Certification remains a legitimate tool

The FMA has been making noise about the wholesale sector for quite some time. Until now action was fairly limited with a few direction and stop orders here and there. And those were largely focused on fair dealing matters, including the recent Du Val and The One Management GP Limited orders.

Some will interpret the FMA’s guidance as a regulatory signal not to use eligible investor certificates. However, as a matter of law, eligible investor certificates remain a legitimate tool. So long as offerors have robust processes in place, there is no reason why they cannot continue to be used and relied on.

The review process

In late 2021, the FMA asked a number of investment companies for information relating to their offer processes and types of investors, including prospective investors who did not end up investing. Amongst the information requested were reasons investors used to support their ‘qualification’ as wholesale. And, in particular, why investors certified themselves as being ‘eligible investors’.

Rather than being a broad look at the wholesale investment sector there was a focus on property offers during the review. It is therefore best to consider the FMA’s findings through this narrow lens.

Key findings

Eligible v wholesale investors

A key point to note is that investment offers that are limited to wholesale investors do not require the offeror to be licensed, and do not need to be supported by a Product Disclosure Statement (‘PDS’). ‘Eligible investors’ are simply a subset of investors able to be classified as ‘wholesale’. This makes references to wholesale and eligible investors a bit redundant – all eligible investors are, by definition, wholesale investors. From the review findings, the problems identified by the FMA are limited to the eligible investor space.

Advertising

The FMA reiterates points from its previous advertising guidance, including the usual warning of not comparing unrelated financial products. A common misstep by property syndicators is to compare their projected returns with those of term deposits. The FMA has been pretty clear that offerors need to ensure marketing material is fair and accurate and, in particular, does not downplay the risks involved.

General concerns were raised by the FMA about the advertising channels used and the search terms applied. There’s some aversion to wholesale offerors use of social media channels to find investors. The FMA seems to prefer a direct approach, i.e. offers should be made to individuals who are already known to be interested rather than the broader ‘public’.

The FMA is also worried that investors searching online for ‘personal term deposit rates’ and the like were exposed to wholesale property investment advertisements. The FMA’s view is that targeting advertising in this manner might mislead investors.

Descriptions

The FMA raised concerns that promotional materials did not clearly show offers were limited to wholesale investors, suggesting such an omission equates to bait advertising.

In addition, according to the FMA, an offer advertised as being open to wholesale investors should not specify it is also open to the ‘eligible investor’ subset. The FMA believes the word ‘eligible’ implies some status other than wholesale or some availability to persons other than a wholesale investor. The guidance provided is to avoid using the term ‘eligible investor’ alongside the term ‘wholesale investor’.

Eligible investor certificates

Under the FMC Act, investors certifying themselves as ‘eligible’ (as opposed to meeting the more objectively determined wholesale investor criteria) must state the grounds for the certification. They must also set out why they have previous experience that allows them to assess the merits of the offer, their information needs, and the adequacy of the information provided.

The FMA found that some certificates were incomplete, vague as to experience, or relied on what the FMA regarded was irrelevant experience. The FMA contends that the stated experience must be relevant to the offer. And that offerors should at least ensure the grounds are relevant before deciding whether to accept the certificate. Otherwise, it will not meet legislative requirements.

This simple check does not require offerors to go further and actually verify the information provided. Rather, the certificate on its face needs to show some connection between the investor’s previous experience and the transaction to which the certificate relates.

The real problem here, according to the FMA, is that offerors are providing ‘tick box’ templates (i.e. providing prospective investors with a pre-determined list of various investments and experience to tick) that attempt to ensure investors can self-certify as eligible where no real grounds exist for them to do so.

Confirmation of certifications

The extra wrinkle in the eligible investor certification process is that certificates must be confirmed by a financial adviser, accountant, or lawyer. A certificate can only be confirmed if the adviser, accountant, or lawyer is satisfied the investor has been sufficiently advised of the consequences of the certification. They must also be satisfied there is no reason to believe that the certification is incorrect or that further information or investigation is required as to whether or not the certification is correct.

In the FMA’s view this also requires the adviser, accountant, or lawyer to assess the adequacy and relevance of the grounds relied upon rather than just form a belief as to whether the certification is factually correct or not.

Our take

How do you advertise to potential investors?

As Gault J mentioned in the Du Val case “it may not be feasible to advertise in a way that targets only wholesale investors.” So, putting aside the FMA’s preference for ‘shoulder tap’ approaches for wholesale opportunities, those offerors who wish to use social media and other mainstream marketing channels will, at the very least, need to make a prominent statement that the offer is ‘limited to wholesale investors and not suitable for retail investors’.

Are they really ‘eligible’?

The FMA recommends that a check (without requiring verification) be undertaken of the relevance and adequacy of the grounds provided for eligible investor certification. This means offerors must ensure that the grounds stated are actually relevant to the transaction.

The law is clear that offerors cannot rely on certificates where they know an investor did not in fact have any previous experience that is useful to assess the transaction. The FMA has gone one step further in expressing the view that this includes where the experience stated is not relevant to the offer in question or is otherwise inadequate on its face.

We largely agree. If the stated experience relied upon to support an eligible investor certificate is not relevant to the offer and underlying investment or is manifestly inadequate, the certificate effectively tells the offeror that the investor does not actually possess the requisite level of experience. Examples where investors have used the sale of a farm or rental properties, or past involvement in buying and selling properties, are not going to be relevant to most wholesale investments. They should not be relied upon as an appropriate basis for accepting the investor as an eligible investor.

We strongly recommend offerors relying on eligible investor certificates review, and if necessary, tidy up their templated processes. This includes providing more free-form space for investors to fill out their relevant investing experience, and proactively assessing whether or not that experience satisfies the requisite requirements.

Refining the tick box approach

Although the FMA has frowned upon taking a ‘tick box’ approach we still see merit in offerors using a more tailored list approach; one that is correctly scoped to match the offer. This way offerors can provide a short list of investment experience that is of specific relevance to their particular offer as a prompt for the sake of efficiency. A free form section can also be included that requires investors to elaborate on the relevant investment experience category selected.

Short ‘tick box’ lists can therefore act as an initial gate for the eligibility test. If a potential investor cannot select an option or two from the list provided, then they will not be eligible. Simple as that.

What about individual ineligible investors?

One piece missing from the findings is the lack of any stance being taken by the FMA regarding those individuals who have falsely claimed to be eligible. The FMC regime is quite clear: It is an offence to give a certificate knowing that it is false or misleading in a material particular. The offence has a penalty of a fine not exceeding NZ$50,000. This wording is set out in the prescribed warning statement that investors must receive. Individuals who have given incorrect certificates are also guilty of an offence, yet from what has been reported by the FMA, it seems no action is being taken against them. Perhaps we shouldn’t be surprised – the apparent lack of individual accountability for investors is a recurring theme.

A warning shot

Using the FMA Act to issue warnings rather than utilising specific regulatory or enforcement tools under the FMC Act is a curious approach by the FMA. As the warnings state, the offerors “failed to give disclosures to investors as required by Part 3.” That is a serious contention. Without knowing the factual background to each warning, it is difficult to discern why this approach has been taken, as opposed to moving straight to more invasive enforcement action.

A right to withdraw?

If Part 3 disclosure was required, then presumably some investors have a right to withdraw and be repaid. Timing might be tight as the FMC Act requires the repayment right to be exercised within the earlier of 6 months from the investor knowing, or ought reasonably to have known, that they were not provided a PDS or 12 months after the financial products were issued or transferred. In any event, investors that were ineligible and felt they were forced into investing may wish to consider their rights to withdraw on the basis they did not receive a PDS for the investment offer.

And what about those confirming certificates?

There were what looked to be some fairly ‘easy wins’ for the FMA in criticising the adequacy of some eligible investor confirmation practices. Providing confirmations where no grounds were stated in the certificate is just plain wrong, as is confirming your own certificate.

As part of the confirmation process financial advisers, accountants, and lawyers must consider the investor’s grounds for certification. If the grounds are not sufficient then advisers, accountants, and lawyers should not confirm the certification. This requires a judgement call to be made. Certifications and confirmations remain open to second guessing by the FMA if challenged – or by investors with the benefit of hindsight if the investment goes badly.

The FMA only provides brief comments as to the circumstances when a certificate can be confirmed or otherwise, so the guidance provided for grey areas is limited. Advisers, accountants, and lawyers should therefore exercise caution in this space. As with most exceptions to regulatory requirements, the circumstances in which an eligible investor certificate can be relied upon to relieve an offeror from the full disclosure and other regulatory obligations should be narrowly construed as “if in doubt, don’t confirm”.

Concluding thoughts

The report is certainly a shot across the bows of those taking the eligible investor mechanism too far. It is perhaps a prompt to consider the use of other, more objectively determined, wholesale investor status criteria.

The requirements for being an investment business, ‘large’, or satisfying investment activity rules are objectively defined and unequivocal. The added benefit is that offerors can rely upon a safe harbour certificate from the investor to provide absolute assurance as to status, without needing a third party confirmation. The FMA’s focus on eligible investor processes in the report indicates that the wholesale safe harbour categories are not seen as a problem at this stage.

Overall, the FMA has issued a clear warning to take care in the wholesale offer space: the wholesale offer regime does not place those purporting to operate within it outside the reach of the law.

Start a conversation

If you would like to discuss wholesale offers please contact Catriona Grover on +64 4 498 0816, David Ireland on +64 4 498 0840, or Mark Schroder on +64 9 375 1120 or email the team at bankingandfinancialmarkets.nz@dentons.com.