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Do “Sophisticated Investors” Have Less Legal Protection?

Jocelyn, 4thWay subscriber, wrote: “I'm having real problems understanding what the implications are of saying that I am a sophisticated rather than retail investor in the new appropriateness checks, and I wonder whether 4thway will be doing a short piece on this – I tried a brief search of your site and couldn't see anything.”

That's an excellent question from Jocelyn, who often writes to us with excellent questions. It leads to a long answer, but Jocelyn wanted something short. S I'll start with a summary of what I think she'll find are the most important points.

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What are the implications of self-certifying as a sophisticated investor?

P2P lending companies and IFISA providers have to explain the risks properly to everyone, regardless of the experience of the lender.

When a lender chooses to class themselves as “sophisticated”, P2P companies have to be able to show evidence that the lenders truly are that.

The type of information P2P companies are required to explain might vary a bit in theory. Businesses promoting financial investments have some leeway in what they write and how they write it, depending on the investors' level of understanding. Investors who are genuinely sophisticated and who also pass standard checklist criteria (such as showing a minimum level of experience) are said to have a greater understanding.

That said, in practice, most P2P lending companies and IFISA providers are allowed to sell to both sophisticated and ordinary lenders, so usually lenders all get the same level of information in the same words.

If you have a complaint about a P2P lending company, it seems likely that both a court and the powerful Financial Ombudsman Service would be more interested to know whether you really are a sophisticated P2P investor than whether you signed something saying that you are.

However, the biggest risk in any investment, including P2P lending, is simply that your investments don't perform as you hoped. Unless you have been mis-sold or there was some other specific issue of dodginess or negligence, you won't get compensation for any investment losses. This applies to both sophisticated and unsophisticated investors in P2P loans, as it does to all other types of investment.


Jocelyn's question is about how P2P lending platforms must ask ordinary lenders (retail investors) to temporarily limit their lending through P2P until they have some experience. Afterwards, lenders are allowed to voluntarily promote themselves to “self-certified sophisticated investors”. But you're not obliged to. So the question is about whether there are any consequences to lenders for doing so.

I asked three law firms that have specialists in financial regulation. None of them were confident enough of the specific situation in the P2P lending industry to publicly provide advice or it was simply against their policy to provide any public advice.

However, without specific regard to the P2P lending industry, one law firm called Wellers Law Group has published a more general note about self-certified sophisticated investors. This citation is echoed by many financial advisors too:

“Appropriate ‘risk warnings’ must still be included in all promotional material given to [all] potential investors. Whether this will prove to be sufficient protection for ‘self-certifiers’, or whether it will open the floodgates to the marketing of low-quality high-risk investments to them, remains to be seen.”

Another law firm had this to say:

“Once someone has been accepted, the protections for investors in regard to the promotion of securities by someone authorised under the Financial Services Act are removed. ‘Risk warnings’ must however still be included in all promotional material.” Nelsons Law.

Risks still have to be clearly explained

Those few words from both Wellers Law and Nelsons Law pack a lot of information that is worth expanding on properly.

The first takeaway is that P2P lending companies still need to sufficiently explain the risks to you, whether or not you self certify as sophisticated. The Financial Conduct Authority (FCA) has, as usual, been hammering this home to the P2P businesses, as it does to all companies that promote financial products.

In P2P lending, both self-certified sophisticated lenders and ordinary lenders take appropriateness tests that force lenders to demonstrate an understanding of the key risks.

These tests help educate lenders a little bit. They also help to cover the providers' backs somewhat too: the test results provide some evidence for the FCA that lenders understood the risks.

You're allowed to be sent more types of financial promotions

The second takeaway from the citations above is about what types of investments are allowed to be sold to investors.

In short, companies are allowed to sell more different types of investments to sophisticated lenders than they are to ordinary lenders.

That is actually the main point of the whole category of “sophisticated investor”. It's to stop more complicated or riskier kinds of investments from being too widely advertised and promoted.

But peer-to-peer lending is a unique case, because both ordinary and sophisticated lenders are allowed. And both categories buy exactly the same product. As Zopa says, if you certify yourself as sophisticated, “this doesn't mean that you will take on more risk than someone with less experience”.

The reason P2P has this unique position is quite simple. The FCA acknowledges that P2P lending is not generally one of those high-risk investments that shouldn't be sold widely. Yet it recognises that it's still a pretty new type of investment and relatively few people understand it at present.

So the FCA came up with an unusual compromise: P2P and P2P IFISA providers ask you to limit your lending to just 10% of your money across all your P2P lending accounts for a short time. You are easily able to self-certify afterwards, in order to lend more.

What knowledge are you expected to have?

The third and final scrap of information I can expand on from those two short citations is about what information you must be told.

All investors must always be told about the inherent risks of the investment.

But if a peer-to-peer lending platform contacts you in the belief you're sophisticated or could self certify as such, an investment provider might omit peripheral information.

I'll give you a specific example about IFISAs that I've taken from the FCA's main handbook to financial companies. It states that IFISA promotions sent to ordinary investors should tell investors about the tax consequences of withdrawing their money.

However, if the promotion is sent to a sophisticated investor, you might not be told about simple facts like that. If the financial company has kept evidence that you're genuinely sophisticated, it might argue you would already know this.

Again, though, P2P lending is an unusual case. Most P2P lending websites allow both ordinary lenders and sophisticated ones. The promotions that I have seen from them so far have been multi-purpose, serving all types of investor at once.

That's why the wording and depth of information needs to be suitable for ordinary lenders too. For this category of lender, the FCA says that the information needs to be “sufficient” and “presented in a way that is likely to be understood by the average [person]”.

The main point is the financial company must be able to show you understand the underlying risks. FCA guidance to any P2P business is that it must take “reasonable steps to satisfy itself that the investor does in fact have the requisite experience, knowledge or expertise to understand the risks…A retail client who meets the criteria for a self-certified sophisticated investor may be unable to properly understand and evaluate the risks.”

What protection do the courts offer sophisticated investors?

I lied, there is a fourth takeaway from those citations: the hint that things could go wrong for sophisticated investors when they invest – and that what happens next is not always clear.

Put another way, as a sophisticated lender, would you lose a claim against a P2P lending company in court simply because, as a self-declared sophisticated lender, “you should have known better?”

To seek the answer, consider how the courts work. The courts interpret the law. By doing so they also set legal precedent through so-called “case law”. That means that, once a court has made a ruling, other judges usually endeavour to follow the spirit of that ruling in future judgments.

One piece of case law contains a judgment where the judge obliges us with relevant comments. This is the case of Arrowhead Capital Finance Ltd (in Liquidation) v KPMG LLP.

In this court case, the claimant was a sophisticated investor. But it was a business, not a person. And the case was about a complicated VAT-scheme investment that went wrong.

Judge Stephen Males rejected Arrowhead's claim on the basis that it was a sophisticated investor and therefore knew what it was doing when it got into it.

Yet the judge's ruling makes clear why he considered the business to be a sophisticated investor. And that had nothing to do with its directors signing a form saying that they were so.

Instead, the judge considered the evidence and found that the investor truly understood what it was doing and therefore was in reality sophisticated, not just sophisticated on paper.

The fact that the judge went to such pains to consider and establish whether the claimant really was sophisticated is telling. It means that, if other judges follow suit, they won't assume that all your protections should disappear just because you've told the P2P lending website that you think you're sophisticated. The P2P lending companies will have to provide sufficient evidence that you are.

That evidence might include the result of the appropriateness test. But do remember that even ordinary lenders take that same test and they're still not classed as sophisticated.

Most tellingly, Judge Males noted that the ruling might have been different if the investor was a “consumer” who was being sold a different financial product, even if the investor was so-called sophisticated.

I think that all means that, if you've just lent for a short time in two different P2P loans or lending accounts, a judge is less likely to really believe you're deeply knowledgeable about what you're doing.

What does the Financial Ombudsman say about sophisticated investors?

It always pays to try going to the free Financial Ombudsman Service before going to court. It has the power to force financial companies to compensate you.

Using the ombudsman can have no negative consequences on you, i.e. it can't ask you to pay the financial company if it thinks you're in the wrong.

The financial business, on the other hand, is not able to overturn a decision from the ombudsman. It has no recourse but to accept the decision and pay out. Whereas, if you don't like the ombudsman's decision, you can still go to court if you want.

The ombudsman's decisions are not restricted to following the law. Its decisions are based on what it considers fair and reasonable under the circumstances. I know this from personal experience, having had a successful complaint about unnecessary delays in the sale of shares. (I also know it from a lot of research into the ombudsman's decisions in the noughties.)

Quite a lot of people who were sophisticated investors did poorly out of a now banned investment called UCIS, which was widely mis-sold. According to Money Marketing, 1,500 people had complained to the ombudsman between 2014 and September 2016. 61% of their complaints were upheld.

So being “sophisticated” on paper doesn't mean you lose your main protections. Indeed, a spokesperson for the ombudsman previously told the Money Observer that a sophisticated investor is someone who is “really, really experienced”.

That spokesperson won't then have had self-certified lenders in P2P in mind. But I think it might indicate the starting point of the ombudsman's thinking if you asked it to consider your case.

Here's a quote from an ombudsman case study of one of its decisions when a sophisticated investor was compensated:

“[A Financial Ombudsman] adjudicator noted that Mr C had also raised separate complaints about the sale of those previous investments saying he was not aware they were unregulated or high risk. I’m not determining those complaints here but the fact Mr C had invested in UCIS before does not necessarily mean he was fully aware of the risks or that those investments were suitable for him.

“I’m not satisfied that Mr C is truly a sophisticated investor. Mr C’s success in business does not qualify him as a sophisticated investor. And other than the declaration signed by Mr C, I have seen no evidence that he was a sophisticated investor.”

What if you don't state you're sophisticated but lend more than 10%?

A follow-up question would be: what are the consequences of going over the 10% restriction if you're an inexperienced (retail) lender or of declaring yourself as sophisticated when you don't pass the basic requirements?

You have a right to buy what you like, but the P2P lending companies can't sell as much as they want to whomever they like. It's an important distinction, because it means it's not a crime for you to buy too much, but its against regulations for them to sell too much.

However, if at some point you wanted to take the company to the ombudsman or to court, and you managed to let slip that you as an ordinary lender had lent over 10%, the result is untested. Would your compensation be limited as if you had just lent 10%, for example?

I can find no source to provide comfort. I would hope the ombudsman and the courts would come down on the small lender' side. But it's surely better for you to self-certify as sophisticated to cover your back! You can read the easiest way to self-certify as sophisticated here.

The best protection is yourself

Most losses that lenders face in P2P lending will be due to their loans not performing as well as they hoped. This is never going to be enough cause for you to get compensation by itself. It takes something else, such as mis-selling, before you have a chance in court or with the ombudsman.

If you lose money as a result of something that was explained to you clearly enough in the appropriateness tests, your case for compensation would become weaker. P2P platforms generally are doing a reasonable or great job in explaining the key potential risks.

The tests help you to understand some of the risks that might happen, but you should arm yourself further to better assess the scale of the risks with each specific lending account or provider. Risk warnings aside, you still need to look into whether they are good at what they do for yourself, to ensure you mostly lend in good loans.

Whether you're sophisticated or retail, complaining and winning doesn't mean you actually receive compensation. Perhaps the company has no money left to do so if it's been mis-selling to everyone.

I suggest that your best defence starts by following our 10 Principles Investing Principles and using our Anti-Fraud Checklist.

Further reading and sources used:

How To Easily Qualify As A Self-Certified Sophisticated Investor To Lend Freely Through Any P2P Lending Website.

How To Pass The P2P Lending Appropriateness Tests.

Who Can Invest In P2P Lending?

Financial Ombudsman Service and Mr C's complaint.

Wellers Law.

FCA Handbook and here.

Nelson's Law.

Arrowhead vs KPMG.

Money Observer.

Money Marketing.


FCA factsheet.

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