Anyone contemplating an investment in a private or unlisted Real Estate Investment Trust, or REIT, should consider the motivations of the broker and brokerage firm hawking it.
Unlisted REITs are investments that aren’t traded on the New York Stock Exchange or Nasdaq market. As such, they can be difficult for investors to sell and difficult for investors to value. To overcome marketplace concerns, the managers and operators of private REITs have offered brokers and brokerage firms high commissions to sell these products to retail investors.
At this point in history, most brokerage firms and brokers have seen revenues drop significantly from just a few years ago. Looking to fill the void, brokers and brokerage firms have turned to selling high-commission products such as unlisted REITs to maintain their incomes. High commissions paid by unlisted REITs serve as a powerful motivator for brokers and brokerage firms to sell these products.
This creates a significant conflict of interest: Brokers and brokerage firms may shy away from objectively recommending products and strategies that are more appropriate and suitable — but less lucrative than high-commission unlisted REITs for the broker and brokerage firm to sell.
This strong commission-based motivation to sell unlisted REITs has not gone unnoticed by regulators. In March 2009, the Financial Industry Regulatory Authority (FINRA), began questioning multiple brokerage firms about their sales and promotion practices related to private or non-traded REITs.
Some unlisted REITS are registered with the Securities and Exchange Commission (SEC) and some are sold using an exemption to registration. FINRA is questioning what investors were led to believe by the brokerage firms and brokers who sold them these private REITs.
Among FINRA’s questions to brokerage firms selling unlisted REITs: Which REITs did the firm promote? How many shares were sold? How many customers of the firms were sold these products? What were the ages of the customers who bought these products? How much were brokers to sell these unlisted REITs? What documentation was obtained from the customer in connection with these sales? What compliance and supervision procedures were employed to monitor these sales to customers in terms of risks and activity in general?
As a precursor to questioning brokerage firms, FINRA issued a regulatory notice (09-09) in February 2009 regarding additional concerns about post-sale representations surrounding private and unlisted REITs. In the regulatory notice, FINRA reminded brokers and brokerage firms of some of their obligations to investors: Specifically, once unlisted REIT customers have owned their investment for a while, their monthly statements should begin to contain a reasonably current estimated per share value of the unlisted REIT investment.
Specifically, brokers and brokerage firms are prohibited from using a per share estimated value that’s based on data that’s more than 18 months old compared to the customer’s account statement date. According to FINRA, “ … firms must not use par value in a customer account statement more than 18 months following the conclusion of an offering, unless an appraisal of the program’s assets and operations yields the same value.”
The staleness of data used to value these unlisted REITs is particularly important due to the illiquid nature of these investments.
In the current economic environment, the NASD Rule allowing an 18-month window is inadequate: With data that old, how can a broker or broker-dealer actually carry out their duties and obligations to the customer? Additionally, even prompt data reporting without an 18-month lag time is suspect without a transparent and liquid market for trading the unlisted REIT shares.
Vernon Healy is currently investigating claims on behalf of investors surrounding misrepresentations about the safety and liquidity of unlisted REITs and the suitability of marketing of these products to certain investors, including older, risk-averse investors. For more information, contact Vernon Healy by phone at 239-649-5390 or by e-mail at info@vernonhealy.com.
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