The Singapore Law Gazette

The Accredited Investor Scheme – Penetrating the Fog of War

The Accredited Investor scheme in Singapore has come under scrutiny in recent months following highly publicised payment defaults by several prominent bond issuers. This article examines legislative changes to the Accredited Investor scheme, the consequences that arise from being an Accredited Investor, and the protections available to a retail investor.

A. BACKGROUND: THE ACCREDITED INVESTOR SCHEME

Introduction

1. 2016 saw the default of two prominent bond issuers: Swiber Holdings Ltd and Pacific Andes Resources Development Ltd, to the dismay of Accredited Investors (“AIs”) who had invested sizeable sums in buying bonds issued by the aforementioned two parties.¹Wong Wei Han “Choppy bond market raises questions” The Straits Times, 22 August 2016 The Accredited Investor scheme attracted significant attention as some of the AIs attributed their misfortune to the scheme.²Chanyaporn Chanjaroe “How Singapore’s Not-Really-Rich Investors Have Been Burned By Swiber Bonds” Bloomberg 20 September 2016 In the words of an affected investor, one may not “understand the full consequence of being an accredited investor” as it could be “a grey area”.³Ibid

The Accredited Investor Scheme in Singapore

2. Individual AIs, which this article concerns itself with, are typically individuals with a higher capacity for investment exposure as compared to the typical retail investor. The AI status opens doors for the investor to invest in a greater variety of financial products (possibly more complex with varying degrees of risk) which are not offered to the typical retail investor. The Swiber bonds, for example were offered to AIs on the “wholesale” market.⁴Goh Eng Yeow “Bond market: A Lehman moment?” The Straits Times, 26 September 2016

3. Recent amendments to the Securities and Futures Act⁵Securities and Futures Act (Cap 289, 2006 Rev Ed). The amendments had not yet come into force at the time of writing. (“SFA”) and proposed amendments to the Securities and Futures (Prescribed Specific Classes of Investors) Regulations 2005⁶Securities and Futures (Prescribed Specific Classes of Investors) Regulations 2005 will refine the qualifying criteria for individual AIs such that it will include the following persons:
   1. Individuals whose net personal assets exceed SGD 2,000,000 or its equivalent in foreign currency or such other amount as the Monetary Authority of Singapore (“MAS”) may prescribe, the value of their primary residence not accounting for more than SGD 1,000,000 of net personal assets, such value calculated by deducting any outstanding amount on any credit facility secured from the residence from the estimated fair market value of the residence;⁷Securities and Futures Act (Cap 289, 2006 Rev Ed) s 4A(1)(a)(i)(A) read with Securities and Futures (Amendment) Bill 2006 (Bill 35 of 2016) Cl 6
   2. Individuals whose income in the preceding 12 months is not less than SGD 300,000 or such other amount as MAS may prescribe in place of the first amount;⁸Securities and Futures (Amendment) Bill 2006 (Bill 35 of 2016) Cl 6
   3. Individuals whose financial assets as legislatively defined net of related liabilities exceed SGD 1,000,000 or its equivalent in foreign currency or such other amount as MAS may prescribe in place of the first amount;⁹Securities and Futures (Amendment) Bill 2006 (Bill 35 of 2016) Cl 6

4. Importantly, proposed amendments to the Securities and Futures (Prescribed Specific Classes of Investors) Regulations 2005 will ensure that individuals who prima facie qualify for AI status will have the option to “opt-in” or “opt-out” of the scheme depending on whether they are already existing AIs.¹⁰Draft Legislative Amendments To The Securities and Futures (Prescribed Classes of Investors) Regulations 2005 – Amendments To Definitions of “Accredited Investor”. “Institutional Investor” and “Expert Investor” s 2A This allows AIs to come under the regulatory safeguards offered to non-AI retail investors, to which we now turn.

B. REGULATORY SAFEGUARDS FOR NON-AI RETAIL INVESTORS

Mandatory Licensing Requirement

5. The Financial Advisers’ Act¹¹Financial Advisers Act (Cap 110, 2007 Rev Ed) (‘FAA’) (“FAA”) imposes a requirement for all financial advisers to be licensed unless they are exempted by specific provisions.¹²Financial Advisers Act (Cap 110, 2007 Rev Ed) s 6(1). The regulatory safeguards discussed in this paper are neither exhaustive nor representative of all the protections offered under the SFA. This licensing function ensures (inter alia) that: (1) the financial adviser is financially sound and has the proper indemnity insurance policies to serve as asset cover;¹³Financial Advisers Act (Cap 110, 2007 Rev Ed) ss 9(1)(b), 9(1)(c) and 10 read with Financial Advisers Regulations (2004 Rev Ed) paras 15 – 18 (2) the employees and officers of the financial adviser have the necessary ethical and educational qualifications to function as financial advisers, being fit and proper persons for their roles;¹⁴Financial Advisers Act (Cap 110, 2007 Rev Ed) ss 9(1)(i) – 9(1)(n) read with Financial Advisers Regulations (2004 Rev Ed) paras 10 – 13 and (3) the financial adviser adheres to all lawful orders and regulations governing its operations and puts in place strong internal compliance functions as well as effective controls to mitigate potential conflicts of interests that may arise from the performance of its day-to-day duties.¹⁵Financial Advisers Regulations (2004 Rev Ed) S462/2002 para 14(1)

6. AIs derived limited protection from the mandatory licensing requirements due to the availability of exemptions related to the advisory of AIs. For example, a resident in Singapore who acts as a financial adviser to not more than 30 AIs on any occasion by giving advice directly or “through publications or writings or by issuing or promulgating research analyses or research reports, concerning any investment product (other than life policies)”¹⁶Financial Advisers Regulations (2004 Rev Ed) S462/2002 para 27(1)(d) is exempt from the licensing requirements. An exemption also exists in respect of giving advice or analysis on bonds to an AI.¹⁷Financial Advisers Regulations (2004 Rev Ed) S462/2002 para 28(1)(b)

Corporate Accountability, Key Product Information, and Product Disclosure

7. In keeping with a disclosure-based capital market regime in Singapore, the SFA generally requires that an offer of securities should be accompanied by a prospectus in compliance with prescribed requirements to be lodged with MAS,¹⁸Securities and Futures Act (Cap 289, 2006 Rev Ed) Pt XIII Div 1 ss 240-271 unless the offer is specifically exempted under the SFA. The prospectus is expected to contain the highest standards of accuracy and should contain all information that investors will “reasonably require to make an informed assessment” of the security as an investment product including the financial position and performance of the issuer.¹⁹Securities and Futures Act (Cap 289, 2006 Rev Ed) s 243 The requirement that such prospectus should be signed by the director or equivalent person of the issuer or by the person making the offer (in a case where the offeror is not the issuer) reflects the standard of accountability that key officers of the issuer or offeror must maintain in committing to a fair and transparent capital market for investors.²⁰Securities and Futures Act (Cap 289, 2006 Rev Ed) s 240(4A)

8. The FAA and Financial Advisers Regulations (“FAR”) also work in tandem with the SFA to impose several obligations on the licensed financial adviser, its representatives and supervisors for the benefit of non-AI investors. s 25 of the FAA embodies a ‘product-disclosure’ obligation on the licensed financial adviser mandating disclosure to clients and prospective clients all material information relating to any designated investment product it recommends including: (1) the terms and conditions of the designated investment product;²¹Financial Advisers Act (Cap 110, 2007 Rev Ed) s 25(1)(a) (2) benefits and risks, or likely benefits and risks arising from the product;²²Financial Advisers Act (Cap 110, 2007 Rev Ed) s 25(1)(b) and (3) premiums, costs, expenses, fees or other charges that may be imposed in respect of the product.²³Financial Advisers Act (Cap 110, 2007 Rev Ed) s 25(1)(c) This obligation is fleshed out in greater detail by MAS’s Notice on Information to Clients and Product Information Disclosure which further clarifies that clients are to be furnished with information such as the nature and objective of the product, the level and duration of financial commitment required of the client, and details of the product provider.²⁴MAS ‘Notice on Information to Clients and Product Information Disclosure; No FAA-N03 para 24 dated 1 October 2002

9. s 27 of the FAA also imposes an obligation on the licensed financial adviser to have a ‘reasonable basis’ for making investment product recommendations to persons who may reasonably be expected to rely on such recommendation.²⁵Financial Advisers Act (Cap 110, 2007 Rev Ed) s 27 This essentially requires that the licensed financial adviser should conduct ‘Know-Your-Client’ (“KYC”) exercises designed to understand the investor’s investment objectives, financial situation and particular needs.²⁶Financial Advisers Act (Cap 110, 2007 Rev Ed) s 27(2) The due diligence effort is buttressed by corresponding provisions in the FAR which require the financial adviser to carry out a due diligence exercise to ascertain whether new products are suitable for targeted clients²⁷Financial Advisers Regulations (2004 Rev Ed) S462/2002 para 18B in accordance with the evaluative criteria specified in paragraph 18B(2).²⁸Financial Advisers Regulations (2004 Rev Ed) S462/2002 para 18B(2) Similar language contained within the MAS Guidelines on ‘Fair Dealing – Board and Senior Management Responsibilities for Delivering Fair Dealing Outcomes to Customers’ reinforce the point that pre-rollout product suitability and investor-specific concerns should be manifestly addressed.²⁹MAS Guidelines No FAA-G11 dated 3 April 2009 (“Fair Dealing Guidelines”)

10. Licensed financial advisers are exempt from the requirements of ss 25 and 27 of the FAA in respect of advising or recommending products to AIs.³⁰Financial Advisers Regulations (2004 Rev Ed) S462/2002 paras 33(1)(a) and 34(1)(a) Even so, it is necessary for the licensed financial adviser to disclose to such AIs concerned that it is under such exemption.³¹Financial Advisers Regulations (2004 Rev Ed) S462/2002 paras 33(2) and 34(2) This basic disclosure requirement helps the AI appreciate the contrast between the duties owed to a non-AI retail investor and himself, and provides a basis for further investigation into product viability vis-à-vis the investor’s risk appetite, financial health and investment horizon. While the Fair Dealing Guidelines promulgate best practices for the financial services industry in general,³²Supra n 28 the AI should note the lack of regulatory bite in the form of penalties for non-compliance.³³In contrast, penalty provisions for non-compliance with ss 25 and 27 of the FAA exist in the form of ss 25(5) and ss 27(3) respectively Optimists will argue that market competition inevitably levels the playing field for AIs as financial services providers compete to attract AIs by offering higher standards of service and transparency above and beyond the regulatory baseline, given that AIs logically gravitate towards service providers with a higher commitment to investor protection. Realists will nonetheless mark the possible presence of information lag, infrastructure or operational stress, and various other market factors which may impede the development of ideal market practice.

Mandatory Internal Controls: Balanced Scorecard Framework and Internal Sales Audit Unit

11. The FAA also offers non-AI Investors an additional layer of protection in the form of mandatory internal controls that the licensed financial adviser must institutionalise. For instance, licensed financial advisers are to establish and adhere to a remuneration system modelled after Balanced Scorecard Framework (“BSF”).³⁴See Financial Advisers Act (Cap 110, 2007 Rev Ed) ss 22A and 38. See also the Financial Advisers (Remuneration) Regulations S816/2015 and MAS ‘Notice On Requirements For The Requirements For The Remuneration Framework for Representatives and Supervisors (“Balanced Scorecard Framework”) and Independent Sales Audit Unit’ FAA-N20 dated 31 December 2015 The BSF integrates a mix of financial and non-financial measures for assessing performance and reward across business operations, combines them and establishes their legitimacy and effectiveness in setting compensation.³⁵Paul Willman, Understanding Management – The Social Science Foundations (Oxford University Press, 1st Ed, 2014) at p 136 The remuneration system aims to

…align the interests of FA representatives and supervisors with that of their customers and minimise conflicts with customers’ interests that are inherent in volume-based remuneration³⁶MAS Consultation Paper 022-2014 para 26

12. s 38 of the FAA also requires non-exempted licensed financial advisers to establish an independent sales audit unit (“ISA Unit”) to be staffed by individuals with the necessary qualifications prescribed by the FAA and MAS.³⁷MAS ‘Notice On Requirements For The Requirements For The Remuneration Framework for Representatives and Supervisors (“Balanced Scorecard Framework”) and Independent Sales Audit Unit’ No FAA-N20 dated 31 December 2015 The ISA Unit conducts reviews every calendar quarter comprising document checks, mystery shopping exercises and client feedback checkpoints for infractions committed by representatives of the licensed financial adviser.³⁸Supra n 37 at para 3.2.2 These infractions include: (1) recommending unsuitable investment products for clients with little regard to the fact find process; (2) recommending switching to investment products for the representative’s benefit; (3) failure to provide product-related information which would have had a material impact on the client’s decision to purchase the product; (4) failure to execute the client’s instructions without valid cause resulting in material losses; and (5) acts of gross negligence or serious misconduct.³⁹Supra n 37 at para 4.5

13. The internal controls mentioned in the preceding paragraphs will be of obvious interest and attraction to retail investors. They promote investment service fidelity and assure that the financial adviser has a strong internal mandate to put customers’ interests at the fore. Such internal controls are important in the aspiration towards the fair dealing outcomes envisioned by the MAS. Even so, licensed financial advisers are exempted from these requirements in respect of AIs.⁴⁰Financial Advisers Regulations (2004 Rev Ed) S462/2002 para 34A(1)(d)(i). Exemptions also exist for other categories of dealings as stipulated by para 34A such as for the provision of only factual service and where no recommendation or advice is provided by the financial adviser or its representatives. From one perspective, the exemptions for specific categories reduce transaction costs, resulting in savings which can ultimately be passed on to the AIs – the BSF and ISA framework have been described as “resource-intensive” in terms of setting up and operational requirements.⁴¹Lorna Tan “Financial sales reps face audits from next year” The Straits Times, 15 December 2015 Reducing turnaround time for processing transactions in respect of the specified exempted categories also accelerates investor-based financing and supports the growth of larger capital markets. It is then for the AI to carefully appraise his risk appetite and financial objectives in determining whether the exemption from such protective provisions are balanced by the benefits to be derived under the AI scheme.

C. CONSIDERING INVESTOR RE-CLASSIFICATION AND REVIEW

Investor Re-classification and Monitoring

14. An individual’s net worth and financial health typically varies over the course of his investment time-span. There may be certain retail investors who, having previously met the requirements for the AI scheme and opted into it, subsequently fall short of the quantitative requirements in terms of wealth and financial assets. Is there then a duty to carry out a re-assessment of such investors’ eligibility and on whom does this duty lie?

15. The current provisions of the SFA are silent as to a re-classification situation. Nonetheless, one may appreciate the implications that may follow if an investor continues to be exposed to financial products and risks that he should not be privy to under eligibility requirements. When investments take a turn for the worse, it is not difficult to imagine that some investors may second-guess their existing level of categorisation and challenge the validity of the financial adviser’s classification as well as the validity of investment decisions made whilst under that classification.

16. In 2015, MAS responded to queries on whether “a client’s opt-in to AI status must be reviewed every two years and if clients would be required to provide a new written “opt-in” confirmation during the periodic review”.⁴²MAS Response To Feedback Received – Proposals to Enhance Regulatory Safeguards for Investors in the Capital Markets para 6.41 The response was unequivocal – financial institutions are expected to monitor if an investor continues to meet AI thresholds.⁴³MAS Response To Feedback Received – Proposals to Enhance Regulatory Safeguards for Investors in the Capital Markets para 6.42 MAS further suggested that the review of such status could be worked into existing processes in place for periodic account reviews under the MAS Notice on Prevention of Money Laundering and Countering the Financing of Terrorism,⁴⁴MAS ‘Prevention of Money Laundering And Countering The Financing Of Terrorism – Financial Advisers’ FAA-N06 dated 24 April 2015 and that financial institutions should “minimally remind clients of their AI status and their right to opt-out of such status at any time”.⁴⁵Supra n 41.

17. It seems that whilst the onus remains on the investor to assess his own suitability for the scheme in light of his financial objectives and circumstances, there should be a complementary effort by financial institutions to monitor the status of AI investors and provide necessary reminders of their options at periodic intervals. As a matter of good practice, financial institutions should not be too quick to assume that all AIs possess by default the necessary experience and knowledge to understand the implications of the scheme.

D. CONCLUSION

18. The amendments to the AI scheme will be welcomed by AIs who desire a higher level of regulatory clarity and oversight. Grappling with the concept of the ‘sophisticated’ investor always raises difficult questions of categorisation and appropriate bounds of protection. While the present changes represent a right step towards fair and responsible financial markets, all investors should take the reins of their investment choices and remain accountable for their own choices. In this respect, knowledge represents the best armour against unwise investment decisions with long-lasting consequences.