Category Archives: Non-traded REITs

LPL Financial LLC has been ordered by the Massachusetts Security Division to pay restitution of more than $2 million to investors who bought shares of non-traded real estate investment trusts (REITs).

In addition to the restitution order, Massachusetts regulators levied a $500,000 administrative fine against LPL. As reported Feb. 6 by Investment News, the settlement stems to allegations that LPL failed to supervise brokers who sold investments in non-traded REITs. LPL also agreed to review all other non-traded REITs offered to Massachusetts residents and to make restitution to investors in the state whose transactions violated Massachusetts or company rules.

LPL Financial and Ameriprise Financial are big players in the non-traded REIT world. They account for almost 20% of the industry’s annual sales of $10 billion. Recently, regulators have put non-traded REITs on their 2013 priority watch list, reviewing how the products are sold and whether advisers and broker/dealers may be misrepresenting the investments to clients.

In its consent order with Massachusetts regulators, LPL admitted to a series of statements of fact around the sales of the REITs. In doing so, however, the firm neither admitted nor denied allegations stemming from the training and oversight of sales of the products.

Every year, the Financial Industry Regulatory Authority (FINRA) takes note of key regulatory and examination issues that it plans to prioritize in the new year. In 2013, those priorities include a number of hot-button – and familiar – financial products, from structured investments, to non-traded REITs, to business development companies, or BDCs.

In a recent notice to investors, FINRA highlighted the following products and issues, along with an explanation as to why they merit top placement on FINRA’s 2013 watch list.

Structured Products: These products may be marketed to retail customers based on attractive initial yields and, in many cases, on the promise of some level of principal protection, according to FINRA. Moreover, structured products are often complex, and have cash-flow characteristics and risk-adjusted rates of return that are uncertain or hard to estimate. In addition, structured products generally do not have an active secondary market.

Suitability and Complex Products: FINRA’s recently revised suitability rule (FINRA Rule 2111) requires broker/dealers and associated persons to have a reasonable basis to believe a recommendation is suitable for a customer. FINRA says it is particularly concerned about firms’ and registered representatives’ understanding of complex or high-yield products, potential failures to adequately explain the risk-versus-return profile of certain products, as well as a disconnect between customer expectations and risk tolerances.

Business Development Companies (BDCs): BDCs are typically closed-end investment companies. Some BDCs primarily invest in the corporate debt and equity of private companies and may offer attractive yields generated through high credit risk exposures amplified through leverage. As with other high-yield investments – such as floating rate/leveraged loan funds, private REITs and limited partnerships – investors are exposed to significant market, credit and liquidity risks. In addition, fueled by the availability of low-cost financing, BDCs run the risk of over-leveraging their relatively illiquid portfolios, FINRA says.

Exchange-Traded Funds and Notes: In many instances, retail investors may not fully understand the differences among exchange-traded index products (i.e., funds, grantor trusts, commodity pools and notes) and the risks associated with these investments, particularly those that employ leverage to amplify returns. FINRA says it also is concerned about the proliferation of newly created index products that lack an established track record. Examples include products with valuations and performance tied to volatility, emerging markets and foreign currencies.

Non-Traded REITs: FINRA’s interest in non-traded REITs centers on the fact that many customers of non-traded REITs are unaware of the sales costs deducted from the offering price and the repayment of principal amounts as dividend payments in the early stages of a REIT program.

Private Placement Securities: Private placements will continue to be a key focus of FINRA’s investor protection efforts in 2013, with particular emphasis on sales and marketing efforts by broker/dealers. To improve its understanding of private placements, FINRA implemented Rule 5123, which requires member firms that sell an issuer’s securities in a private placement to individuals to file a copy of the offering document with FINRA.

FINRA also reminds member firms that the relative scarcity of independent financial information and the uncertainty surrounding the market- and credit-risk exposures associated with many private placements necessitates reasonable due diligence on prospective issuers. FINRA notes that due diligence should focus on the issuer’s creditworthiness, the validity and integrity of their business model, and the plausibility of expected rates of return as compared to industry benchmarks, particularly in light of the complex fee structures associated with many of these investments.

Independent broker/dealers continue to face a wave of legal and regulatory issues in 2013, with many expected to shutter their businesses.

As reported Jan. 20 by Investment News, the problems facing smaller B-Ds with 150 registered representatives or fewer include higher compliance costs, record low interest rates for money market accounts, competitive commission rates from large or discount broker-dealers and a tax increase that will cut available discretionary funds that investors can put to work in the stock market.

Small B-Ds make up the majority of firms registered with the Financial Industry Regulatory Authority (FINRA).  In the first 11 months of 2012, pressures on the industry reduced the number of FINRA-registered firms to 4,319 – down 97 firms from the prior year and a 14% decline since the end of 2007.

Regulatory and compliance issues are a key factor contributing to the reduction in smaller B-Ds. In a move to improve investor protections, the Securities and Exchange Commission (SEC) approved FINRA Rule 4524 in 2012, which mandated that broker/dealers file additional financial or operational schedules or reports as FINRA deemed necessary.

Many B-Ds to close up shop in the past few years have done so because of deals involving failed private placements, such as those connected to Provident Royalties LLC and Medical Capital Holdings LLC. The SEC charged both of those firms with fraud in July 2099, which in turn spurred a rash of investor lawsuits and arbitration claims. As a result, many broker/dealers were unable to contend with the litigation costs and subsequently shut down.

Non-traded real estate investment trusts (REITs) have traditionally been associated with independent broker/dealers – that is until last month when Merrill Lynch announced that its 17,000-plus registered reps would begin selling the Jones Lang LaSalle Income Property Trust to investors.

The move means Merrill Lynch becomes the first major wirehouse to sell a non-traded REIT. So far, the firm has raised about $50 million from interested clients.

Merrill Lynch’s foray into non-traded REIT territory is based on demand for an “attractive, direct core real estate investment product among mass-affluent investors,” said Keith Glenfield, head of alternative investments for Merrill Lynch, in a Jan. 2 article by Investment News.

“The primary investment objectives are designed to provide attractive current income, preserve and protect invested capital, achieve [net asset value] appreciation over time and enable stockholders to utilize real estate as a long-term portfolio diversifier,” Glenfield said.

Despite Merrill Lynch’s characterization of the Jones Lang Lasalle REIT as a safe source of income, investors may have plenty of reasons to be cautious. Non-traded REITs have been under the radar of state securities regulators for several years now, as have the sales practices of the broker/dealers that sell them.

Issues with non-traded REITs include their complex fee structure, high-risk factors, illiquidity and often inaccurate valuations. Moreover, early redemption of shares is typically extremely limited, and fees connected with their sale can be high and erode total return.

In 2012, the Financial Industry Regulatory Authority (FINRA) reissued an Investor Alert on nontraded REITs following an enforcement action against David Lerner & Associates. One of FINRA’s concerns with Lerner focused on the valuation irregularities that appeared on the monthly statements of investors who owned shares in Lerner’s Apple REITs. Specifically, shares of certain Apple REITs had been listed on the statements as $11 per share even after FINRA instructed broker/dealers in 2009 to adjust prices on the investments more frequently.

Non-traded real estate investments (REITs) have caused the undoing of several high-profile firms and broker/dealers in recent years, especially following the collapse of the commercial real estate market and the credit crisis of 2008. Now, one prominent non-traded REIT player – Wells Real Estate Funds – is at least temporarily saying goodbye to the non-traded-REIT industry.

As reported Jan. 15 by Investment News, Leo Wells announced his departure in a letter dated Jan. 11 to broker/dealer executives. In it, Wells said his firm would not register any new investment products at this time but may in the future. The firm will continue to serve existing clients in its line-up of real estate investment trusts and private real estate funds.

Wells attributes his pullback to a lack of clarity surrounding the regulation of REITs.

“As most of you are aware, [the Financial Industry Regulatory Authority] has been working toward producing new transparency guidelines for alternative investments, which they expect to become effective mid-2014,” Wells said in the letter. “As a result, I do not believe it is prudent to register a new product that may or may not meet the new regulatory requirements.”

According to Wells, the Wells Real Estate Investment Trust II is moving to become an independent company early this year and the Wells Core Office Income REIT will close to new investments in June. The Wells Timberland REIT also is looking toward “its appropriate exit strategy.”

The Investment News article says Wells Real Estate Funds does not intend to close its wholesaling broker/dealer, Wells Investment Securities Inc.

Last year, FINRA imposed a $300,000 fine against Wells Investment Securities over misleading marketing tied to Wells Timberland REIT. In reaching the settlement, Wells Investment Securities neither admitted nor denied the charges.

Wells Real Estate Funds is one of the biggest sponsors of investments in the non-traded REIT industry, with $11 billion in assets and 300,000 investors.  As the Investment News article points out, the man behind the company is known as an outspoken and colorful figure in the non-traded REIT world.  In October 2003, FINRA’s precursor, NASD, sanctioned Wells Investment Securities for improperly rewarding broker/dealer reps who sold the firm’s REITs. Among those rewards: High-end entertainment parties and lavish dinners that included one at a Civil War fort complete with costumed Civil War heroes, fireworks, fife and drum players, skydivers and a cannon re-enactment.

The regulator also censured Wells and suspended him from acting in a principal capacity for one year.

LPL Financial LLC is among five firms fined by the Financial Industry Regulatory Authority (FINRA) for failing to deliver mutual fund prospectuses.

As reported Jan. 2 by Investment News, LPL Financial LLC agreed to pay a $400,000 fine as part of the agreement; State Farm VP Management Corp., $155,000; Deutsche Bank Securities Inc., $125,000; Scottrade Inc., $50,000; and T. Rowe Price Investment Services Inc., $40,000.

In the settlement, FINRA stated that LPL relied on its brokers to deliver prospectuses, but had no procedures in place to determine if the documents were delivered late. Over FINRA’s review period of January 2009 through June 2011, LPL was required to deliver 3.4 million prospectuses.

According to the settlement, State Farm was responsible for delivering 154,129 prospectuses during that period, at first through its brokers and later through a service provider. In each case, however, the firm had inadequate supervision, FINRA said.

Scottrade failed to deliver prospectuses in about 14,000 transactions out of 300,000. Deutsche Bank Securities missed delivery in 3,800 cases out of nearly 71,000 trades, and T. Rowe Price had 2,500 failures in more than 68,000 transactions.

Last month, LPL Financial faced sales abuse charges tied to non-traded real estate investment trusts when Massachusetts Secretary of the Commonwealth William Galvin filed civil charges against the firm for failing to supervise LPL brokers who sold investments in seven non-traded REITs.

The non-traded real estate investment trust known as the Wells Timberland REIT recently lowered its stock valuation by 35% to $6.56 per share. When shares of the REIT were offered to the public in 2006, the price was $10 a share.

As reported Dec. 17 by Investment News, the company blames the REIT’s 35% drop in value on the economic downturn and continued problems in the housing industry.

Wells Timberland REIT is sponsored by Wells Real Estate Funds, one of the biggest players in the non-traded REIT industry. According to Wells’ corporate Web site, the company has invested more than $11 billion in real estate for more than 300,000 investors.

As noted in a letter sent to stockholders last week by Wells President Leo Wells III, the $6.56 estimate for common shares was based on information as of Sept. 30. However, investors in the Wells Timberland REIT might find it hard to actually get that price in the market based on the illiquid nature of non-traded REITs.

Last October, the trust suspended redemptions of shares until the new estimate of share values was completed. Beginning in January, shareholders should theoretically be able to redeem shares for 95% of the estimated value – or $6.23. The REIT, however, funds redemptions out of its “distribution reinvestment plan,” and because it has made no cash distributions, it also has not made any ordinary share redemptions, according to the Investment News article.

It’s more bad news for non-traded real estate investment trusts (REITs) and the broker/dealer firms that market and sell them to investors. Yesterday, Massachusetts securities regulators filed a complaint against LPL Financial, charging the B-D of failing to supervise registered reps who sold the non-traded REITs in violation of both state limitations and the company’s rules.

As reported Dec. 12 by Investment News, the charges stem from sales of $28 million of non-traded REITs to almost 600 Massachusetts clients from 2006 to 2009. Nearly all of the transactions in question violated state securities regulations or LPL’s own compliance practices, the Massachusetts Securities Division says.

Secretary of the Commonwealth William Galvin also charged LPL with dishonest and unethical business practices. He is seeking restitution to investors who bought the REITs, a fine and other sanctions, according to the complaint.

LPL reps sold $28 million in investments in non-traded REITs and collected about $1.8 million in fees as a result, Galvin’s office alleges.

“Non-traded REITs present risks to investors,” Galvin said in a statement. “Massachusetts recognizes those risks and requires limits on an investors’ exposure to the high fees, potential illiquidity, and risky nature of non-traded REIT products.”

REITs own and manage income-producing property or are involved in real estate financing.  Non-traded REITs are more difficult to get one’s money out of, and tend to carry high fees and commissions, Galvin said.

Of the REITs listed in the complaint, the largest amount of sales was for Inland American Real Estate Trust. Inland American is the biggest non-traded REIT in the industry, with more than $11 billion in real estate assets. Massachusetts investors put more than $20 million in Inland American, which currently is the focus of a probe by the Securities and Exchange Commission (SEC).

LPL calls Galvin’s claims “substantially overstated.”

Non-traded real estate investment trusts (REITs) are bringing more bad news for David Lerner Associates. Last week, the Financial Industry Regulatory Authority (FINRA) ordered the firm to pay $12 million in restitution to clients who bought shares of Apple REIT 10. In addition, FINRA fined Lerner more than $2.3 million for charging unfair prices on municipal bonds and collateralized mortgage obligations.

David Lerner, the firm’s chief executive, was fined $250,000 and suspended from the securities industry for one year. Following the ban, he faces a two-year suspension from acting as a firm’s principal. Lerner’s head trader, William Mason, was fined $200,000 by FINRA and suspended from the securities industry for six months.

“David Lerner and his firm targeted unsophisticated and elderly customers, grossly failing to comply with basic standards of suitability in selling Apple REIT 10 to thousands of customers,” said Brad Bennett, FINRA’s chief of enforcement, in a statement about Lerner.

More than regulatory problems, however, David Lerner Associates faces a slew of investor arbitration complaints from clients who bought certain REITs from the company.

Lerner was the sole distributor of Apple REITs. According to FINRA, Lerner solicited thousands of customers and, specifically, targeted unsophisticated investors and the elderly without performing adequate due diligence to determine whether the REITs were suitable investments.

To sell the Apple REIT 10, FINRA says that Lerner used misleading marketing tactics that promised 7% to 8% annual returns. What the firm reportedly did not disclose was that income from the REIT was insufficient to keep paying out distributions without taking on significant amounts of debt.

Between January and December 2011, Lerner allegedly recommended and sold more than $442 million of Apple REIT 10 to investors.

The Financial Industry Regulatory Authority (FINRA) is calling out David Lerner Associates in a big way over alleged unfair sales practices and excessive markups concerning a non-traded real estate investment trust (REIT) known as Apple REIT 10. On Monday, the regulator ordered Lerner to pay $12 million in restitution to clients who bought shares of the non-traded REIT.

David Lerner Associates was the sole distributor of the Apple REITs. According to FINRA, the company solicited thousands of customers and, specifically, targeted unsophisticated investors and the elderly. FINRA says that as Lerner sold the illiquid REIT, it failed to perform adequate due diligence to determine whether the product was suitable for investors.

FINRA noted that in order to sell the Apple REIT 10, David Lerner Associates used misleading marketing materials in which performance information for the closed Apple REITs had been presented without also disclosing that income from those REITs was insufficient to support the distributions to unit owners.

In addition to the $12 million in restitution to clients, FINRA fined David Lerner Associates more than $2.3 million for charging unfair prices on municipal bonds and collateralized mortgage obligations (CMOs) that the company sold over a 30-month period.

The firm’s founder and chief executive, David Lerner, was fined $250,000 and suspended from the securities industry for one year, followed by a two-year suspension from acting as a firm’s principal.  William Mason, the firm’s head trader, was ordered to pay $200,000 and suspended for six months.

“David Lerner and his firm targeted unsophisticated and elderly customers, grossly failing to comply with basic standards of suitability in selling Apple REIT 10 to thousands of customers,” said Brad Bennett, FINRA’s chief of enforcement.

In concluding the settlement, David Lerner Associates and Lerner neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.