At the end of last week, the High Court delivered its decision on the case stated proceeding brought by the FMA, seeking a High Court determination about the use, confirmation, and acceptance of ‘eligible investor certificates’ for ‘wholesale’ investments.
To recap, the ‘eligible investor’ route is one of the key hard-wired exceptions from the FMC Act disclosure regime and relies on a category (subset) of wholesale investors to self-certify that they meet the criteria. The FMA’s press release, at the time that the proceedings were launched, indicated that the FMA had gone down this path as result of the apparent [mis] use of ‘eligible investor certificates’ by ‘wholesale’ property developers.
In doing so, the FMA said that its goal was to provide (market) clarity on the [proper] use of ‘eligible investor certificates’ – and ensure that those investors who require the protections provided by the FMC disclosure regime, receive them. And it focused on a sort of straw man example that was designed to provide certainty about the amount of detail to be included in an eligible investor certificate – and the extent to which an offeror must interrogate a certificate in order to rely on it. The latter element being a response to FMA concerns about the lack of detail in certificates and/or what was seen as a culture of reliance on certificates that were apparently inadequately detailed.
As well as submissions from the FMA, the Court granted two industry bodies (representing angel investors and the wider venture capital / private equity industry) the opportunity to be heard.
Questions for the Court
The FMA had observed that whilst some of the other categories of ‘wholesale investor’ are determined by reference to objective criteria, whereas (arguably) qualification for the ‘eligible investor’ category relies on more subjective matters.
The use of the straw man / scenario approach was aimed at developing a proper interpretation of the ‘eligible investor’ exclusion and its application in practice. To do so, the FMA described a number of practical scenarios and asked the Court to determine whether an ‘eligible investor’ certificate would be valid in each case.
The Court’s response can be summarised as:
| 1. | Does an ‘eligible investor certificate’ needs to expressly describe: (a) the previous experience that [the investor] has in acquiring or disposing of products; and (b) the aspects financial of [the investor’s] experience in acquiring or disposing of financial products which they consider would enable them to assess the matters required by clause 41(2)(a) – (c) for the transaction to which it relates? | The answer to both limbs is No. The certificate does not need to explicitly describe the investor’s experience or how it enables them to assess the investment. But, to be a valid, the certificate must meet those formal requirements specified in clause 42 – and the grounds stated must not, on their face, be incapable of supporting the certification. Certificates with no grounds or patently deficient grounds are invalid and must be weeded out. |
| 2. | For an offeror to rely on an ‘eligible investor certificate’, or otherwise treat an investor as an eligible investor, in respect of the transaction to which it relates, does the offeror need to be satisfied that: (a) the ‘eligible investor certificate’ is valid? (b) in the context of an offer of financial products, based on the grounds stated in the certificate, [the investor] could make the assessments requirement by clause 41(2)(a) – (c) in respect of: (i) a financial product of any kind; and (ii) the financial products involved in the transaction to which the certificate relates. | On the first part, an offeror must (at the very least) satisfy itself that the certificate is valid (meets the statutory requirements – and is not subject to any of the prohibitions). But, despite the FMA’s submissions, there is no positive duty on the offeror to vet the grounds given by the investor (in the certificate) to be satisfied as to their adequacy – and the investor does have the necessary experience. The judge held that to find otherwise would be inconsistent with both the wording and the scheme of the exclusion – by imposing more onerous obligations, when the wording of the exclusion said that reliance was unwarranted only when the offeror actually knows that the investor did not in fact have necessary experience. If vetting was required, self-certification would be redundant. Consequently, the answers to question #2 are Yes to (a) and not to both limbs of (b). |
| 3. | If the answer is Yes to limbs (b)(i) or (b)(ii) of – can an offeror rely on information which is not contained in the ‘eligible investor certificate’? | No answer was needed because of the answers to #2, that a determination of validity must be based on the certificate itself – and not external information. To hold otherwise would be inconsistent with a statutory scheme designed to be simple (and certain). |
| 4. | If an offeror makes an offer of financial products to [the investor] in circumstances where it is not permitted to rely on [the investor’s] ‘eligible investor certificate’, is disclosure required under Part 3 of the FMC Act? | The judge agreed with the approach of both the FMA and the two industry bodies – that disclosure is required where the relevant investor is not otherwise a wholesale investor. |
Whilst the judgment relied heavily on the history of the ‘eligible investor’ exclusion, the discussion of the role of the confirmation of certificates by a financial adviser, accountant, or lawyer is interesting. Under clause 43, the person providing that confirmation must be satisfied that the investor has been sufficiently advised of the consequences of certification and has no reason to believe the certification is incorrect or that further information or investigation is needed as to whether the certificate is correct.
Here, the judge said if the grounds set out in the certificate are not incapable of supporting the certification but are nevertheless pretty “thin”, the confirmer may still conclude that further information or investigation is required. Consequently, the confirmer may make enquiries of the investor before confirming the certificate. But the judge agreed with the industry bodies that an offeror ought to be entitled to proceed on the basis that the confirmer has no reason to believe that the certification is incorrect or that any further information or investigation is required.
Interestingly, the judge also agreed with the industry bodies, that the case stated procedure is not well-suited to assessing policy matters and concerns – and commented that if the FMA considers there is a need to “re-balance” the approach to the ‘eligible investor’ exclusion, or to prescribe further information which must be included in a certificate, that is a matter for legislation not the Courts.
Concluding comments
In the interim, the judgment provides some process certainty for offerors seeking to rely on the ‘eligible persons’ exclusion.
In practice, the judgment will likely also manifest itself in some additional process protections – including better/clearer riding instructions being applied by third party confirmers.
The judgment references the policy goals of the ‘eligible investor’ regime in terms of simplicity and certainty and, thanks to the submissions of the industry bodies, the severity of the consequences of getting it wrong in terms of transforming what was intended to be an offer that was confined to a wholesale audience into a retail one, requiring full disclosure (and the exposure to penalties and enforcement action).
Longer term, if there is a more insidious pattern of behaviour that is spotlighted by (for example) some of the high-profile cases of fallout from ‘wholesale’ offers by property developers, then it is hoped that any policy response that flows into legislation is careful to pay attention not only to the submissions of the industry bodies in this case but also those across the Tasman. In Australia, the responses to the Parliamentary Joint Committee on Corporations and Financial Services’ inquiry into the ‘wholesale investor’ test for offers of securities in Australia are important. There, in the context of a much larger and deeper pool of industry experience, the inquiry drew submissions from industry bodies that underlined the importance of the private capital industry as a critical source of capital for investment into start-ups and growth companies in Australia – and the need to balance regulatory certainty with the law of unintended consequences and not (for example) risk imposing a significantly adverse effect on the availability of capital for start-ups and growth businesses – starving them of capital or driving them offshore.
Once again, it is hoped that a significant effort is made to both achieve the right outcome going forward and ensure that (perhaps other than in cases of egregiously bad behaviour) the shape of capital raising at a wholesale level is not driven by solely by the fallout from behaviour of those at the margins.
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