The short-lived tenure of former UK Prime Minister Liz Truss has led to a unique determination from the Australian Financial Complaints Authority where the wholesale test was incorrectly applied.
In a webinar hosted by law firm Cowell Clarke on Thursday, financial services lawyers discussed the impact of a client put into an SMSF through a managed discretionary account which was used to invest in a margin FX (foreign exchange) contract with a leverage ratio of 1000 to one.
The product tanked due to a weak pound during the tail end of the short-lived Truss premiership, famed for being outlived by a head of lettuce, which lasted 49 days between September and October 2022.
However, AFCA ruled the wrong wholesale investor test was applied to the client, meaning they were eligible to be part of the external dispute resolution process which granted them the same protections as retail investors.
The client had been characterised as a wholesale client, basing it on the general test of $2.5 million in assets. Yet the complainants disagreed and argued the specific SMSF test should have been applied, which requires net assets of at least $10 million dollars.
Financial services lawyers Richard Hopkin and Zac Mizgalski discussed how the categorisation of wholesale versus retail clients can be crucial in determining what appropriate products are for different clients.
“The question for AFCA became, which of those two tests applied in this situation? Was it the specific test that requires $10 million in net assets, or was it the general test, which requires $2.5 million?” Mizgalski said.
“[AFCA found] the general test didn’t apply, the specific [SMSF] test did apply. As the SMSF did not have at least $10 million in net assets, they didn’t qualify as wholesale clients and should have been credited as retail clients.”
AFCA’s final determination required a $150,000 compensation payment to the trustees.
Hopkin explains this payment was “partly on the basis that the trustee wouldn’t have been able to acquire the product at all had it been currently categorised”.
AFCA’s controversial ‘but for’ methodology, which applies to many of the determinations, is applicable here as the original wholesale assessment was incorrect.
“The but for test here is made out because the complainant would not have had access to the relevant wholesale product, which was at leverage of 1000 to one, if they’ve been correctly classified according to AFCA as a retail client,” Hopkin said.
“[In this case] the test isn’t about whether they’d issued the product wrongly or whether they’d done something really wrong with that provision of services.”
Despite this particular determination, Hopkin said AFCA has not always been consistent in their ruling.
“We did find a determination from back in 2022 that said the opposite, where AFCA actually applied the law consistently with ASIC’s no action position,” Hopkin said, referring to the regulator’s policy of not enforcing mis-categorisation between wholesale definitions.
“We’re not actually clear on whether AFCA will be consistent in its future determinations.”
The lawyers recommended financial firms that are members of AFCA take a close look at their wholesale client policies and consider how they apply the policies in practice, to avoid ending up in a similar situation.
Hopkin recommended firms “go back and look over your wholesale clients to assess what sort of exposure you might have”.
The Parliamentary Joint Committee on Corporations and Financial Services commenced an inquiry into the wholesale investor test and wholesale client test in March 2024.
The outcome of the inquiry was very conservative, with only two recommendations made and no tangible change to the wholesale client test.
“The outcome of [the inquiry] was pretty damp in terms of Parliament. [They] basically kicked the can down the road,” Hopkin said.
