The Australian Securities and Investments Commission (ASIC) takes a firm stance against those who manipulate ‘sophisticated investor’ exemptions for retail investors interested in acquiring securities in a corporate body.
Generally, when companies raise funds by offering shares to the public, they must make available to prospective investors certain disclosure documentation prescribed by the Corporations Act 2001 (Cth) (the ‘Act’). The type and extent of disclosure depends on the circumstances and may include a full or short-form prospectus, profile statements and other information statements.
The disclosure provisions are also subject to various exemptions, including offers made to sophisticated investors.
Corporate fundraising and the sophisticated investor
Disclosure is designed to provide detailed information to potential investors to enable them to make informed and balanced decisions about the investment on offer.
The laws are explicit in protecting individual investors. They may, however, be avoided if the minimum amount payable for the offer is at least $500,000 or a proposed individual investor:
- has net assets of at least $2.5 million; or
- has a gross income for each of the last two financial years of at least $250,000; and
- a certified accountant provides the relevant sophisticated investor certificate no later than six months prior to the investment offer being made.
Exposed loopholes in sophisticated investor strategies
In 2017, ASIC investigations discovered that inappropriate sophisticated investor certificates were issued with respect to investments in phone-app company Kwickie International Limited.
ASIC’s concerns emanated from strategies by accountants to formulate trust or company structures that represented their clients as sophisticated investors. Consequently, the statutory disclosure requirements are bypassed and retail investors do not receive the level of protection otherwise afforded through the prescribed disclosure requirements.
By using certain trust or company structures, investors who would otherwise be deemed retail investors were offered shares without a prospectus or other prescribed disclosure documents.
Sophisticated investor certificates were issued on the basis of the aggregate net worth of the respective members of the investment entity. In other words, whilst the overall value of the investor vehicle exceeded that necessary to invoke the exemption provisions, the individual wealth of each investor fell short of the test.
After investigations, ASIC declared that shares in Kwickie could not be offered to retail investors through a trust vehicle and conducted further investigations into the use of certain structures designed to undermine the disclosure requirements of the Act.
The key issues
ASIC’s concerns in the Kwickie investigation targeted the inappropriate issue of sophisticated investor certificates and the use of trusts or company structures to facilitate receiving share offers without the prescribed disclosure requirements.
Retail investors who suffer financial loss from having relied upon a false or misleading statement or through a material omission in a prospectus may have grounds for compensation. Sophisticated investors have far fewer protections under the Act.
Investors who circumvent the prescribed disclosure requirements by creating trusts or schemes waive the right to receive important risk-management information crucial to the proposed investment. Consequently, an otherwise ‘ordinary’ investor risks jeopardising the key protection provisions prescribed by the Act.
Trustees and directors also have statutory reporting requirements when participating in trusts and company schemes established for the purposes of investment.
Statutory disclosure obligations exist to protect retail investors by requiring a corporation offering securities to provide prescribed information concerning the contemplated investment. Attempts to circumvent these rules pose serious risks to the investors and significant compliance concerns with those facilitating such schemes.
Investors should be aware that accountants and financial advisors are prohibited from providing financial product advice for interests in managed investment schemes unless they hold an Australian Financial Services Licence.
Appropriate financial and legal advice is critical, and there are no due diligence shortcuts when assessing any investment.