Sophisticated investors: Should you join the club?

According to latest Credit Suisse’s latest Global Wealth Report, Aussies topped the global rankings for median wealth per adult, at $315,000 per person. 

With this wealth growth, more investors in the country now have access to an annual gross income above $250,000 with net assets that surpass $2.5 million. And if you’re one of these retail investors, congratulations! You are now at the threshold of becoming certified as a “sophisticated investor”. 

But what exactly is a sophisticated investor? How can you become one and should you get accredited? 

What is a sophisticated investor? 

According to the law, a “sophisticated investor” is defined as an investor that can be offered securities without the need to provide them with product disclosure requirements that are provided to retail investors. 

To fully understand what a sophisticated investor is, let’s discuss what a product disclosure statement is.

Generally, people buying securities and other financial products must, under the Corporations Act 2001, be provided a regulated disclosure document, such as a prospectus or product disclosure statement. 

According to the Australian Securities and Investments Commission (ASIC), a regulated disclosure document offers client consumer protection to retail investors where financial advisors deliberately miscategorise their clients or when companies fail to properly disclose their businesses. It provides you with the necessary information to help you decide whether to invest in a financial product by using clear and easy-to-understand language. 

Issuing product disclosure information can be a complex and time-consuming process. So there are exceptions to the act. 

Firstly, securities issuers, or companies, are able to offer securities without providing disclosure information if the total investment amount is more than $500,000 or a wholesale investment. They are classified as wholesale clients.

Another exemption is when a person holds a certificate from a qualified accountant certifying they have a prescribed net asset or gross income level that can buy financial products without a regulated disclosure document. They are classified as sophisticated investors.

Simply put, a sophisticated investor is someone who earns, invests, or holds a lot of money, and has a certificate (Qualified Accountant’s Certificate) to prove it.

The rationale is that people meeting the set criteria are expected to have in-depth knowledge and experience in investing in a range of investments and have amassed enough wealth to back it up, so there is no need to provide a regulated disclosure document to them. 

How do you become a sophisticated investor?

To be considered a sophisticated investor, you must obtain certification from a qualified accountant.

This certification proves that the investor holds net assets of more than $2.5 million or the gross income of the investor has reached a minimum of $250,000 per year in the last two financial years. You could also qualify if you have control of a company or trust which meets the aforementioned requirements. 

Sophisticated Investor Certificates are considered valid for two years and you need to make your initial investment within six months of obtaining your certificate.

Remember that when the net asset value of an individual seeking this investor classification, the money lent to the person or entity is not included. However, the net assets of a firm or a trust that is controlled by the person can be included. 

If you want to become certified as a sophisticated investor, you can contact your accountant or a financial adviser recognised as a qualified licensee. As long as they are qualified to do so under the Corporations Act 2001, they can apply for you. However, the decision to certify you is up to the accountant.

What are the benefits of being a sophisticated investor?

Being a sophisticated investor opens doors to a greater number of premium investment opportunities.

As an SI, you have access to both retail investment opportunities and additional offerings and opportunities that would otherwise be unavailable to you. 

This investor classification allows an investor to participate in private companies’ pre-IPOs, IPOs and receives tax benefits for investing in Early Stage Innovation Companies (ESICs). It also allows them to participate in complex share placements, exotic bonds and exclusive private equity deals. 

In real estate, certain investment groups such as property investment groups, unlisted property trusts and property syndicates are required to hold a certain percentage of sophisticated investors in their pool of investors. If you’re a sophisticated investor, you can have access to highly exclusive investments.

This means that while everyone is sitting on the sidelines, you can capitalise on the rare investment opportunities only available to these investment groups. Such investments would likely offer appetising (and often lucrative) yields and a high chance of capital growth.

What are the downsides of being a sophisticated investor? 

While sophisticated investor status can give you access to a wider range of investment opportunities, it also exposes you to a greater amount of risk.  

Compared to retail investment opportunities, wholesale investment opportunities carry far higher levels of risk. As a sophisticated investor, you need to apply a higher level of caution before playing your cards.

And while being a sophisticated investor opens up more opportunities compared to other retail investors, it comes with the risk of losing protections afforded to those investors. This is because some of the protections provided by the Corporations Act are applicable to only retail investors. A person certified as a sophisticated investor or wholesale client is unable to benefit from these protections, which include:

• Provision of a Financial Services Guide (FSG), which explains the retail services and fees charged.
• Statement of Advice (SoA) confirming or providing personal advice.
• Consequences or information about the consequences of replacing one product with another.
• Adviser’s best interest duty and associated obligations under Future of Financial Advice (FOFA). 
• Bans on particular forms of conflicted remuneration introduced by FOFA.
• Access to external dispute resolution processes and services offered by financial product issuers.
• Ability to pursue dispute resolution systems offered by regulators such as the Australian Financial Complaints Authority. 

To add to this dilemma, wholesale offers are generally executed very quickly. Clients are notified by brokers that placements may be available on the same day at close of market. This can result in clients having just a few hours to determine whether they want to take up an offer.

Aside from these risks, there is also growing concern that the qualifications for sophisticated investors need to be re-assessed. 

In 2017, when property prices were rising, investors whose wealth has increased through soaring property prices and rising assets easily gained the sophisticated investor status.

But experts were concerned that these investors were not completely prepared for riskier investments. “We can’t just assume that because someone has a certain value of assets and income that they understand these products,” Mark Brimble, chair of the Financial Planning Education Council and lecturer at Griffith University, stated in an article for the Sydney Morning Herald. 

In 2011, The Federal Treasury issued an options paper as part of the Future of Financial Advice consultancy process, requesting submissions regarding the application of investor and wholesale client tests. A series of submissions during the process delivered a criticism of the rules that govern sophisticated investors in Australia. However, as of writing, the Federal government has not yet acted to alter the rules that govern sophisticated investors in Australia.

Final word

So should you be a sophisticated investor? 

Determining whether you are eligible for certification as a sophisticated investor is a complex process and must be carefully considered. Before you decide, it’s important to weigh up the risks and rewards. The potential for loss of capital, opportunities for the investment to generate income, and how easy it is to understand the entities backing an investment should be key considerations. 

However, most experts agree on one thing: just because you can, doesn’t mean you should.

Ideally, this investor status is best suited for individuals that have the right professional advice and also have extensive financial knowledge and skills to be able to understand the products that they’re investing in.  

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