Home / Regulation / ‘Their mood will change’: Lawyer warns against licensees signing sophisticated investor test

Cowell Clarke lawyer Richard Hopkin said there are reasonable grounds for licensees to certify clients as wholesale, but the practice invites a much higher degree of risk than the traditional route of gaining an accountants' certificate. 

Licensees may have the ability to certify that clients qualify as wholesale or ‘sophisticated’ investors themselves and bypass the need for an accountants’ certificate, but that doesn’t mean they should. Clients may freely agree to it at the time, but that may not be the case when something goes wrong and they’re looking for someone to blame.

The traditional route for financial advisers to operate under wholesale investor rules is to gain an accountants certificate confirming a client has net assets of $2.5M or a gross income of at least $250,000 each of the previous two years. This method is used by most HNW advisers, including those at wholesale outfits such as Escala, Koda and Crestone.

There are advisers, however, that employ Corporations Act 761GA [Meaning of a retail client – sophisticated investors], to certify clients as wholesale. The standout requirement for this exemption is that that licensee has ascertained that the client has a reasonable degree of financial nous, and can judge what’s in front of them independently.

As per the Act, the licensee must be satisfied “on reasonable grounds that the [client] has previous experience in using financial services and investing in financial products that allows the client to assess (i) the merits of the product or service; (ii) the value of the product or service;  (iii) the risks associated with holding the product; (iv) the client’s own information needs and the adequacy of the information given by the licensee and the product issuer…”

Yet using this method invites a high level of risk, says Cowell Clarke financial services lawyer Richard Hopkin, that may not be so evident when the decision is made.

“We always say that this should be treated with a high degree of caution,” Hopkin explained on a recent webinar. “You have to be able to defend that you have reasonable grounds to say the client has enough financial literacy to be able to make this decision without all the retail client protections,”

The issue with the 761GA method, he said, is that the certifying licensee takes on all the risk themselves. “The client will happily sign that document… [but] three or four years down the track when something’s gone wrong their mood will change. We’ve seen it happen in all sorts of ways.”

Speaking to The Inside Adviser, Hopkin said this exact scenario is more common than a lot of advisers and licensees believe. “It’s absolutely something we are seeing, in all sorts of contexts,” he says. “We’ve seen advisers swear that a cohort of clients that have lost in an investment are rock solid, and none will complain. Then, of course, the complaints roll in.”

Licensees need to assume that a commercial relationship is going to go through its ups and downs, he argues. During those difficult discussions with clients, in particular when markets decline, licensees have a more solid legal foundation if an accountant was responsible for deeming the client wholesale.

That doesn’t mean 761GA should never be employed, however.

“I’m not suggesting it shouldn’t be used,” he said. “The position could defensible, and if licensees have reasonable grounds for using the exception they’re going to be able to defend that decision. If the client has a demonstrably high level of financially literacy and they’re confident of that, then absolutely it’s appropriate.”

A clear safeguard for licensees is to document where they believe the client got their knowledge from, Hopkin says, and how that knowledge was sourced. “A lot of them are already doing that as part of the Code of Ethics,” he says. “But as with everything else in advice, it needs to be documented.”