In Australia, like many countries, there are rules designed to protect retail (non-professional) investors from making big money mistakes. Finance is a difficult area, and having protections in place is a good idea.
One of those rules is the “Sophisticated Investor” test. In order to make certain types of investments, including investing in investment pools that allow people to make small investments in promising startups, you must pass this test.
Before explaining the test, here is a quiz.
For each of the following, decide whether you believe they are a “sophisticated investor” or not:
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My parents died in 1970 when I was 25. I inherited their house, worth $70,000 at the time, and still own it today.
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I won $4 in a Powerball jackpot. I lost $1M of that gambling at the casino in six weeks, but I have a new system so I am going to start betting bigger and will win it back quickly.
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I am one of Australia’s leading a medical specialists, earning over $500K a year, although I don’t really understand the how compound interest works.
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I bought $300 worth of bitcoin in 2010 because it was the only way I could buy drugs on the dark web. I spent $295, leaving me with $5 which I forgot about until I found it again a few weeks ago.
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I have two finance degrees, one specialising in investments. I worked in banking for three years, then investments for eleven years. I participated in an intensive investment workshop at Harvard with leading investors from around the world. I became at a Partner and one of Australia’s most prestigous investment firms. My team won an award for Fund Manager of the Year. I was a Registered Representive for my employer, meaning I met a long list of education and experience requirements set by Australia’s financial regulator. I have been a director and advisor to multiple startups and have helped with things like negotiating the sale of a business, structuring funding rounds, and setting up employee option schemes. In recent years I have been building my own startup, investing my own money and not taking a salary. I have a modest lifestyle and understand that happiness comes from doing what you love and having strong relationships with family and friends, not substantial material wealth.
Scroll down for answers:
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It may surprise you, but only one of these people would NOT qualify as a sophisticated investor. Also, only one of these people is real… and it is me!
- IS a sophisticated investor because the house they inherited is now worth over $3M.
- IS a sophisticated investor (for now) because they still have $3M that they are yet to gamble away.
- IS a sophisticated investor because of their income.
- IS a sophisticated investor because that $5 of bitcoin is now worth $3.6M.
- Is NOT a sophisticated investor because I don’t have the required income or assets.
Definition of a sophisticated investor
ASIC definition (from: https://asic.gov.au/regulatory-resources/financial-services/financial-product-disclosure/certificates-issued-by-a-qualified-accountant/)
The Corporations Regulations prescribe the asset and income criteria which must be met before you can issue a certificate. A person is only eligible to be the subject of a certificate if they have:
- a gross income of $250,000 or more per annum in each of the previous two years or
- net assets of at least $2.5 million (reg 6D.2.03 and reg 7.1.28).
The rationale is that people meeting one of these criteria are more likely to be able to evaluate offers of securities and some financial products (such as interests in managed investment schemes) without needing the protections of a regulated disclosure document.
This is NOT a sophisticated investor test…
…it’s a “rich investor test”.
That’s fine, if that is why our government wants, but stop using weasel words and just call it the “rich investor test”.
If the most important thing is whether or not you can afford to lose the money, that’s reasonable. People should be (relatively) free to use their own money how they see fit.
But let’s add a new test that is a genuine sophisticated investor test. We have tests to decide whether you can drive a car, get into university, qualify for certain jobs, and even tests for financial literacy (https://www.finra.org/registration-exams-ce/qualification-exams/series7).
It will cost money to admister this system, so charge people who want to take the test. By definition, if they are looking to start investing then they have some money.
Until this is changed, this is simply another rule that makes it easier for the rich to get richer while making it harder for everyone else to have a fighting chance to catch up.
Summary
To be fair, the rationale in ASIC’s own document states that the definitions are set because people who pass the tests “are more likely” to be sophisticated investors, not they ARE sophisticated investors. And I admit that I picked some examples that might be a bit extreme.
It is probably correct that, all other things being equal, rich people “are more likely” to be sophisticated investors, because it’s more likely that you will go out of your way to learn about investing if you have money to invest than if you don’t!
But what does “more likely” mean? 99% accurate or 51% accurate?
In my opinion it’s lazy, thoughtless, and careless to just say “eh, close enough”. It is shutting some very smart people out of being able to back some great startups. Whether it is a deliberate attempt to help the rich stay rich and keep out everyone else, or just a result of a lazy government, we can do better and we should do better.