When raising capital in Australia, corporations are generally required to comply with the disclosure obligations under the Corporations Act 2001 (Cth) (Corporations Act) by providing prospective investors with sufficient information about the company’s operations and financial position prior to offering the relevant securities. These requirements are intended to protect investors by ensuring that they are made aware of the risks of participating in the offer.
One of the exemptions to these disclosure requirements is the ‘sophisticated investor’ test,1 which allows individuals with net assets of at least $2.5 million or gross income of at least $250,000 for two years (together, the Thresholds) to access what might be complex investment opportunities without the need for a disclosure document. These Thresholds have been in place since 2001 and Treasury has recently sought industry feedback in relation to their continued use, as part of a wider review of the regulatory framework for managed investment schemes.2
Australia’s high tide
Australia’s economic growth in the past 22 years has acted as a rising tide, with the exponential increase in home values across the country3 lifting many Australians over the Thresholds and placing them into the category of ‘sophisticated investor’. This rising tide has increased the number of Australians who qualify as ‘sophisticated’ from 1.9% of the population in 2002 to more than 16% of the population in 2021.4
Projected increases in income and asset prices indicate that the number of sophisticated investors could increase to 6.78 million adults (29.1% of the population) by 2031 and 11.5 million adults (43.6% of the population) by 2041.5
While these individuals will have access to potentially more lucrative investment opportunities, such as unlisted real estate, private equity and seed rounds for start-up entities, they will also give up certain consumer protections. From a policy perspective, such a trade-off is generally only acceptable if investors have a sufficient level of financial sagacity to compensate for the lack of safeguards, such that they can make their own informed investment decisions.
Using wealth as a proxy for financial literacy is somewhat controversial and it’s arguable that, in the context of the ‘sophisticated investor’ test, this already blunt instrument has been further dulled by the passage of time.6
Playing catch-up (but don’t overshoot)
The Labor Government is reportedly7 considering an increase to the Thresholds to realign the test with the modern demographics of the Australian economy. While no final decision has been made as to the extent of any increase, the Australian Financial Review has suggested that indexing the Thresholds for inflation (as recommended by the Australian Securities and Investments Commission)8 would result in a net asset threshold of $4.5 million and a gross income threshold of $450,000.
However, the need to increase the Thresholds is not unanimously agreed amongst financial experts. The Financial Services Council has recommended against increasing the Thresholds but instead suggested that the family home be excluded from the net asset test (or increased to $5 million where the family home is included).9
Other commentators have highlighted an overreliance by some advisors or product issuers on accountant’s certificates to confirm the sophistication of a prospective investor, and that determining whether an investor has the appropriate ‘knowledge, experience and risk appetite’ is a question for the advisors recommending the financial product.10 It has also been suggested that the compliance burden associated with offering securities to retail investors is driving issuers to preference the sophisticated investor regimes where possible, and there are concerns that a continued reliance on accountant’s certificates (which are intended to be pure statements of fact) suggests an undue shifting of risk away from the advisors and product issuers towards accountants.
In light of these criticisms and the broad scope of the Treasury’s review,11 any changes to the Thresholds will likely be part of a wider overhaul of the test. In its recent submissions, CHOICE recommended that the government adjust the Thresholds to account for inflation, include a mechanism to automatically index those Thresholds on a periodic basis and exclude the family home when calculating a person’s net assets.12
While many regulators and consumer advocates are pushing for change, 13 there are some stakeholders who argue that increasing the Thresholds will disadvantage investors and reduce consumer choice by forcing otherwise financially competent individuals into retail offerings with less risk but lower returns.14This, in turn, may have a flow-on effect for start-ups and other micro-cap companies seeking to raise funds in Australia.
The Financial Services Council estimates that approximately 275,3000 existing ‘sophisticated investors’ could fail to meet an increased asset threshold and recommends that such investors be grandfathered into any legislative changes to prevent unintended adverse financial and legal consequences.15
It has also been suggested that an increase to the Thresholds reflects a baseline assumption by policymakers that most Australians are financially illiterate, and that Treasury should demonstrate systemic problems within the current processes before making any changes to the test.16 While having a certain level of wealth is not necessarily indicative of a high level of financial acumen, increasing the Thresholds to a point where only 2% of the population would be considered ‘sophisticated’ would ignore the impacts of the Banking Royal Commission,17 the internet and social media over the past two decades – the average Australian certainly has greater access to quality financial advice and information, free or otherwise, than they did in 2002.
Finding ‘sophistication’
The Labor government will be tasked with finding a middle ground between these two disparate and somewhat ideological positions. On the one hand, the policy should work to uphold the objective of the disclosure obligations set out in the Corporations Act, which are intended to protect the average investor from entering risky transactions which they may not have the financial education to understand without proper disclosure. On the other hand, the government should be cautious not to unduly exclude willing and astute participants from the market, particularly since doing so may have unintended consequences, such as increasing the national wealth disparity or otherwise dampening innovation and restricting access to capital for emerging start-ups.18
A financial benchmark alone may not be sufficient to achieve the necessary balance. While some commentators are advocating for a simplified regulatory environment,19 others have suggested that additional thresholds (such as a knowledge test or establishing a history of generating sufficiently healthy returns through previous investments)20 should be introduced to bolster the objectivity of the test. These suggestions come with their own difficulties and questions of fairness, including how such an approach would work in practice.
While simplification of Australia’s Byzantine corporate legal landscape might be a pleasant reverie, it may be more realistic to simply hope that the impeding changes do not add to the Corporations Act’s current legal and administrative complexities.
Following consultation with industry stakeholders, Treasury is expected provide its advice to Assistant Treasurer Stephen Jones in early 2024.21
1 Corporations Act 2001 (Cth), section 708(8)-(10).
2 Australian Government (Treasury), ‘Consultation paper – Review of the regulatory framework for managed investment schemes’ August 2023 https://treasury.gov.au/sites/default/files/2023-08/c2023-404702-cp_0.pdf.
3 Nominal property prices have increased by approximately 282 per cent since 2001: Organisation for Economic Co-operation and Development, ‘Analytical house prices indicators’, nominal house price index, 2023 https://stats.oecd.org/Index.aspx?DataSetCode=HOUSE_PRICES#.
4 Associate Professor Ben Phillips, ‘Research Note: Sophisticated Investor Projections’, Australian National University Centre for Social Research & Methods, October 2021, page 3 https://csrm.cass.anu.edu.au/sites/default/files/docs/2021/10/Research_Note_Sophisticated_Investor.pdf .
5 See footnote 4.
6 Although the Thresholds are also premised on the assumption that, even if those investors who meet the Thresholds but don’t necessarily have the knowledge or experience to understand the risks or lack of protections afforded to them, they will at least have the means to acquire professional advice in relation to those issues: Explanatory Memorandum, Financial Services Reform Bill 2001 (Cth) at [6.19]-[6.24].
7 Australian Financial Review, ‘Labor to overhaul ‘sophisticated investor’ test’, Michael Read, 12 January 2024 https://www.afr.com/policy/economy/labor-to-overhaul-sophisticated-investor-test-20231219-p5eseg.
8 Australian Securities and Investments Commission, Submission in response to review of the regulatory framework for managed investment schemes, September 2023, page 9 https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-asic.pdf.
9 Financial Services Council, Submission in response to review of the regulatory framework for managed investment schemes, 15 January 2024, page 12-13
https://treasury.gov.au/sites/default/files/2024-01/c2023-404702-fsc.pdf.
10 Chartered Accountants Australia & New Zealand (CA ANZ), CPA Australia, the Institute of Public Accountants and the SMSF Association, Joint submission in response to review of the regulatory framework for managed investment schemes, 29 September 2023 https://www.cpaaustralia.com.au/-/media/project/cpa/corporate/documents/policy-and-advocacy/consultations-and-submissions/financial-planning/2023/joint-submission---review-of-the-regulatory-framework-for-managed-investment-schemes-consultatio.pdf?rev=aba863cf141e470c86580ebafeeae929.
11 See footnote 2.
12 CHOICE Consultation paper, Submission to in response to review of the regulatory framework for managed investment schemes, September 2023, page 4
https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-choice.pdf.
13 For example, see Australian Securities and Investments Commission, Submission in response to review of the regulatory framework for managed investment schemes, September 2023
https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-asic.pdf; and
Financial Advice Association Australia, Submission in response to review of the regulatory framework for managed investment schemes, 3 October 2023, page 5
https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-faaa.pdf
14 For example, see Stockbrokers and Investment Advisers Association, Submission in response to review of the regulatory framework for managed investment schemes, 29 September 2023 https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-property-funds.pdf.
15 See footnote 9, page 14.
16 Stockbrokers and Investment Advisers Association, Submission in response to review of the regulatory framework for managed investment schemes, 29 September 2023, page 2-3 https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-property-funds.pdf.
17 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
18 Stew Glynn – Managing Parter & Co-Founder at TEN13, ‘Investment Inequality: The Perils of Doubling Australia's 'Sophisticated Investor' Thresholds’, 18 January 2024.
https://www.linkedin.com/pulse/investment-inequality-perils-doubling-australias-investor-stew-glynn-kv3nc/.
19 Chartered Accountants Australia & New Zealand (CA ANZ), CPA Australia, the Institute of Public Accountants and the SMSF Association, Joint submission in response to review of the regulatory framework for managed investment schemes, 29 September 2023 https://www.cpaaustralia.com.au/-/media/project/cpa/corporate/documents/policy-and-advocacy/consultations-and-submissions/financial-planning/2023/joint-submission---review-of-the-regulatory-framework-for-managed-investment-schemes-consultatio.pdf?rev=aba863cf141e470c86580ebafeeae929.
20 Boardroom Pty Ltd has proposed a consideration of educational qualifications and work experience given the rationale of introducing the Threshold focuses on ‘knowledge’ or ‘experience’: Boardroom Pty Ltd, Submission in response to review of the regulatory framework for managed investment schemes, 29 September 2023, page 2 https://treasury.gov.au/sites/default/files/2023-11/c2023-404702-boardroom.pdf.
21 Hon Stephen Jones MP – Assistant Treasurer and Minister for Financial Services, ‘Review of the Regulatory Framework for managed investment schemes’, 8 March 2023 https://ministers.treasury.gov.au/ministers/stephen-jones-2022/media-releases/review-regulatory-framework-managed-investment-schemes.