The increase in stock prices and house prices in Australia in recent years has cast the spotlight on the definition of ‘sophisticated investors’, also known in the investment industry as ‘wholesale investors’.
The definition was last reviewed in 2011 in the Corporations Act. Since then, more and more Australians have been able to satisfy the requirements for this definition without lifting a finger. It is estimated that as many as three million Australians now qualify, but they have become wealthier but no more sophisticated while the number is increasing rapidly.
So what's the catch?
Sophisticated investors can be offered securities without the usual product disclosure requirements that apply to everyday mum and dad investors. Stockbrokers and financial advisers are able to offer sophisticated investors access to investments that cannot go to retail clients, such as some unlisted property investments, bonds and other unlisted investments.
Many companies also prefer dealing only with sophisticated investors. It means smaller and tighter share registers, access to bigger amounts of cash and less compliance issues.
In order to be classified as sophisticated investor, an investor needs gross personal income over the last two years of at least $250,000 or to have assets of more than $2.5 million. They also need sign-off from a qualified accountant. Importantly, the stockbroker or financial adviser also needs to be confident that the investor truly is ‘sophisticated’ – aware of the financial implications of both the advisor’s advice and their investment decisions.
The definition makes it easier to do business
Many advisers prefer dealing with sophisticated or wholesale investors, as it shifts much of the burden of risk of investing to the client, who are trusted to make their own decisions. In addition, it reduces compliance obligations for the advisor. Sophisticated investors require no statements of advice or annual reviews and they can be offered products which are more complex to understand.
Crucially, the significant rises in both property and stock prices over the past 10 years suggests the time has come for the qualifying numbers for sophisticated investor status to be dramatically scaled up.
Property prices in many parts of the country have doubled in the past 10 years. The median house price in Sydney is now more than $1.3 million, and the average of all residential dwellings in Australia is $835,000.
During the same period the stock market has had a big run, leading to huge increases in paper wealth. The All Ordinaries Index has risen from around 4,300 on 1 October 2011 to 7,700 now, an increase of almost 80%. During this time investors have been receiving dividends, increasing their wealth still further.
More Australian investors have satisfied the numbers side (assets and/or income) of the sophisticated investor definition, but it is clear that many are not really ‘sophisticated’ in any sense of the word. They have not accumulated any greater knowledge of investing or capital markets. Inflation and a rising stock market simply does not make an investor ‘sophisticated’.
Many others have inherited money or invested in a stock many years ago that has made spectacular gains, such as CSL or the Commonwealth Bank. Some have sold houses that they owned for many years or divested an investment property.
Adviser responsibilities
Importantly, an adviser’s duty of care is towards the client. If a savvy daughter brings in her mother who has significant assets, then the mother is the client. It is the mother who must understand the advice that she is given. A simple discussion with the mother will enable an adviser to determine if she is ‘sophisticated’ far more than a certificate from the family accountant.
We often ask a client to repeat back to us what we have suggested or to explain the significance of certain advice.
But many advisers don’t take seriously enough their responsibility to properly assess if an investor truly is ‘sophisticated’ and the Australian Securities and Investments Commission (ASIC) doesn’t have the resources to check. Accountants tend to pass the buck as rarely will an accountant refuse a client a certificate confirming their sophisticated investor status.
It’s time to review the area. The criteria is strictly financial and it has not been changed for more than a decade. It has left the system open for abuse and the people who pay the price are everyday investors who may suffer dearly if the classification leaves them with less protection. The government can make a big start by raising the qualifying threshold for sophisticated investors in the Corporations Act and index them for the future.
Rodney Horin is CEO of wealth manager and aged-care advisor Joseph Palmer & Sons. This article is general information and does not consider the circumstances of any investor.