Risks involved in being a ‘sophisticated investor’ for uneducated retirees
Inexperienced investors are losing their life savings and retirement nest eggs through a regulatory loophole being sold dodgy fixed income and equity accounts offering high returns.
Each year hundreds of investors, many retirees, lose millions of dollars through fund managers and advisers scamming the unwary and uneducated under the term of ‘sophisticated investor’, allowing promoters to sidestep retail protections.
The criteria for a ‘sophisticated investor’ have not been changed in 20 years, as such, many more retirees meet the criteria of having total assets of $2.5 million, if you include property. With today’s soaring house prices, it has enabled the definition to include increasing numbers of unwary investors who meet the net wealth thresholds but have no experience of advanced investment products.
As the market picks up and more companies wish to raise money quickly – without the time and expense of issuing prospectuses and product disclosure statements to retail investors – the number of retail investors being certified as sophisticated tends to swell.
Additionally, fund managers and advisers are creating fixed income products and equity accounts that focus on ‘sophisticated investors’.
By definition a “sophisticated investor” gets to access investments excluded to every day investors such as share placements, exotic bonds and private equity deals.
This article explores what it takes to become a ‘sophisticated investor’, and the risks that can be associated to this financial decision.
What is a ‘sophisticated investor’?
To become a sophisticated investor, you have to acquire a certificate from a qualified accountant, stating that you have net assets of $2.5 million and/or that your gross income for the past two financial years has been at least $250,000 a year. That certificate must have been obtained within six months of accepting any wholesale offer to acquire securities.
All you need to do is ask your regular accountant to certify that you meet those thresholds and you are on your way to accessing wholesale and institutional offers, usually the preserve of the big end of town.
It sounds straightforward and has some definite advantages. Perhaps that’s why some brokers are actively encouraging their retail clients to switch to sophisticated/wholesale.
The benefits are that it gives you additional offerings because you are included in opportunities that retail investors cannot access.
However, in exchange for those opportunities, the investment risk is regarded as being born by the investor. The corporate regulator says some accountants may be putting retail investors in harm’s way by inappropriately supplying them with ‘sophisticated investor’ certificates.
Recently, the corporate regulator has found instances where accountants bypassed these regulations and enabled retail investors to access investment opportunities that should only be available to sophisticated investors.
“ASIC is aware that, in certain recent fundraisings, some accountants have used trust or company structures that purport to allow investors who are not sophisticated investors to receive offers to purchase shares without a prospectus or other disclosure document,” the corporate regulator said.
Brokers or financial specialists can’t lie to ‘sophisticated investors’, but they can advise them to buy something without any comeback if it goes wrong.
In other words, if you buy $500,000 or more of a product it is implied that you are a sophisticated or “wholesale” investor, in which case you again have to rely on your own advice. Because if it goes wrong, you are going to have no one to sue because you are deemed to be sophisticated enough to evaluate the product without advice and are instead operating under the core principles of caveat emptor (buyer beware) rather than under the protection of the Corporations Law.
Consumer watchdog Choice says it is only a good idea to forego the disclosure available to retail investors if you fully understand the nature of capital markets. Choice spokesman, Tom Godfrey says “many of the types of investments that are not available to retail investors, such as some IPOs and discounts, can get people who don’t quite know what they are doing into a lot of financial trouble.”
How it works
According to ASIC, many protections in the Corporations Act are provided only for retail clients. If a person is certified as a sophisticated investor or a wholesale client, they do not have these protections, including: provision of a Financial Services Guide (FSG) and a Statement of Advice (SoA); the advisers’ best interests duty and related obligations under FoFA; and the bans on some forms of conflicted remuneration introduced by FoFA.
Wholesale offers are often made at lightning speed. A broker may inform their sophisticated clients that a placement will be available at close of market, that same day, and they will have two hours to decide whether or not to take up the offer.
Essentially, this means that as the level of opportunity goes up, your level of caution should go up accordingly, as wholesale investment opportunities shouldn’t be considered less risky than those available to retail investors. In fact, they are usually more risky.
Horror stories from ‘sophisticated investors’
Many ‘unsophisticated’ investors have been victims of financial collapses, including Mayfair 101, which advertised products online with fancy fixed fund terminology being spruiked as comparable to bank term deposits but with higher returns.
Take the ‘sophisticated investors’ who bought into music streaming platform Guvera led by Claes Loberg and Darren Herft. Many of these were DIY fund holders who later learnt that the ASX had blocked the company from listing on the local exchange as had been planned. Prior to the ASX’s decision the company faced criticism for high debt levels — two of its subsidiaries have since been placed in voluntary administration. All sophisticated investors lost their investment.
Or more recently, the collapse of Mayfair 101. An example was a retired builder who we will call ‘John’, invested $200,000 in Mayfair 101 on promised rosy returns. John had no experience in investing and was looking for higher fixed returns than a bank deposit. He saw Mayfair’s ad online and deposited the money, “I was led to believe it was as safe as a bank and deposited the money for 12 months.”
Another victim of Mayfair collapse was a married retired couple who deposited around $1 million of their live savings and more on behalf of their parents aged 89 and 90. The funds were later frozen when they attempted to redeem 5 months later.
A recent Federal Court of Australia judgement on Mayfair savings products were marketed to “inexperienced investors, at least a substantial subset of whom were unlikely to understand the significant risk associated with Mayfair products.” The judgement, which found Mayfair guilty of misleading and deceptive conduct, was brought by the Australian Securities and Investments Commission.
Most do not have the education, experience or acquired knowledge to be termed ‘sophisticated’. It is increasingly middle-working class people who are victims.
The investor needs to fully understand where securities on offer are coming from. They may even be from private companies, who are not permitted to sell securities to retail investors. In that instance, you may be entering a high-risk arrangement.
The general advice then is read your paperwork, know your rights, and if you are asked by a broker if you want to join their select group of ‘sophisticated investors’, it is not flattery, it is because the broker will be able to offer you literally “exclusive” sharemarket deals that they are not allowed to offer to the unsophisticated investor – a process that often enrages the excluded qualified masses. Most Hybrid issues, for instance, have been going to wholesale clients only.
Additionally, an ASIC spokesman recommends that they should only do so if they themselves feel that they are actually a sophisticated investor, as opposed to someone who just meets the monetary threshold. “It is important to weigh up the benefits of being labelled sophisticated with the cost of doing so; that is, loss of the disclosure protections in the law, and the obligations on the advisers to provide information that is personal to the investor’s circumstances.”
– The Sydney Morning Herald. Dangers for unwary but ‘sophisticated’ investors. 11 May 2015 by Marcus Padley. Read more
– ASIC. Certificates issued by a qualified accountant. 10 Jul 2017. Read more
– Adviser Voice. ASIC takes action over misuse of ‘sophisticated investor’ certificates. Read more
– Financial Review. How to be a sophisticated investor. 21 Aug 21 2015. Read more
– The Australian. Reality check for ‘sophisticated investors’. 9 July 2016 by Emma Koehn. Read more
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