Financial advisers are generally bound by the terms and conditions contained in a prospectus or product disclosure document (PDS) issued to a retail investor when buying securities or a financial product.
But under the Corporations Act 2001, a ‘sophisticated investor’ or a ‘wholesale client’ receives special treatment and is exempt from receiving regulated disclosure documents, if their accountant has certified them to be either a sophisticated investor or a wholesale client.
In 2017, ASIC found inappropriate sophisticated investor certificates had been issued for investments in a phone app company. By doing this, investors who would normally have been classified as retail investors, were offered shares without a PDS and classified as sophisticated investors.
In the event that these investments turn bad, a retail investor who has suffered a financial loss having relied upon misleading financial advice or through an omission of the company prospectus will usually have grounds for compensation. However, a sophisticated investor does not.
The requirement to become a sophisticated investor, is to have at least $2.5m in assets or annual income exceeding $250k.
According to modelling done by Australian National University associate professor Ben Phillips, the number of sophisticated investors in Australia has exploded from just 1.9 per cent in 2002 to +16 per cent. This equates to roughly, 3 million consumers that are open to this trap. Mr.Phillips modelling showed that 1.09 million households or 3.25 million individuals are classified as sophisticated investors.
Modelling done by Coolabah Capital out to 2031, shows a stark rise in the percentage 29.1 per cent or 6.78 million adults. Just a small rise in wage growth and almost half the population can be classified as sophisticated investors, if forecasting out to the next few decades.
One of the predominant reasons for the exponential rise is owing to the phenomenal growth in the family home, which is included in the net assets test. With the median property price in Sydney and Melbourne touching north of $1m, many investors would automatically be considered sophisticated because of skyrocketing property prices, irrespective of their investment experience.
As a financial adviser, it begs the question: Is your client really a sophisticated investor?
Clients that reclassify to wholesale or sophisticated investors forfeit their rights to disclosure obligations and their right to any recourse when things go bad. Although it may seem like a benefit to the client, often it benefits the advice business more so than the client.
However change is on its way. According to an article in the AFR, “The Financial Services Council supports doubling the minimum assets needed to become a “wholesale investor” from $2.5 million to $5 million.”
Calls to increase the minimum from 2023 and index it against household inflation will result in some 275,300 investors being redesignated back to retail investors. Following on, the FSC has also called for the removal of the ‘objective test’ from 2026 and for it to be replaced with a financial adviser’s individual judgment on the investor’s competence and risk appetite, instead of basing the test purely on income and assets.