Wholesale investor exclusions – pejorative labels

In an interesting article earlier this week, BusinessDesk referred to commentary from some retail [investor] client advisers that was again quite critical of both the framing or the wholesale investors exclusions and some observed practices around their use. 

Whilst not all of the criticism are new, a number of them (especially around practices/behaviours) are worth repeating. 

Whilst the article was not overly critical, one point that wasn’t mentioned but which gets some airtime over coffee or around the BBQ, and with which I have some sympathy, is that the FMA should be prepared to lose a few cases.  But that is not to say that the decision-making process would be easy.  This is because of the concern that, at the taxpayer’s expense, a narrow loss might not hurt too much and may yield some useful lessons, there is the ever-present risk that a pattern (of losses) might be observed by some.  So, possibly the taxpayer should only be exposed the costs/risk of fight the ones that they are likely to win/can’t afford to lose.

Where I do part company with some of the commentators cited in the article, is in the suggestions about re-branding the exclusions for wholesale investors or (worse still) shifting the bar – to have a bright line test that is so high, that very few will clear it.  The wholesale investor exclusions are there for a reason. More on this below.

At the risk of sounding over-wrought, it needs the efforts of all members of the band to weed out the cheats.  The business media has an important role to play – by asking the hard questions and putting a spotlight on questionable behaviour.  But I suggest that so too do a range of other professional advisers, including investment advisors as well as lawyers and accountants advising private clients may be at risk of being preyed on by those at the fringes. 

I think that retail [investor] client advisers are quite right to point to the advantages of a low doc / low disclosure regime applying to sourcing funds from wholesale investors.  With that regime comes added risk.  In part, that is the point – that wholesale investors (by definition) are better equipped to make enquiries and undertake their own risk management.  Similarly, wholesale investors can do more to ensure that they price that risk – and gear (negotiate) their terms to adequately compensate them for that risk element.

But it is a bit too melodramatic (and inaccurate) to paint all wholesale investment as some sort of wild west – or worse.   Maybe the use of such pejoratives will help educate a few more people who might be at risk of being swayed by the promise of above market returns and a too good to be true spiel.  And, for those of us who have seen an economic cycle or two – we seem forget the baggage of history, rather too quickly.

The FMA, in its 2022 thematic review, was also quite right to draw attention to some poor compliance practices around enquiry and certification – affecting those being shoehorned into the ‘eligible investor’ subcategory of wholesale investor.

But the wholesale investor exclusions are not a ‘loophole’ – and where there are examples of issuers or their advisers who apparently deliberately seek to raise funds from investors who are (truly) retail – then that behaviour should be called out and dealt with.   Any and all of the band members can shine that spotlight.

Whilst it is not central to the article, misleading and deceptive conduct, particularly in the content of advertising material or in subsequent dealings with investors should be dealt with – by the full force of the law.

As the article notes, the wholesale investor exclusions provide a means for SMEs to raise capital at a lower compliance burden and cost.  Exclusions of this sort were present in the predecessor to the FMC Act and exist in many other OECD countries.  The underlying rationale is the same – and proposals floated in Australia earlier this year to substantially increase the threshold to qualify as a ‘sophisticated investor’ (the first changes in over 20 years) were met with criticisms that are equally or more valid in New Zealand.  These include:

• such a (blunt) change could adversely impact innovation and technology, with a loss of competitiveness against the US and the UK who maintain lower thresholds than those proposed;
• the apparent inflexibility – with one example being that it would rule out high earners with fluctuating incomes; and
• the risk of baking in a number of existing disparities, including those between regions (because, just like New Zealand, the value of the family home and other property investments differs between regions).

The Australian proposals have led to a list of innovative solutions being floated – including some that seek to better target the level of investor experience and financial literacy. 

These are important discussions, and New Zealand could learn a lot from a country only next door, with a much deeper pool of capital and more years of experience in getting to grips with what works for funding start-ups and the SME sector.  Getting this wrong could strangle a number of green shoots, stifle innovation and force SMEs to seek capital from offshore.  It also risks amplifying the Kiwi love affairs with real estate. 

I don’t share one of the correspondent’s pessimism about the risk of crooks outrunning the regulator.  Whilst I continue to question if there is a place on social media for an investment pitch – in an increasingly online world, there is little hope of regulating how would-be investors get their information.  And the flipside is that the online world provides much greater scope for the cheats to be found out – and disinfected with appropriate does of sunlight.

But enough of the pejorative labels – and no kneejerk reactions (please).  Let’s pause, see how the very large market next door reacts to some of the same sorts of pressures – and be fast followers (right-sized for New Zealand).  To finish, a recent probe has found water in molecular form in the far side of the moon – this type of water could be a potential resource for lunar habitation.  Someone cleverer than me might find this a more useful analogy.

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