Sophisticated investor must be redefined

Author: | Published: 1 Oct 2012
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Regulators must rethink the definition of sophisticated investor. The major stock exchanges have become increasingly focused on protecting the minority and retail investor base post-crisis.

But lawyers on yesterday’s ‘Corporate governance standards: differences between stock exchanges and consequence for disclosure’ panel argued the financial crisis had proved sophisticated investors were equally capable of misunderstanding the risks of certain investments.

Wong Partnership’s Singapore partner and panel co-chair, Rachel Eng, said the time had come to reconsider how the term ‘sophisticated investor’ is applied.

Under the majority of regimes, a retiree who had invested all his savings into structured products would be considered a sophisticated investor but a 23-year old economics graduate with no practical investment experience would not. “The retiree has the money to invest, but possibly not the understanding,” said Eng, who is also co-chair of the IBA Capital Markets Forum.

An audience member agreed, but said the problem went much further than that. “Think of all the subprime-related structured products sold to the various banking institutions in the years pre-crisis,” he said. “They were as sophisticated as you can get and it’s since become known that they didn’t understand a word of what they invested in.”

Debevoise & Plimpton partner and panel co-chair, Kate Ashton, said there was tension in this area for governments and exchanges. “Why only let the big institutions make more money on these good investments?” she asked. “It’s not fair to prevent people from investing in something which could be very profitable.”

“Why prevent the young finance graduate who thinks he’s so brilliant from investing? If he's going to lose all his money then that’s a good learning experience,” added Ashton, who is also the IBA Capital Markets Forum website officer.

Gavin Nesbitt, from Deacons in Hong Kong, said the issue there was that every citizen considered themselves to be a sophisticated investor, until something went wrong at which point they instantly metamorphosed into a victim.

Perhaps as a result of this, the city’s Securities and Futures Commission (SFC) had adopted a slightly cautious approach to protecting retail investors, he said.

This prompted criticism in 2010 when the regulator allowed only sophisticated investors, or those willing to invest HKD1 million ($130,000), to subscribe to the Hong Kong listing of Rusal, a Russian aluminium firm, in a bid to protect retail and minority investors from various risk factors associated with the deal.

Hong Kong shareholder activist, David Webb, argued at the time the SFC had been wrong to assume the man on the street would not fully fathom what the real risks associated with the transaction. “The poor do not have a monopoly on ignorance,” he wrote in a 2009 commentary on the move.

Eng said in Singapore’s disclosure- based regime, there was also a feeling that minority investors could not take care of themselves. “The onus is therefore on potential ListCos to disclose as much as possible,” she said. “Even so, the regulator will still read through the possible risk factors during the prospectus process to make sure that these are made clear and disclosure is sufficient.”

But McCann Fitzgerald’s David Byers believed the regulatory focus on less sophisticated investors was changing. Recent European legislation, such as the Alternative Investment Management Directive (AIFMD) clearly recognised the need to protect everybody within the financial system, he said.

“The AIFMD targets those typically viewed as sophisticated investors, such as private equity firms,” he said. “The exchanges are also growing increasingly aware of the need to protect as many investors as possible,” he said.

For more of IFLR's coverage of the IBA Annnual Conference in Dublin:

Former World Bank chief economist Joseph Stiglitz on why austerity measures will not solve the global financial crisis

'How market rumours shape global M&A'