Sophisticated Investors

According to Australian corporations legislation, only 4.3% of households are savvy enough to evaluate investments which do not require disclosure materials. How have they decided this? Was it an IQ test, education requirement or a minimum level of CFA? No, it’s a simple minimum asset and income test.

The term ‘sophisticated investor’ is not meant to be derogatory to everyone else, it’s a legal term under the Corporations Act. Also known as a ‘wholesale investor’, the classification grants access to riskier, but potentially more lucrative opportunities barred to ‘retail investors’. However, it’s important to understand that the protections these investors are entitled to in respect of sophisticated/wholesale investment opportunities are reduced, including (but not limited to) the rules and regulations around the type of advice they can receive and the important disclosure documentation that might otherwise be available in offers to retail investors.

Making the cut

How does one break free of retail status? Despite the difference in investor classification being based in investor protection, knowledge has nothing to do with achieving sophisticated status. All you need is a certificate from a qualified accountant. As moneysmart.gov.au states:

To be eligible for a certificate, you must have:

• a gross income of $250,000 or more per year in each of the previous two years, or

• net assets of at least $2.5 million (see sections 6D.2.03 and 7.1.28 of the Corporations Regulations 2001 (Cth))

Even if you qualify and wish to participate in sophisticated/wholesale investment opportunities, you should still undertake your own extensive due diligence and consider seeking independent financial advice before pulling the trigger on a transaction.

Pushback

While some argue there should be no difference between retail and wholesale investors, the vast majority of the critics of the income and asset test just want a new test, not a removal of the concept.

Two key examples of industry distaste for the income-based test are Super Consumers Australia policy manager Franco Morelli and President of the Australian Law Reform Commission (ALRC) Justice Sarah Derrington.

In early May 2022, Franco said:

‘In the context of high capital city house prices and a maturing superannuation system, a lot of Australians may end up being classified as wholesale investors without necessarily having the knowledge required.

This test needs to be better aligned with people’s actual financial knowledge and sophistication rather than how much money they have.’

Justice Sarah has echoed similar sentiments, also in early 2022:

‘The result of that is that they lose the benefit of all the consumer protections. So just because you might be wealthy on a numerical basis, doesn’t seem to us to be a legitimate reason for removing all the protections that those people would otherwise have.’

However, not everybody agrees. The Financial Services Council has backed a lift in the threshold to $5m, rather than a whole new standard.

Sophisticated products

While sophisticated investors have reduced protections, they also gain access to additional investment options barred to retail investors. These products are classified with the label ‘wholesale-only’. Let’s look into a few of them.

One of the most controversial wholesale-only products is early-stage investments in startups or other venture capital investments. While there are a few exceptions, for the most part accessing these investments in Australia requires sophisticated investor status.

Another example is pre-IPO offerings and other single asset closed products. These closed products can include debt instruments, private equity, etc.

Still, with the backing of some powerful reformers and no legislated indexing of the requirement, it seems likely that a change in sophisticated investor status is in Australia’s future. The only question is which direction it will take, and if it’s in a matter of months or years.