Sophisticated investors: precisely what are they?

Section 708 of the Corporations Act 2001 (Cth) (Act) contains what’s known as the small scale offerings exception to the obligation to issue a disclosure document.  This is more commonly known as the “20/12 rule”.  Subsection 708(8) provides an exception to ‘sophisticated investors’ where a qualified accountant provides a certificate dated not more than 6 months before the date that the offer (of securities) is made attesting that the person is ‘sophisticated’.

How does the accountant determine sophistication?

Section 708(8) of the Act describes one of the exceptions for what is known as a ‘sophisticated investor’.  This section provides:

(8)  An offer of a body’s securities does not need disclosure to investors under this Part if:

(a)  the minimum amount payable for the securities on acceptance of the offer by the person to whom the offer is made is at least $500,000; or
(b)  the amount payable for the securities on acceptance by the person to whom the offer is made and the amounts previously paid by the person for the body‘s securities of the same class that are held by the person add up to at least $500,000; or
(c)  it appears from a certificate given by a qualified accountant no more than 6 months before the offer is made that the person to whom the offer is made:

(i)    has net assets of at least the amount specified in regulations made for the purposes of this subparagraph; or
(ii)    has a gross income for each of the last 2 financial years of at least the amount specified in regulations made for the purposes of this subparagraph a year; or

(d)  the offer is made to a company or trust controlled by a person who meets the requirements of subparagraph (c)(i) or (ii).

Who is a person?

To determine whether an investor could be sophisticated it is necessary to ask who the offer was made to.   The term person’ (noting the use of the singular) is defined by section 761A of the Act which says:

“the term person is affected by section 761F (which deals with partnerships) and section 761FA (which deals with multiple trustees).”   

Section 761F provides that a partnership is also a person.  Section 761FA provides that a person generally includes trustees.

What do the regulations prescribe in relation to net assets and gross income?

Regulation 6D.2.03 of the Corporations Regulations (2001)(Cth) (Regulations) provide that a person is eligible to receive a certificate if they have:

  • assets of at least $2.5 million; or
  • a gross income of $250,000 or more per annum in each of two previous years.

ASIC Guidance on requirements for issuers of sophisticated investor certificates

On its website, the Australian Securities and Investments Commission (ASIC) provides guidance on sophisticated investors.[1]  Only qualified accountants can issue sophisticated investor certificates.  ASIC expands on the definition of ‘qualified accountant’ as contained in s 88B of the Act, and states that a person is a qualified accountant if they:

  • belong to one of the following professional bodies at the declared membership classification; and
  • comply with that body’s continuing professional education requirements.

The guidelines contain a list of the professional bodies in Australia as well as the eligible foreign professional bodies.  With respect to foreign bodies, ASIC provides that foreign investors and some Australians working overseas may be able to access Australian financial products without triggering significant additional disclosure obligations on the issuer.  ASIC provides a further regulatory guide with additional details explaining why and how only these specific bodies are recognised.

The guidelines also discuss the gross income and net asset levels which must be met before a certificate can be issued, as provided in 6D.2.03 of the Regulations.

Can a self-managed superannuation fund (SMSF) be sophisticated?

SMSF’s can be classified as sophisticated investors for the purpose of investing in securities if the trustee of the trust provides an accountant’s certificate, in accordance with the requirements discussed above that the trustee:

  • has net assets of at least $2.5 million (Assets Test)
  • has gross income for each of the last financial years of at least $250,000 (Income Test).

The threshold question of course is who is the trustee and who is going to make the investment.  The ‘person’ referred to in section 708(8)(c) of the Act is the person to whom the offer (to subscribe for securities) is made.  In the case of an SMSF the investor will be the trustee or trustees rather than the trust itself, because the trust itself is not a legal entity.

At law the trustee is the owner of the assets of the trust which it holds for the benefit of the beneficiaries.  Therefore the trustee holds the assets of the trust on trust for the beneficiaries.  In contrast, section 708(8)(d) refers to offers made to a company or trust controlled by a person (being the person or persons who controls the trust) who meets the requirements in sub-section (c).

The question of ‘control’ then arises.  Section 50AA of the Act says that a person controls a company or a trustee if that person has the capacity to determine the outcome of decisions about the company’s or trustee’s financial and operating policies.  This is a practical test and involves an assessment of the practical influence a person can have, or has had, over decisions.

Applying the assets test to self-managed super funds

Corporate trustee of an SMSF

Applying the logic above if an SMSF meets the assets test and it has a corporate trustee then it can be a sophisticated investor.

Two individuals as trustees of an SMSF

In the case of two individual trustees, if for the sake of analysis the trust has say $3million in assets then technically $1.5 million will vest in each individual trustee and they could, be eligible to receive a sophisticated investor certificate.

The determination of whether an investor who is the trustee of an SMSF (for an investment by the trustee on behalf of the SMSF) is sophisticated or wholesale can be challenging.

Can an individual’s share of the assets of an SMSF be added to their own assets to determine sophistication?

In short, the answer is no.  The Assets Test requires that an individual must have at least $2.5 million in assets.   An individual beneficiary of an SMSF is presently not entitled to their share of the assets of the trust.   So an individual looking to satisfy the Assets Test cannot include their share of the assets in an SMSF unless they are entitled to the assets of fund.

Counting assets held as joint tenants

This is perhaps more complicated because on its face each joint tenant has an interest in the entire asset.  For example if a couple holds an asset worth $5million as joint tenants then they each own 100% of the asset.  In this simplified example they would each satisfy the Assets test and would be capable of being sophisticated.

In ASIC v Cassimatis (No 8) [2016] FCA 1023 one of the issues that the Court had to determine was whether investments by jointly advised clients could be ‘aggregated for the purposes of determining whether they are retail clients’.  Note that section 761G(7) is the equivalent to 708(6) as it relates to sophistication and investment in financial products.  It was said by Edelman J at 596 that:

“When a couple invests jointly, each person owns, and is entitled to, 100% of the investment unless the joint ownership is severed. Joint ownership is ownership of the entirety of the investment for each joint owner”.

Whilst this is not directly relevant, it does highlight one of the legal issues to be considered when assessing sophistication and the Assets Test.

Takeaways

If you are counting concessions for the purposes of compliance with the 20/12 rule and there is any doubt about whether a proposed investor is sophisticated it is important to obtain legal advice that takes into account all of the investor’s circumstances.

Links and further references

Resources

ASIC Media Release 17-228

ASIC Regulatory Guide 154 – Certificate by a qualified accountant

Certificates issued by a qualified accountant

Sample sophisticated investor certificate

Legislation

Corporations Act 2001 (Cth)

Corporations Regulations 2001 (Cth)

Cases

Dawson v Dawson [1945] VLR 99

ASIC v Cassimatis (No 8) [2016] FCA 1023

Articles by Dundas Lawyers

The 20/12 Rule and anti-avoidance provisions

[1] https://asic.gov.au/regulatory-resources/financial-services/financial-product-disclosure/certificates-issued-by-a-qualified-accountant/

Further information

If you need advice about whether a proposed investor is sophisticated, please, contact me for a confidential and obligation free discussion:

Malcolm Burrows B.Bus.,MBA.,LL.B.,LL.M.,MQLS.
Legal Practice Director
Telephone: (07) 3221 0013 | Mobile: 0419 726 535
e: mburrows@dundaslawyers.com.au

 

Disclaimer

This article contains general commentary only. You should not rely on the commentary as legal advice. Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

Dundas Lawyers
Street Address Suite 12, Level 9, 320 Adelaide Street Brisbane QLD 4001

Tel: 07 3221 0013

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