Wholesale Investing: Look before you leap

Peter Burgess

The Australian Securities and Investments Commission’s change of heart to allow SMSF members to qualify as wholesale investors comes with both opportunities and dangers. Krystine Lumanta examines the implications.

TThe corporate regulator revised its position on wholesale investors in August last year as a way to address the ongoing legal uncertainty in this area. There are various tests for investor classification under the Corporations Act.

In the future, for non-superannuation products, any individual will be deemed a wholesale investor if they have $2.5 million in net assets as certified by a qualified accountant or if the investment in question is at least $500,000 in value. Prior to August, net assets had to be in excess of $10 million.

As a result of this change, the industry is expecting more SMSFs to be classified as wholesale investors, although the issue of wholesale and retail investor distinction is not a new one.

On 24 January 2011, then financial services and superannuation minister Bill Shorten released the options paper, “Wholesale and Retail Clients: Future of Financial Advice”, which considered the possibilities for refining the legislative distinction between wholesale and retail clients. The paper put forward four options to change the current system for distinguishing between wholesale and retail clients and concluded revisiting the wholesale and retail client distinction was arguably overdue.

However, an Australian Securities and Investments Commission (ASIC) spokesperson told selfmanagedsuper it was not looking to expand on its August announcement and any further clarification was a matter for government and Treasury as a case of law reform.

A whole new world

Opening up the wholesale universe to SMSFs will mean first-time access to markets, including certain infrastructure and mezzanine investments, as well as exclusive capital raisings or share offerings – a move that signals a positive assessment of the way the sector has been evolving.

Nevertheless, it is accompanied by  the loss of safeguards with no required statements of advice (SOA), financial services guides or prospectuses needed for investments that are much more complex and have higher risk than retail products.

Another disadvantage includes the restrictions placed around withdrawing cash from wholesale-type products.

“That is the trade-off,” AMP SMSF head of policy, technical and educational services Peter Burgess says.

“If you are treated as a wholesale investor then you are forgoing some of your consumer protection rights that you had as a retail client and that’s why it’s important that we get these classifications right. And I would say that it’s now more important than ever to have access to professional advice.”

He says the distinction recognises that as a wholesale client, the same level of disclosure that other investors need is no longer required. “So if you are a sophisticated investor it is intended to make the system more efficient,” he says.

“It was one of the suggestions included in the options paper as well as doing away with the distinction altogether so that everyone is treated as a retail client. But it acknowledged the disadvantage of that approach was it wouldn’t be as efficient and would be more costly for some product providers who, in the past, have not been required to produce disclosure statements.

“Hence the reason we have this classification today.”

SPAA director of technical and professional standards Graeme Colley says while trustees must understand the reduction in net assets will mean access to new markets, the documentation and guarantees that come with these opportunities won’t be available to those investors. “That’s the area where we have a bit of a reservation about, from the point of view that trustees really need to make sure that they do their due diligence and inquiry into the types of investments they’re going into,” Colley warns.

“It’s a real ‘look before you leap’ situation, where while you may have had assistance in the past through SOAs and the advice given by financial planners, because you’re now regarded as a wholesale investor in relation to the SMSF. But you really need to think more deeply about the investments you’re going into.”

During a December seminar last year, the decision to amend the classification was labelled as an “extremely unusual move” by Townsends Business and Corporate Lawyers superannuation consultant Tony Negline.

“We are constantly being told that SMSFs are dangerous territory and people are going to be preyed upon, and everyone needs to be protected from themselves, mainly from the experts and the large funds,” Negline said.

“But here we are having ASIC not necessarily appearing to agree with that, saying let’s amend these rules slightly to expand the number of investors who are not going to be subject to the normal consumer protections, and that expanded capacity happens to be in the SMSF sector.”

Advisers beware

While the ASIC amendment set out to provide clarification, there were still murky waters surrounding the risks for financial advisers, as legal uncertainties as to how the classification applied existed even with the previous policy definitions.
The regulator’s revision states it will not take enforcement action against advisers who recommend wholesale products to SMSF clients that do not meet the $10 million net asset threshold.

Despite this, there is no change to any private rights of action available to third parties in the event of a loss.
Further, ASIC announced there would be no leniency given to advisers who treated retail clients as wholesale investors without the required certificate from a qualified accountant confirming the $2.5 million net asset threshold.

“We’ve got some certainty, but we’ve got to be cautious here as there has been no law change; all that has changed is that ASIC has amended its interpretation of its policy,” Burgess says.

“Individuals still have the same civil rights that they’ve always had and can take action if they believe they’ve been incorrectly classified as a wholesale client.

“Therefore providers of advice need to make their own commercial assessment whether to get involved here, in addition to relying on the ASIC approach, and if you are going to rely on the wholesale classification, you need to make sure that you are getting that certification from an accountant.”

DBA Lawyers director Dan Butler believes the law is uncertain. “ASIC’s non-enforcement of the $10 million test does not preclude legal action – advisers are to manage this risk as ASIC will take action if investors are treated as wholesale when they are really retail,” Butler says, adding it’s a pity the law itself cannot be clarified.

“The regulator’s new statement is likely to become the norm and people remain exposed to legal action unless they are extremely careful as this area has been uncertain for many years.

I accept that some investors may require protection and the policy to date applies this to entities and trusts and SMSFs. Thus to continue the policy of the past we just need clarification so the distinction is clear to all and simple to apply”.

Murray report omits classifications

Adding to the confusion, the 7 December 2014 release of the Financial System Inquiry’s (FSI) full report, or the Murray report, did not make any reference to the wholesale/retail distinction, which many in the industry regard as a missed opportunity.

“It would’ve been encouraging had it come out because the discussion paper that came out four years ago from Treasury had some very good ideas in it,” Colley says.

However, while there was no specific mention of the tests, the FSI did recommend the adoption of a more principles-based approach to product design and distribution.

“What they’re saying is that product issuers need to consider a number of factors, including who the target market is and then design their disclosure material and strategies depending on the complexity of the product they’re offering. So this recommendation could have an impact.

It’s going to be more important going forward should this recommendation be accepted and if [product issuers] are trying to determine who their market is and who their market is not, then we do need to have a clear distinction,” Burgess said.

“The options paper is still on the table, but we haven’t seen any developments since”.

No rush to wholesale products

The proportion of SMSFs currently recognised and operating as wholesale clients is relatively small and is not expected to suddenly expand or be propelled by a flurry of advisers who want to start providing investments in the space, according to Colley.

“I think it will be absorbed into the market,” he says.

“You’re looking at relatively high-value SMSFs and when you’ve got average assets of about $1 million and with many of these investments being at least $500,000 [as a minimum], it would be unlikely that there would be a rush just from SMSFs.

“The median SMSF [balance] is about $600,000 and the average assets are about $1 million, so it certainly is at the lower end of that investment scale. With advisers, we’ve got no indication that they’re jumping into this and going ahead and advising their clients on these particular investments. Hopefully they’re all looking before they leap and have clients who are well briefed and will do the right research.”

Burgess agrees there hasn’t been a rise in trustees coming under the wholesale classification since the change. “But looking at it from face value, you would think that more SMSFs will look to come under the wholesale classification,” he says.

“I think it will accelerate a trend that we’re probably already seeing – that product providers and issuers are looking to become more principles-based, consistent with the recommendation made in the FSI report.

“In a nutshell, it’s good to get clarification from ASIC, but we need to remain cautious because it’s not a change to the law so the civil rights of individuals have not changed and it’s important to get the [accountant] certificates if you’re going to rely on clients being classified as wholesale.”

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