Is your client really a sophisticated investor? How changes to the financial advice landscape is affecting clients

This article was originally published 11 August 2020.

The Financial Services industry continues to undergo significant change and with the Australian economy now in a recession, many of our clients are looking to us to provide advice and reassurance. However, as the number of financial advisers continues to dwindle and many predicted to leave the industry in the coming years, many people are left without the support and advice they need.

In addition to this challenge, we also are starting to see a growing number of financial advice clients being re-classified from the retail to sophisticated investor category, even though they may not have the financial literacy or capability required for that classification. This, in turn, can lead to repercussions for both the adviser and the accountant.

Given these challenges, we're expecting to see an increase in the number requests for changes to wholesale or sophisticated investor classification to come across your desk. Therefore, I’ve written a brief article discussing this issue and the current landscape of the financial advice industry so you are best prepared when faced with these requests.

What’s changed in the financial advice landscape?

There’s no doubt that the Royal Commission into Banking and Financial Services uncovered many issues within Australia’s Financial Services industry - especially around the provision of financial advice – and provided many great recommendations to improve and strengthen the sector including the increase to the educational standards for advisers.

However, one of the side effects of the changes to this industry is that we are now seeing a significant number of financial advisers – especially older and experienced advisers - leave during a period where demand for financial advice is high. While there are multiple reasons why advisers are leaving the industry such as major banks closing or downsizing their advice divisions, the introduction of new standards, retirement and career changes – the crux of the matter is that many clients are now left without their long-term known and trusted adviser.

What impact has this had on advisers?

This reduction in adviser numbers is expected to be significant. The Independent Financial Adviser reports that by the end of 2021, they expect there to be only 16,000 advisers remaining in the industry. To put this decline in context, according to the Financial Planning Association of Australia on 30 June 2019, there were 26,100 financial planners in Australia. Today, that number much lower, with Adviser Ratings reporting that adviser numbers had reduced to 22,893 by the end of Q1 2020.

Moreover, as many large financial institutions such as the major banks and insurers continue to re-evaluate the merits of being in the advice business - which for a majority is a non-core area – as well as weigh up the pros and cons of providing a service that has received significant amounts of negative publicity over the past several years, we can expect this decline in adviser numbers to accelerate further as these major institutions downsize or sell off their advice businesses.

Thus, as advisers and accountants, we must understand how this decline in the number of financial advisers in Australia may impact our clients who are receiving or looking to obtain financial advice.

So, what does this have to do with Wholesale or Sophisticated Investor Certificates?

While many large institutions are leaving the advice industry now as the cost and risk of operating in it for many exceed its benefits, those that remain are pushing for greater efficiency and looking to the higher end of town. As a result, we are now seeing a first-hand push from the banks to corral their clients onto a Wholesale or Sophisticated Investor Certificate who may not have the financial understanding of literacy for that classification.

One of the possible reasons for this is that clients classified as retail clients, generally speaking, have greater protections than those of wholesale or sophisticated investors. Advisers also have greater accountability and additional obligations as retail investors (such as mums and dads) are assumed to be less financially literate.

Sophisticated investors, however, have less of these protections and their advisers are exempt from providing regulated disclosure documents and statements of advice. They also tend to have access to more advanced and often higher-risk financial products. One of the most important differences to note though is that a client classified as a sophisticated investor forfeits certain legal protections and rights held by retail investors. But, what do you need to have to be classified as a sophisticated investor?

Under the Corporations Act introduced in 2001, to be classified as a wholesale or sophisticated investor certificate a client must either have $250,000 in annual income or $2.5 million of net assets. While this is a steep sum, the number of people today with annual incomes or net assets greater than these amounts has increased significantly. This means that significantly more people can be classified as wholesale or sophisticated investors even if they may not have the financial literacy or capability. This misclassification can put clients at significant risk especially if they do not know or understand what these classifications and their differences mean for them.

What can you do? Offer your clients a second opinion

To meet the criteria of a wholesale or sophisticated investor requires a Wholesale or Sophisticated Investor Certificate to be reviewed, approved and signed off by their accountant - this is where you can help.

For clients requesting or already under a Wholesale or Sophisticated Investor Certificate, we encourage you to review not only their financials to ensure they qualify, but also to assess their financial literacy and determine whether you believe they are truly sophisticated and have the appropriate knowledge in the arena of investing to be classified as such.

When faced with these requests, one of the first questions you should be asking as their accountant or adviser is; “are they just being signed off as a wholesale or sophisticated investor for the client’s benefit or is it for the advice business or provider’s benefit?

As clients reclassified from retail to wholesale or sophisticated investors are effectively signing away their rights to disclosure obligations (risk warnings), as well as their rights to any recourse (should something go wrong), you as their accountant or adviser must check in with your clients to ensure they understand the decision they are making and when it doubt encourage them to seek a second opinion.

BDO Private Wealth maintains all investors under the protections provided to retail clients, whilst still having access to a diverse range of high-quality investment opportunities. Our portfolios are well researched and highly diversified, with exposures to international markets and defensive fixed interest, which has helped BDO Private Wealth-advised clients to come through this period of uncertainty in a strong position. Should any of your clients be affected by these changes or simply want a second opinion, please don’t hesitate to contact your local BDO Private Wealth Adviser or PPN contact for more information.

Mark Wilkinson is an authorised representative of BDO Private Wealth Advisers (Pty Ltd and AFSL238280).

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