FINRA Reminds Brokerage Firms That Communications Regarding Nontraded Real Estate Investment Trusts Must Be Fair and Balanced

The Financial Industry Regulatory Authority Inc., has issued a Notice to Members, in which it reminds brokerage firms of their obligations to investors when communication about nontraded real estate investment trusts. FINRA Rule 2210 requires that a firm’s communications be fair, balanced and not misleading. According to the Notice, however “[r]ecent reviews by FINRA of communications with the public regarding real estate programs have revealed deficiencies.” Materials distributed by firms may contain misleading and inaccurate statements regarding the risks and benefits of illiquid real estate investments.

The Notice discusses what would be considered a balanced presentation of risks and benefits with respect to distribution rates, stability/volatility, redemption features and liquidity events, performance of prior related real estate events, use of indices and comparisons, pictures of specific properties, and capitalization rates.

Distributions, for example, are dividends paid by illiquid real estate investment to investors. Investors seeking growth and income have been attracted to nontraded REITs, because they begin paying distributions as soon as they are sold. Many investors, however, are unaware that the distributions being paid are simply a return of the investors’ principal. FINRA’s Notice provides that a firm’s communications regarding distributions are fair and balanced on where they “clearly and prominently disclose” the following:

• distribution payments are not guaranteed and may be modified at the program’s discretion;

• if the distribution rate consists of return of principal (including offering proceeds) or borrowings, a breakdown of the components of the distribution rate showing what portion of the quoted percentage represents cash flows from the program’s investments or operations, what portion represents return of principal and what portion represents borrowings;

• the time period during which the distributions have been funded from return of principal (including offering proceeds), borrowings or any sources other than cash flows from investment or operations;

• if the distributions include a return of principal, that by returning principal to investors, the program will have less money to invest, which may lower its overall return; and

• if the distributions include borrowed funds, that because borrowed funds were used to pay distributions, the distribution rate may not be sustainable.

Further, communications may not include an annualized distribution rate until the program has paid distributions that are, on an annualized basis, at a minimum equal to that rate for at least two consecutive full quarterly periods.

Unfortunately, FINRA’s Notice comes too late for many investors who invested in nontraded REITs in 2007 and 2008. In many cases, conservative, risk averse investors purchased shares of nontraded REITS for $10, and received distributions consisting of borrowed funds or return of principal without realizing the source of their distributions. Thereafter, many nontraded REITs halted all distributions, and investors saw share values plummet. In some cases, investors have lost not only their income stream, but also principal invested in the nontraded REIT.

FINRA’s Notice is the latest of regulators’ attempts to improve sales practices regarding REITs. For example, FINRA recently indicated that it would recommend to the Securities and Exchange Commission stricter rules for valuation of nontraded REITs. In addition, in February LPL Financial agreed to pay a $500,000 administrative fine to Massachusetts for failure to follow state guidelines and LPL’s internal guidelines regarding REIT sales.

Firms clearly downplayed the risks associated with nontraded REITs. Investors who have lost money in an illiquid real estate investment, such as Wells REIT II, Wells Timberland REIT, Inland Western Real Estate Investment Trust, Inland American Real Estate Trust, Cole REIT II, Cole Credit Property Trust II, Hines Real Estate Trust, Grubb & Ellis Apartment REIT, CNL Lifestyle Properties, Dividend Capital REIT, and KBS REIT I, can file FINRA arbitration claims against the brokerage firms who sold this high risk, unsuitable investment to them. Investors may be able to sue for damages, while keeping ownership of their illiquid investment.

Sonn Law Group specializes in representing investors (not brokerage firms) in securities arbitration and investor fraud cases throughout the country. Sonn Law Group has represented numerous investors in FINRA arbitration claims against the brokerage firms who sold illiquid, high commissioned, non traded investments, including TICs, REITS, promissory notes, and others, who have filed claims against NFP Securities, Inc., and Investors Capital Corp., among others. Sonn Law Group continues to investigate investment claims against other firms and financial advisors regarding illiquid investments, such as REITs.

To learn more, including whether you may have a claim for your illiquid real estate investment or other investment losses, please call us at 866 372 8311 or complete our “contact form.”