SMSFA

Wholesale status risk significant

TRACEY SCOTCHBROOK is policy manager at the SMSF Association. Specialist SMSF advisers need to think long and hard before they give a client wholesale investor status. Although it may seem a smart and/or easy option that allows advisers to sidestep some regulatory hurdles, the reality is that it can prove to be a minefield.

It’s easy to understand why it’s tempting to go down the wholesale path. No one needs to be reminded of the regulatory ball of wool that is wrapped around the retail investor under the Corporations Act 2001. Whether it be the financial services guide, a statement of advice or a product disclosure statement, regulators are affording retail investors every possible protection.

But the evidence shows going wholesale is anything but a shortcut. Before explaining why, let’s define who falls into this definition. Under this umbrella we have the wholesale client, the professional investor and the sophisticated investor. Various rules and tests apply across these three categories. For SMSFs, the common method is one of the sophisticated investor tests with the use of an accountant’s certificate stating a person has $2.5 million in net assets or gross income of least $250,000 over the past two financial years. Put another way, it’s assumed these two thresholds show a degree of financial knowledge and investment awareness. However, these tests alone are not a measure of an individual’s sophistication.

Classifying a client as a wholesale or sophisticated investor does not mean they fall outside the regulatory system – an adviser’s duty of care and fiduciary duty to the client very much remains. Indeed, it’s because of the very vague nature of how SMSFs as a wholesale client fit inside the regulatory framework that can make it so risky for the adviser.

To begin with there are some critical questions advisers need to ask themselves before anointing a client with wholesale status.

For example, is it appropriate the fund is invested as a wholesale client in higher-risk investments outside of the retail client framework? The answer is not as straightforward as might be imagined because an adviser must remember that obtaining an accountant’s certificate attesting to wholesale status does not remove their legal, professional and ethical obligations.

Although a client may satisfy the relevant income or asset test, this does not measure the client’s sophistication, knowledge, experience or appetite for risk. Where the tests are incorrectly or inappropriately applied, the Australian Financial Complaints Authority has the discretion to consider complaints received from clients.

Another question advisers need to ask themselves is whether wholesale status is appropriate and in the clients’ best interests, including all members of the SMSF. They also need to ensure they comply with the Financial Planners and Advisers Code of Ethics 2019.

Regarding wholesale status, not only advisers but accountants, too, can be at risk for assigning clients wholesale status.

The Corporations Act does have a few options for determining whether a client can have wholesale status. But the most popular option is getting an accountant’s certificate as it is commonly believed to shift the risk away from the adviser or licensee.

But caution needs to be exercised with this approach as accountants may be held liable if a client is later found not to have met the relevant requirements or clients seek to argue they should not have been classified as a wholesale investor and therefore were put at greater risk. It’s critical, therefore, for accountants to exercise their duty of care and apply professional judgment. They must also comply with APES 110, the Code of Ethics for Professional Accountants.

The other problem clouding wholesale status is the regulatory uncertainty. The Australian Investments and Securities Commission (ASIC) simply does not give the guidance advisers or accountants need. Up to 2014, ASIC’s view was that unless an individual in an SMSF context had $10 million in net assets, they would be classed as a retail client. No ifs or buts.

But ASIC has since softened its compliance approach. Now the regulator advises it will not act where an SMSF trustee has been provided with services as a wholesale client that relate to the investments in the fund, where the fund has net assets of at least $2.5 million. This threshold, however, is not legally binding – merely a statement that no compliance action will be taken.

The simple fact is ASIC has not issued any formal guidance on the application of these tests or addressing issues arising in an SMSF context. This highlights the need for legislative change to provide greater clarity and certainty on the subject.

For the adviser or accountant with SMSF clients, it means there are more holes in the regulatory framework than Swiss cheese. Certainly, there is ample scope for aggrieved clients to challenge their classification as a wholesale client. It also highlights that those professionals providing financial services to SMSF trustees need to make their own commercial decisions and consider the legal and business risks. The retail route might be more onerous but also might be safer.