Registrar is on right track over what makes a bona fide co-op

The latest consultation document issued by the FCA on its registration function should be welcomed. Having listened to serious concerns about some aspects of the previous draft guidance,...

The latest consultation document issued by the FCA on its registration function should be welcomed. Having listened to serious concerns about some aspects of the previous draft guidance, the FCA sets out sensible new proposals about share interest and defining a “bona fide co-operative”.

In its original consultation, proposed guidance about “what is not a co-operative” caused consternation as it sought to introduce a test about how much of a society’s trade was with members, and how much with non-members.

It also proposed an upper limit of 25% of members who are “simply investors”.

The revised proposal is for a return to the ICA Statement of the Co-operative Identity, Values and Principles. It rejects, rightly in our view, the suggestion that the ICA statement should be treated as a legal definition – which it is not – recognising that it is for each society to determine the extent to which it adheres to the statement.

But it clearly states how meeting the statement provides indicators to the FCA over whether a society is a bona fide co-operative.

The payment of interest on shares has become controversial in recent years because of a number of new registrations offering attractive levels of interest on share capital.

The revised proposals helpfully set out a number of indicators which the FCA will look at to decide whether a society is likely to be complying with the conditions of registration. And there are further indicators which would suggest non-compliance.

The former include:
• the realisation of the society’s objects is the main motivating factor for membership
• rate of interest set in advance
• where a society sets a rate of interest and then cannot afford to pay that rate, it pays a lower than indicated rate or no interest at all.

Indicators of non-compliance:
• the rate of interest is too high
• the method and content of communications inviting members to subscribe share capital is likely to encourage membership from people motivated by a return on investment
• a greater rate of interest is paid one year because the society was unable to pay interest (or the rate indicated) the previous year.

These are sensible proposals.  For co-operative societies, the third principle states that “Members usually receive limited compensation, if any, on capital subscribed as a condition of membership.”

It goes on to say that members allocate surpluses for “any or all of the following purposes”: developing their co-operative; benefiting members in proportion to their transactions with the co-operative; supporting other activities approved by the membership.

There is no mention of the payment of interest in allocating surpluses – that is not the purpose of a co-operative, and this is clearly underlined by what is now section 2 (3) of the legislation, which states that “co-operative society” does not include a society that carries on business with the object of making profits mainly for the payment of interest, dividends or bonuses.

The payment of interest to community benefit societies must be approached with even more care.

Distributions of surplus to members are not legally permissible, so any payment of interest higher than that which would be payable anywhere else is suspect.

And the fact that particular lines of business are risky, so that borrowing would be expensive, does not justify the issues of shares offering high rates of interest. It justifies rethinking whether it is appropriate to carry on as a business for the benefit of the community. Risky businesses are usually carried on for the benefit of investors.

Both of these areas – definition of co-operative and interest on shares – have become controversial in recent years. Essentially this is because there are various attractions and benefits of registering as a society.

Some of these relate to image; some are financial or legal, such as a more lenient regulatory regime, or fiscal benefits. There will always be those seeking registration simply to obtain the benefits.

Indeed, this is the origin of the “society for the benefit of the community” and the “bona fide co-operative”. In the 1930s, after prospectus laws had been introduced for companies making it more onerous for companies to raise share capital from the public, there was widespread registration of societies and “share-pushing” to avoid the more onerous company law. This was easy because there were few restrictions on the registrations of societies.

So legislation was introduced in 1939 to tighten the grounds of the registration of societies, and to introduce the provisions we are now familiar with – including introducing the word “co-operative” for the first time into legislation.

These provisions were designed to allow registration by those genuinely interested in benefiting the community, or co-operative trading, but not otherwise. The phrase “bona fide co-operative” recognises that there is no legal definition of a co-operative, and what the registrar must do is to look at the underlying intent to see if it is “bona fide”, or in good faith.

This specifically avoids tying the registrar to any fixed definition or criteria (because there aren’t any), and requires the registrar to look beyond the wording of rules to the underlying intentions.

The latest proposals by the FCA should be welcomed.

In our view, they comprise a valid interpretation of the law now set out in the 2014 Act. They aim to prevent exactly the same abuse today that was causing problems 80 years ago, and it is important the registrar continues to be vigilant in what is registered.

The movement of registered societies should support the work of the registrar and seek to work collaboratively in order to serve the best interests of all.

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