In a previous article we looked at various regulatory issues and concerns which have arisen with the current legal definitions of wholesale and retail clients under the Corporations Act 2001 (the "Act") and how the regulators might respond to them.
We noted that a reassessment of the distinction appeared to be warranted as a result of ongoing developments in:
- the manner in which the financial services industry now operates;
- levels of client financial literacy and individual wealth; and
- regulatory methodology (moving from a disclosure based approach to a more active, interventionist approach in relation to conduct and product design).
The findings of the two Government review bodies which are looked at below would indicate that changes to the wholesale client eligibility rules are likely in the next few years.
AFCA's jurisdiction in relation to wholesale clients
The corollary of this is that the holder of an AFSL which only has wholesale client authorisations is not required to become a member of AFCA and its clients cannot, therefore, complain to AFCA.
However, an AFSL holder with both wholesale and retail client authorisations must be a member of AFCA. Under the AFCA Rules and its Operational Guidelines, AFCA states that it has a discretion to handle complaints from wholesale clients of its members.
This result is not particularly fair to those AFSL holders with both wholesale and retail client authorisations and somewhat at odds with the legislative intention that the AFCA complaints resolution scheme should only be available to retail clients.
Under the legislation, which established AFCA in 2018, the Government was required to conduct an independent review of the operation of AFCA ("Review"). This Review was completed in August 2021 but the report was only released publicly in November.
The Review considered a wide range of issues concerning AFCA's operations. One of these was AFCA's consideration of complaints relating to wholesale clients.
It was submitted to the Review by industry participants that:
- wholesale clients were "gaming" the AFCA system to obtain cost free dispute resolution as an alternative to taking action in the Courts; and
- allowing wholesale clients access to AFCA was inconsistent with the legislative intention that wholesale clients did not receive the consumer protections available to retail clients.
The Review did not agree with a proposal for a total exclusion of wholesale clients from AFCA's jurisdiction. Rather, it saw a definite need for some wholesale clients to have access to a free and accessible ombudsman service giving examples of:
- a retiree with a superannuation balance in excess of $500,000 (a somewhat curious example given that superannuation product advice must always be provided on a retail client basis);
- an unsophisticated consumer who has assets (such as their home and superannuation) with a value above $2.5 million but who is unable to navigate the complexity of the financial system - see this article for our view on this "just because you can doesn't mean you should" issue.
The Review recommends that AFCA should focus its enquiries on whether an apparent wholesale client has been "incorrectly" or "inappropriately" classified by the financial firm. Where the wholesale client is a "sophisticated" or "professional" investor, AFCA should not consider a complaint further if the classification was correct and appropriate.
It is interesting to note that this recommendation appears to be designed to create a further distinction between the "sophisticated" or "professional" tests on one hand and the more consumer focussed "product value" and "individual wealth" tests on the other hand.
It is not yet known what the Government's response to this recommendation will be.
The Law Reform Commission weighs in
The Australian Law Reform Commission ("ALRC") has been asked by the Government to inquire into the potential simplification of laws that regulate financial services in Australia. It recently issued its Interim Report A and it includes a chapter on the wholesale client rules.
The report provides a useful background to the history of the wholesale and retail distinction and its policy rationale. However, the ALRC is still at an early stage of the review process and is still mostly focussed on identifying problems, developing recommendations and inviting feedback.
Further, the ALRC's remit is not to make changes to underlying policy. The ALRC recognises that the wholesale/retail client distinction is "pivotal" and of "critical importance" to the operation of the financial services laws. On that basis, they can only consider whether the current wording of the legislation reflects and achieves that policy rationale.
This policy rationale is that wholesale clients are better informed and better able to assess the risks involved in financial transactions and, therefore, do not need to same protections as retail clients. The ALRC notes that the distinction originally only affected disclosure obligations but that it now extends to the wide range of conduct and product design obligations that have been introduced over the years. In light of the relative ease which clients can now qualify for wholesale client status the ALRC is concerned that the distinction no longer meets that policy rationale.
In relation to the legislation itself, the ALRC is concerned that the eligibility criteria is complex and has navigability "challenges" and "questionable" useability.
Some of the ALRC's recommendations from Interim Report A are that:
- Financial services and products provided for use in connection with a "large" business would generally be on a wholesale basis.
- A "professional investor" would remain as a wholesale client - except in relation to superannuation and general insurance products.
- Superannuation products would generally remain as retail only.
- Removal of the product value and individual wealth tests on the basis that wealth is not a proxy for financial literacy.
- Doubt as to the efficacy and practicality of the sophisticated investor test in its present form while recognising that it provides a structure for some form of wholesale client "licence" or "passport" which a person would need to qualify for.
- The lack of alignment between retail clients, consumers under the credit regime and investors that require disclosure documents under the securities offering provisions.
- The proper criteria for being a "large" or "small" business.
These changes would also flow through to the disclosure exemptions for securities offerings under section 708 of the Act.
The overall effect of these recommendations would be to reduce significantly the number of clients that would qualify for wholesale client status.
Interestingly, the ALRC does not consider the issue of whether a person should be required to consent to being classified as a wholesale client - or even whether they need to be informed of such status and its implications.
The final recommendations of the ALRC are likely to be highly influential of the Government's future approach to wholesale client status. We will provide further updates as they arise.
Practical measures to take in relation to wholesale clients
If you presently have a wholesale client model or are considering moving to one, we recommend that you:
- Obtain legal advice on whether and how wholesale client eligibility applies to your products and services. As the ALRC has pointed out, the legislative provisions are complicated, not easy to find and involve many exclusions and exceptions.
- Be careful in how you assess and evidence wholesale client eligibility and make sure that you implement controls to ensure that it is maintained (for example, accountant's certificates need to be renewed every 2 years).
- Carefully consider whether it is appropriate to treat individual investors as wholesale clients based purely on their level of wealth. Some assessment of a client's level of financial literacy would also appear to be prudent.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.