Pamela Hanrahan

Longstanding legislation around wholesale investors is both flawed and outdated according to regulation experts, with the existing definitions for ‘sophisticated’ investors exposing them to undue risk and potential harm.

Under the Corporations Act anyone earning $250,000 for two years or holding $2,500,000 in net assets can be classified as a wholesale investor and accept securities offers without receiving a product disclosure statement or other basic protections afforded to retail investors.

According to Pamela Hanrahan, a professor of commercial law and regulation at UNSW who advised at the Hayne royal commission, the regulation is fundamentally flawed for using a monetary threshold rather than a barrier linked to understanding and experience.

“As time has gone on it’s become less of a proxy for knowledge,” Hanrahan says.

The reasoning behind the regulation is sound; anyone over the threshold should theoretically have either the financial know-how or the resources to source legal and financial advice.

But almost 20 years after the law was enacted, with more people qualifying as wholesale, a host of unregulated providers are targeting wealthy investors willing to forgo protection to access deals marketed as wholesale.

“In securities law theory the idea is that if you’re asking someone to put in a big lump of money they can look after their own information needs,” explains Hanrahan. “But that theory doesn’t translate into these widely advertised public offers.”

Hanrahan points to Mayfair 101 as an example of an investment firm with products seemingly designed for wholesale investors that appear to be marketed to a broader mass-marketed client. This type of targeted mass-marketing, she believes, can be “misleading and deceptive” if it is targeted at people who lack experience with complex illiquid investments.

“I would restrict the general advertising of wholesale offers,” she says. “You shouldn’t be able to advertise in the newspaper, especially without the kinds of warnings that are routinely required elsewhere, including in the UK.”

Using old thresholds

In 2011 Treasury asked for submissions on a number of concerns it had around the distinction between wholesale and retail clients, including whether an indexing mechanism should be applied.

The three monetary thresholds – there is also a $500,000 product value benchmark – stem from a 1997 recommendation made in the Financial System Inquiry that advocated the removal of prohibitions on retail participation in derivatives trades.

The problem is that the figures used in that inquiry were based on figures from 1991. Worse, nobody thought to index them. Treasury addressed this in its discussion paper.

“The threshold for product value was set at $500,000, as compared to average total earnings for Australian full-time workers which were around $29,3004 in 1991,” the Treasury paper notes. “The level of $500,000 is a level now within reach of an increasing number of Australians”.