The Australian Securities and Investments Commission’s recently updated example statement of advice recommends advising clients not to invest in hedge funds. The basis given for this is that hedge funds normally adopt investment strategies which are more suited to investors willing to take on more risk. However, this recommendation is likely to come as a surprise for many hedge fund issuers who don’t see themselves as offering risky trading strategies. Furthermore, the treatment of hedge funds in the example SOA arguably creates uncertainty for advisers who recommend these types of investments.
The question of how the corporate regulator should characterise hedge funds has been on the agenda for some time. ASIC’s guidance and class order on hedge funds disclosure has defined hedge funds by reference to a range of criteria. Those funds captured by the definition will be required to issue product disclosure statements containing enhanced disclosure, by reference to principles and benchmarks. This disclosure initiative has been driven by concerns that investors need enhanced information in order to make informed investment decisions about hedge funds. This has caused some controversy in industry quarters. A key concern has been the risk of false positives, that is, those funds caught by the “hedge fund” definition but which do not have alternative or risky investment strategies.
ASIC’s aim in revamping its SOA was to develop a worked example of good disclosure practice for a particular financial advice scenario that satisfies a basic level of disclosure and complies with the law. However, ASIC acknowledges that advisers should not use this example as a template.
This is particularly the case when it comes to product recommendations. In making recommendations about any investment product and particularly hedge funds, advisers need to look beyond naming terminology and into the substance of the product itself.
There are obvious risks in dismissing hedge funds as only ever suitable for investors prepared to take risks, including that to do so may breach the adviser’s obligations under the best interests duty. A key element of the safe harbour under the best interests duty is that in making a product recommendation, a reasonable investigation must be undertaken into the products that may meet the client’s objectives. Advisers will therefore need to form a view based on the individual features of the product itself, including its specific structure and investment strategies as well as the credentials of the issuer.
The debate over how hedge funds should be offered and regulated will no doubt continue. It is worth noting that ASIC has also recently released the findings of a survey on the Australian hedge funds sector. In those findings, the regulator concluded that Australian hedge funds do not currently appear to pose a systemic risk to the Australian economy. This more moderate view on hedge funds may inform future regulatory initiatives. In the meantime, advisers should keep in mind that product recommendations need to be approached on the basis of substance over form.
