Non-traded REITs Land in FINRA’s Cross Hairs
Today’s economic climate, while improving over that of recent years,
continues to yield returns that are lower than what many investors need
or want. Unfortunately, this has caused a significant number of investors
to consider alternative investments – like risky non-traded real
estate investment trusts (REITs) – that they likely would never
Even more unfortunate, however, is the eagerness of broker-dealer firms
to satisfy investors’ demands for higher yields by selling complicated
products without first discussing or even understanding the products’
This has, as we’ve seen from a variety of non-traded REIT complaints
and securities arbitration cases like those involving the
Apple Non-traded REITs sold by David Lerner Associates, led to a significant loss of principal
for many investors – losses that are attracting the Financial Industry
Regulatory Authority’s attention.
speech given late last month, Susan Axelrod, executive vice president of member
regulation sales practices at FINRA, discussed the dangers of non-traded
REITs and acknowledged that the organization “has a number of open
investigations” related to the sale of the products.
“In several instances, FINRA examiners have found that firms selling
these products failed to conduct reasonable diligence before selling a
product and failed to make a determination that the product was suitable
for investors,” said Axelrod in the speech. “FINRA examiners
[also] have noted that—in the instances of REITs that have experienced
financial difficulties—red flags existed and should have been considered
by firms prior to the product being offered to firm clients.”
According to Axelrod, to avoid enforcement actions and litigation, broker-dealers
who sell non-traded REITs must make sure they conduct their due diligence,
train their brokers to understand the products, and ensure they are suitable
for their clients for recommending them.
Firms and brokers also should make sure they fully understand – and
advise their clients of – three of the products’ biggest limitations:
Lack of liquidity.
“There is a very limited or no secondary market for shares. Thus,
investors in these products have very few alternatives should they decide
they need to liquidate their positions,” she said. In short, “Non-traded
REITs are rarely suitable for investors with short time horizons.”
Problems with valuation.
“REIT offerings normally last several years, and during the offering
period, broker-dealers selling them reflect an estimated per-share price
on customer statements—typically the public offering price. This
is sometimes the case for years after the customer's initial purchase.
Unfortunately, we have recently seen several high-profile instances of
REITs re-pricing their per-share estimated values at substantially less
than the offering price—with little or no advance notice to investors.”
“Non-traded REITs may also borrow funds to make distributions if
operating cash flow is insufficient. And excessive borrowing may increase
the risk of default or devaluation. In addition, non-traded REIT distributions
may actually be a return of principal. For these reasons, brokers must
use caution when discussing distributions with investors, particularly
when making comparisons to other dividend-paying investments.”
Based on Ms. Axelrod’s remarks, it seems likely that we’ll
see a number of new enforcement actions filed in the coming months against
broker-dealers for actions related to the sale and recommendation of non-traded
REITs. These claims will likely involve
misrepresentations, lack of due diligence, and
unsuitable recommendations. Investor claims based on such misconduct likely will
rise as well.
For more information about non-traded REITs and to find out why they’re
generally considered too risky for the average investor, click
here. If you believe you have suffered losses in a non-traded REIT due to a
broker’s misconduct, contact us to discuss your case or complete
the online form on the top of this page and we will respond promptly.