Retail or sophisticated investor? How changes to the financial advice landscape may be putting you at risk

This article was originally published 13 August 2020.

Ongoing changes to the Australian financial advice landscape is resulting in some financial institutions classifying ‘everyday’ retail investors as sophisticated investors - increasing their exposure to risk. BDO Private Wealth Partner, Mark Wilkinson discusses why it’s occurring, the differences between retail and sophisticated investor classifications, and what investors can do to protect themselves.

As the Financial Services industry continues to undergo significant change and with the Australian economy now in a recession, many Australians are seeking out financial advisers to guide them during this uncertain time. However, as the number of financial advisers continues to dwindle - with many predicted to leave the industry in the coming years - many Australians will be left without the support and advice they need. 

Adding further complexity to this, there’s a growing trend to classify retail investors or ‘mum and dad’ investors as sophisticated or wholesale investors - even though they may not have the financial literacy or capability necessary for that classification. This misclassification can result in some serious ramifications for both the individual, their adviser and accountant. It’s critical investors understand the difference between these classifications and how it may apply to them.

What’s driving the growing number of wholesale or sophisticated investors?

Today, many large financial institutions are leaving the advice industry largely due to the cost and risk of operating in it. For the institutions that remain, many are pushing for greater efficiency and focussing their efforts on the higher end of town. As a result, we are now seeing first-hand a push from major financial institutions to move their retail clients onto a Wholesale or Sophisticated Investor Certificate even when they may not have the necessary financial understanding.

One of the possible reasons for this trend is there’s decreased accountability for advisors. However, this impacts the protections of investors too. Generally speaking, when an investor is classified as a retail investor they have greater protections than those classified as a wholesale or sophisticated investor. Advisers of retail clients also have greater accountability and additional obligations when working with these clients compared to those under the sophisticated or wholesale classification. This is because retail investors generally have a lower level of financial literacy and knowledge and therefore require a different level of information and support when making financial decisions.

Sophisticated or wholesale investors, however, have less of these protections and their advisers are exempt from providing certain documents such as regulated disclosure documents and statements of advice. They also have access to more complex and often higher-risk financial products.

However, one of the most important differences between these classifications is that investors classified as sophisticated or wholesale forfeit several legal protections and rights that are held by retail investors.

So, 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 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 without knowledge or understanding of the classifications and its outcome.

What can you do? When in doubt always seek 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 your accountant.

Your accountant should have a good understanding of your financial situation and literacy and are a good person to ask questions about your investor classification. They can also usually connect you with an alternative financial adviser for a second opinion.

Therefore, whether you are currently classified as a wholesale or sophisticated investor or are considering that classification, we encourage you to speak to your accountant or adviser about what this classification means, and when in doubt seek a second opinion.

How can BDO help?

At BDO, our Private Wealth team maintain 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. This has helped BDO Private Wealth-advised clients to come through this period of uncertainty in a strong position. Should you be affected by these changes or simply want a second opinion, please don’t hesitate to contact your local BDO Private Wealth Adviser for more information.

Mark Wilkinson provides financial advice under the license of BDO Private Wealth Advisers Pty Ltd, AFSL238280.

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