure paper states that the company is outside the definition and why, and the opinion of counsel in the centre is in the file. Anything less, or anything larger, is a fund.

Drafting the reserved matters

Where a vehicle is to stay outside the definition, the reserved matters are the document that makes it true, and they are drafted from the definition backwards. The definition asks whether the participants manage the property day to day. The reserved matters therefore list the management decisions: every acquisition and disposal above a threshold that is set low; every financing, guarantee and security; the annual business plan and budget and every variation above a tolerance; the appointment and removal of the manager, the administrator and the valuer; every related-party dealing; every distribution; and every change to the property's use or programme. Each is a decision the holders take, by their representatives on the board with a quorum the holders make, on papers the manager prepares and the holders' own committees have approved. A reserved-matters list drafted from a joint venture precedent, reserving the sale of the whole and changes to the constitution, has reserved nothing the definition counts.

The manager's agreement in a club

The manager's agreement in a club is an advisory and administrative agreement, and its drafting is the other half of the control defence. The manager sources, evaluates and recommends; the board decides. The manager implements the board's decisions and reports; it does not bind the company without a board resolution. The manager's authority is listed and limited, with no general power to act for the company. The manager's economics are a charge for services rather than a share of gain, or if a share of gain, one the board approved as a term of the advisory agreement rather than as a manager's entitlement under a constitution. A manager's agreement that gives the manager discretionary authority over the property has described a fund's manager, and the club is a fund.

A timeline, as a type

Year one: a manager forms a platform company for twelve holders, with its own board and a shareholders' agreement reserving the sale of the whole; no notification, because it is a company. Year two: a lender takes a representation that the company is not a fund; the manager signs it on counsel's comfort that a company is a company. Year three: the manager raises a second platform on the same model, and a holder in the first asks its own counsel to review the documents before committing to the second. The holder's counsel reads the definition and writes to the manager. Year four: the manager regularises both platforms by notification at the exempt tier, with the holders' consent, a classification record built retrospectively from what the file holds, and a disclosure to the regulator; the lender's representation is corrected; the placement of the first platform's shares in two onshore states is reviewed with the intermediaries the manager never appointed.

The same timeline with the reading done in year one: a notification, a constitution in the tier's form, and twelve holders classified, and nothing else changes.

Four cases, as types

A platform company with thirty shareholders, a board of the manager's staff and a shareholders' agreement reserving only the sale of the whole to the holders. The regulator's review finds a collective investment fund that was never notified, a manager operating it without the permission, and a placement of its shares to thirty persons with no classification record, in three states whose placement regimes were never read. The regularisation takes a year and the manager's permission is varied.

A club of three sovereign institutions holding a single asset through a centre company, with a board on which each sits, a quorum of all three and minutes that show each acquisition decided by the three investment committees before the board met. The company is a company, because the holders control it in fact and the record shows it, and the regulator's review says so in a letter.

A co-investment vehicle formed alongside a fund for four holders who were offered the excess of an asset. The manager runs it; the holders are consulted; the vehicle was never notified because it was "just a co-invest". It is a fund by shape, and its holders' classification was never performed because they were "the same investors as the fund".

A platform whose manager, advised at formation, forms it as an exempt investment company with twelve holders. The duties are a classification record, a memorandum in the tier's form, an administrator and an annual report. The platform is a fund and says so, and the lender's representation, the holders' protections and the manager's permission all match the facts.

What each party holds

The manager holds the reading of its vehicle against the definition, the decision to form it as a fund or to draft it as a company with real control, and the permission to operate it if it is a fund.

Counsel in the centre holds the opinion on the definition and the drafting that makes the chosen answer true.

The holders hold either real control, with the minutes to show it, or the tier's protections, and not neither.

The regulator holds the definition, the review and the finding.

The lender holds a representation about the borrower's regulatory status.

The placement intermediaries in each state hold a placement of securities whose character depends on the answer.

The sequence

1. Every proposed vehicle is read against the four elements before the form is chosen.
2. Where the holders will in fact control, the reserved matters, the quorum, the board and the management agreement are drafted so that control is real, and the minutes are kept to show it.
3. Where they will not, the vehicle is formed as a fund at the tier its register needs, with the form that suits the register.
4. The manager's own permission is read against the activity of operating the vehicle.
5. The placement of the vehicle's securities is read against the promotion rules of the centre and the placement regimes of each state.
6. Counsel's opinion on the definition is placed in the file.

Questions a manager asks

Does it matter that the holders are sophisticated institutions. Not to the definition, which asks about control, not sophistication. It matters to the tier, which admits professional investors, and the exempt tier is where sophisticated passive holders belong.

Can a consultation right be drafted strongly enough to be control. The definition says consultation and direction rights are not control, and a right drafted as "consultation" that operates as a veto is read for what it does; a veto over every management decision may be control, and the minutes will show whether it was exercised.

What about a joint venture between the manager and one investor. Two parties who jointly control the property are not a collective arrangement in the sense the definition intends, provided the control is joint in fact; a joint venture in which one party manages and the other waits for its return is the shape.

Is a notification really that cheap. A form, a constitution in the tier's form, a memorandum with the required statements, and the providers the tier requires. Against a regulatory finding, it is the cheapest document a manager will sign.

What if the platform was formed years ago. It has been a fund since the day it admitted a passive holder, and the regularisation is done now, with a disclosure to the regulator, rather than at the review.

Does the definition reach a holding company beneath a fund. A wholly owned holding company with one shareholder, the fund, is not collective; the fund above it is the fund. The definition reaches the layer at which several persons' money is pooled under a manager's control.

Terms used

Collective investment fund: an arrangement with the four elements the centre's law describes, whatever its name or form.

Day-to-day control: management of the property by the participants themselves, as opposed to consultation or direction rights.

Reserved matters: the decisions a shareholders' agreement requires the holders to take or approve.

Operating a fund: the regulated activity of managing a collective investment fund, requiring a permission.

Financial promotion: an invitation or inducement to invest, which the centre's rules restrict.

Regularisation: bringing a vehicle found to be a fund within the regime by notification or authorisation.

Club: a small group of holders who in fact control the vehicle jointly.

What to read

The financial services law of each centre for the definition of a collective investment fund, the exclusions, and the activities of operating and promoting one; the funds rules for the exempt tier and the investment company form; the shareholders' agreement, the management agreement and the minutes of any vehicle in doubt. On this site, the DIFC law and ADGM regulations rooms under the restricted reading, and the vehicles room under Structures.