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OPINION: Wholesale investor regime no loophole

Paua Wealth chief risk officer Jude Pereira says the wholesale investor regime is not a “loophole” as some in the media have suggested.

Friday, December 4th 2020, 1:43PM

by Jude Pereira

The (Financial Markets Conduct Act) FMCA, which contains the wholesale investor exemptions is drafted by the government. The Financial Markets Authority (the FMA) oversees and monitors it for compliance.

It is unlikely that as a regulator, the FMA holds the view that being rich means an investor is smart.

The wholesale investor regime is not about benefitting the ‘clever’ per se, rather it’s based on the common underlying premise in financial regulation that wealthy and experienced investors are better placed to assess (relative to retail investors) the merits and risks of an investment, thereby requiring less disclosure and that they are also sophisticated enough to seek further information from their professional advisers when required.

Is the wholesale investor regime under the FMCA “loose”?

A comparison of our supposedly “loose Kiwi laws” with similar wholesale investor laws in other jurisdictions proves to be an illuminating exercise.

The wholesale investor exemptions contained in Schedule 1 of the FMCA is not dissimilar to wholesale investor exemptions available in Australia, Singapore, the UK and the US. In most instances, the New Zealand requirements are higher.

For example, under the Corporations Act in Australia, they have a net assets test of AU$2.5 million (vs $5million in New Zealand). They also have a AU$500,000 investment exemption threshold (vs $750,000 in New Zealand).

Singapore has the “Accredited Investor” classification for individuals with a net assets test of SG$2 million.

In the UK, the “High Net Worth” investor test is having net assets (excluding any primary residence, pensions and contract of insurance) of £250,000 or more.

In the US, Rule 506 of Regulation D of the Securities Act 1933 has similar dollar thresholds of net worth of at least $1 million (in addition to the recently introduced ‘knowledge’ exemptions).

Australia, Singapore and the UK have even lower thresholds (New Zealand does not have these equivalents) that would allow an investor to qualify as wholesale / sophisticated based on annual income tests of AU$250,000, SG$300,000 and £100,000 per annum respectively.

“Loose Kiwi laws?”, far from it.

Do we have a problem in the New Zealand market where unethical advisers are supposedly “slipping” wholesale investor certificates and investors are so gullible that they are signing these documents without reading them?

Regulatory compliant wholesale and eligible investor certificates must contain certain prescribed statements, including a prominent warning statement to investors that in giving such a certificate, the investor may not be receiving a complete and balanced set of information as well as having fewer legal protections concerning the investments in question.

Some of the wholesale and eligible investor certificates seen in the New Zealand market are several pages long, contain free text fields that require clients to complete and in the case of eligible investors, requires the client’s accountant or professional adviser to sign confirming the clients eligible investor status.

In the case of eligible investor certifications, a prudent investor shouldn’t be “getting” their accountant or lawyer to agree they are savvy. A lawyer, qualified accountant or authorised financial adviser has a professional and statutory obligation when providing such certification and such certification acts as a check and balance to ensure

(i) the investor is sufficiently aware of the consequences of providing an eligible investor certification and

(ii) that there is no reason for the certification by the investor to be incorrect.

Any suggestion that an investor “can get” their lawyer or accountant to agree with the investor implies that there are lawyers and accountants that are not doing their jobs properly.

Wholesale and eligible investor certificates can hardly be described as a document that can be “easily slipped into the paperwork” and any such descriptions trivialise the depth of the wholesale investor certification process.


As an investor, does signing a wholesale investor certificate mean your financial adviser is “almost untouchable?”

It is true that wholesale investors do not receive the same level of disclosure and protection that retail investors do, but does that mean you are going to be left out in the cold?

The starting point for any financial advice or service is that they must be based on the client’s needs and outcomes. Investment recommendations to clients must be based on the suitability of products and/or services relative to the client’s investment profile, risk appetite and financial objectives.

Financial advisers must ‘know’ their client – for example, if they asses that a client requires greater guidance in understanding the risks of certain recommendations or products, then more disclosure is what is required, irrespective of the client’s wholesale investor status or net worth. Then there is the ethical consideration – just because a client qualifies to become a wholesale investor, does that mean they should be certified as one?

Financial advisers should ascertain the financial literacy of a client. If you explain the risks of a particular investment and the client doesn’t understand it, then they shouldn’t be certified as a wholesale investor even though they may qualify as one.

Signing a wholesale investor certificate does not mean your financial adviser is “almost untouchable”.

The Fair Dealing provisions in Part 2 of the FMCA (which deals with misleading or deceptive conduct, false or misleading representations and unsubstantiated representations) would still apply.

These provisions provide some degree of protection to wholesale clients and ensures that financial advisers are still ‘on the hook’ for their actions (and inactions). Investors may also have further protection afforded to them under other regulation, as well as common law.

Are there scores of irresponsible financial advisers selling high risk investment products, negligent lawyers and accountants in the New Zealand financial market acting, waiting to pounce on unsuspecting investors via the wholesale investor exemption?

Whilst there may be some financial advisers with questionable ethics selling high risk products, is this indicative of the overall New Zealand financial market landscape?

Does selling or recommending a high-risk financial product and relying on the wholesale investor exemption mean you are engaged in “dodgy practices where the regulators have no oversight”?

The wholesale investor exemption can open a range of investment opportunities (if they are suitable and within the risk appetite of the investor) that will allow investors to diversify their portfolio and thereby lower their overall portfolio investment risk.

Equally, not all products accessible via the wholesale investor exemption are “dodgy” or unsuitable for investors. For example, private placements by publicly listed companies where shares may be offered at a discount or private equity funds by reputable private equity houses.

Finally, one should not assume that the reason financial advisers deal with wholesale investors is to ‘get around’ the rules and sell high risk products.

A financial adviser may be focused on the high net worth and family office client segment because there is unmet demand and this is their area of specialist expertise, i.e. dealing with clients who are by their nature, often sophisticated investors.

It does not follow that just because these clients are classified as wholesale investors that the financial adviser is classifying them as such to avoid legal responsibilities or recommend high risk products.

The problem is not with the wholesale investor regime, but the risk posed by unethical financial advisers and investments in general. In some sense, no amount of regulation can stamp out unethical financial advisers – you can’t find all the bad apples in the barrel and it’s not an issue unique to the financial industry (the legal and accounting professions can have this problem too).

What may help is more stringent licensing requirements and greater monitoring for compliance. But the FMA can’t monitor every corner of the market all the time.

No regulator can.

Most regulators take a risk-based approach to monitoring and focus on areas where they believe there are problems. If there is widespread misuse of the wholesale investor regime, then specific cases should be raised to the FMA so they can investigate.

Likewise, no amount of regulation and monitoring can address the general risks associated with investing. For example, a retail client receiving a product disclosure statement doesn’t guarantee or stop the associated fund or a financial institution from going down and potentially dragging all the investors with it if there is fraud involved.

Often, no amount of due diligence can uncover these types of issues. It’s also worth noting that sometimes even the most sophisticated of investors can get caught out – for example those that lost money with the US blood analysis start up Theranos included well known US venture capitalist Tim Draper and billionaire Rupert Murdoch.

So, what are some of the things you can do as a wholesale investor to protect yourself? Ask the right questions for a start. Be sure your financial adviser is acting in your best interests, rather than their own. Here are some questions you should ask of your adviser:

  • How do you generate your revenue as a firm?
  • How much are you personally compensated by proposing this investment strategy?
  • Do you receive product commissions?
  • What is the basis of your investment recommendations?
  • What are the risks associated with the proposed investment strategy?
  • What is the governance process around how you manage investments?
  • Do you invest your own money this way?
  • What is your experience, qualifications and track record in providing investment advice?

Getting the right outcomes is everyone’s responsibility. As a start, financial advisers must consider their client’s investment objectives, time horizon and risk appetite when recommending any investments. Increased investor education about risks associated with the investment is also the adviser’s responsibility.

Investors must take the time to educate themselves and understand the conflicts and capabilities of their financial adviser and if you have any doubts, maybe it’s time to find another financial adviser.

Jude Pereira is the chief risk officer at Paua Wealth.

Tags: Opinion Paua Wealth

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