Business Insider published an article in 2013 about the pitfalls of being designated a ‘Sophisticated” Investor, a situation that still applies today. Under the Australian Corporations law, anyone earning $250,000 for two years or holding $2.5m in net assets can be designated a sophisticated investor or wholesale investor and therefore are excluded from the extensive retail client protections that exist. The designation allows a client to purchase securities or invest in schemes without a product disclosure statement or other disclosure protections available to retail clients.

In an article in Professional Planner, ‘Pamela Hanrahan, a professor of commercial law and regulation at UNSW who advised at the Hayne royal commission, said the regulation is fundamentally flawed for using a monetary threshold rather than a barrier linked to understanding and experience’.

‘As time has gone on, the monetary threshold become less of a proxy for knowledge’.

The article goes on to say that “Hanrahan points to Mayfair 101 as an example of an investment firm with products seemingly designed for wholesale investors that appear to be marketed to a broader mass-marketed client. This type of targeted mass-marketing, she believes, can be “misleading and deceptive” if it is targeted at people who lack experience with complex illiquid investments”.

That article, that was published in February 2020, proved prophetic regarding Mayfair 101 with the AFR reporting two days ago, “Receivers were appointed on Friday to IPO Wealth Holdings, a Mayfair 101 entity that had borrowed money from the fund. The fund was backed by investors including retirees. The receivers were appointed after IPO Wealth Holdings missed two repayments totalling almost $3 million that were due a week earlier, according to the fund’s trustee, Vasco”.

“Redemptions in IPO Wealth were frozen last month, coming after two Mayfair Platinum-offerings similarly ceased processing investor requests for their money back. While IPO Wealth was structured as a managed fund with an appointed trustee, Mayfair Platinum investment products were structured as debentures or direct debt investments between the investor and Mayfair 101”.

From the CPA website: “As Keddie Waller, CPA Australia, head of public practice, puts it, some advice clients are “put in these products and strategies that they probably don’t have the financial literacy or capability for”. There are, she says, “no protections in place” for such clients.

This, in turn, may create a problem for the accountants. The law requires accountants to certify sophisticated investors and wholesale clients. What should you do with a request for such certification from a client you feel lacks investment smarts?”

CPA Australia says that the Accountant’s Certificate is a statement of fact regarding the gross income of $250,000 + or net assets of at least $2.5m. Therefore, it is not an opinion of suitability as to whether investors have the knowledge to accurately assess the features and pitfalls of a product.

The situation has a similarity to the popular Michael Lewis book, ‘Flash Boys’. Brad Katsuyama, who worked on the Royal Bank of Canada’s trading floor, was trying to work out why, when he went to buy at the selling price, the selling orders disappeared, and the price rose. Similarly, when he went to sell at the buying price, the buyers disappeared before he got his fill, and the price fell further.

Katsuyama searched for all possibilities as to why this was occurring – was it a technical error, a computer error, user error, other traders placing the same trades, or news he did not have access to? Finally, he came to realize that the news the market was reacting to, was him. He was the news the market was reacting to. Katsuyama’s orders were being signalled to his competitors before the order reached the Stock Exchange. The investment product, to his competitors, were his orders.

The product an unsophisticated “sophisticated” investor is applying for may not be the investment product. The Investor may be the product.

You can have intelligence that has allowed you to accumulate wealth, but not the knowledge in this particular area.

Caveat emptor – the buyer alone is responsible. Please remember, in comparison to retail products, this is largely an unregulated market in relation to disclosures, with little to no protection or recourse for investors. The best thing that has happened in the retail market is the ability to bring to account, for no cost, a complaint to the Complaints Authority. In the Sophisticated Investor market, you are on your own, left to expensive legal process to even have a chance to recover funds. This environment will attract players who can take advantage (of the lack of regulations) and therefore will take advantage.