Is becoming a sophisticated investor in your best interests?
Becoming a sophisticated investor sounds good but behind the investment perks are potential pitfalls when it comes to getting financial advice.
It’s only natural to covet the status of a ‘sophisticated investor’. It’s pitched as an exclusive pathway to lucrative investment deals otherwise closed off to the wider population.
But the reality is very different. A new surge in financial advice scandals has grabbed the attention of the regulator, the Australian Securities & Investments Commission, which is pushing to lift the bar for access.
SMSF Association chief executive Peter Burgess told The Australian’s The Money Puzzle podcast the sophisticated investor test needed much sharper disclosure rules to stamp out a notorious aspect of the scheme where investors were being classified as ‘sophisticated’ without their express consent.
At present, investors can qualify as sophisticated if they earn more than $250,000 for two years in a row or hold more than $2.5m in assets.
In exchange for this status most investors lose key consumer protections such as the right to seek compensation from the Australian Financial Complaints Authority (AFCA).
ASIC wants the entry level to qualify as a sophisticated investor lifted to $4.6m (and the income level to rise to $450,000).
Mr Burgess said investors also need to be protected from the underside of the scheme with many financial advisers now dealing exclusively with sophisticated investors.
“The downside is that you don’t have the same level of consumer protection that you would have if you are being treated as a retail investor,” Mr Burgess said.
“So, for example, the financial adviser that may be giving advice about the product is not bound by the requirement to act in your best interest when giving that advice. There are much more relaxed disclosure rules in this area.”
The sophisticated investor system was introduced three decades ago but the dollar threshold for entry was never indexed for inflation. As a result the number of Australians who are eligible for the scheme has risen tenfold from about 30,000 to about three million today.
There has also been widespread unease with the qualification being solely linked to money with no recognition of an investor’s competence or experience.
Concern with the integrity of the qualification has spread beyond financial services. Arnold Bloch Leibler partner Jeremy Lanzer recently argued: “The test presumes assets and income make a person financially literate and capable of assessing risk – that assumption is shaky at best.”
Mr Burgess said individuals classified as a sophisticated investor should be required to formally acknowledge that they were fully aware of the consequences of the decision.
As it stands, the sophisticated investor qualification comes in the form of a certificate signed by an accountant and remains valid for two years.
Mr Burgess also suggested that some form of knowledge test would be useful in conjunction with money-based criteria.
“You could argue that thresholds are not the only thing that should be taken into consideration here when determining whether someone is financially literate or not and there is a place for some other types of assessments.”
With an increase in alternative assets such as private equity funds, investors continue to aspire to the sophisticated investor status.
Less well known is the attraction for financial advisers in dealing with clients who hold the qualification. The status greatly reduces red tape and responsibility on behalf of the adviser, instantly making the investor a more profitable client.
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