FINRA Plan May Dramatically Change The Way Brokerage Firms Report On Nontraded REITS & Other Illiquid Investments on Client Statements

The Financial Industry Regulatory Authority’s board of governors has a plan that could radically modify the way brokerage firms report illiquid investments’ value on the account statements of clients. The SRO, which wants to give investors more transparency in regards to the actual value of such investments, has been trying to modify its rules about REITs and private placement valuations on client statements for well over a year.

Earlier this month, in changes it is proposing to Rule 2340, the FINRA board presented two reporting alternatives for brokerage firms. With the first option, a brokerage firm wouldn’t need to have the per-share estimated value of an REIT or a private placement that is unlisted included in customers’ account statements. The second choice lets a brokerage firm chose from three options:

• A valuation done by an external service at least one time every three years.
• A valuation performed by a service that performs valuations according the methodology revealed in the prospectus.
• For a couple of years after the initial investment, a “net investment” valuation that is comprised of the offering price without cash that is distributed to investors and “organization and offering expenses” paid for via the offering or borrowing of proceeds.

The majority of nontraded real estate investment trusts sell at $10/share and they generally stay at that value on a client’s account statement until a year and a half has passed since the REIT ceased to raise funds. This means that years may go by without a client being able to see that the nontraded REIT has a value that differs from that $10/share price.

However, when the recent credit crisis hit, some of the biggest nontraded REITs experienced steep drops in valuation each quarter, and advisers and investors found it difficult to figure out how, why, and to what extent the valuation declines occurred. The matter of the way a nontraded REIT should be valued (and a brokerage firm’s duty to make sure that valuation is stated on client account statements) has become a highly charged issued.

Also, to the dismay of FINRA, its examiners, who have studied quite a number of retail sellers of nontraded REITs in the last couple of years, have found that firms selling these instruments didn’t perform much reasonable diligence before selling them or failed to determine whether the product was appropriate for investors. In comments made to a Securities Industry and Financial Markets Association forum last year, FINRA executive vice present of member regulation sales practices Susan Axelrod said that when REITs have gotten into financial trouble, there were usually red flags that brokerage firms could have assessed first before making more sales.

Our REIT lawyers represent investment fraud victims. Contact Shepherd Smith Edwards and Kantas, LTD LLP today.

Finra plan could upend illiquid investment reporting, Investment News, April 24, 2013

Public Non-Traded REIT Tip Sheet


Why nontraded REITs are in Finra’s cross hairs, Investment News, October 1, 2012

More Blog Posts:
Majority of Non-Traded REITs Underperform Compared to Benchmarks, Reports New Study, Stockbroker Fraud Blog, August 25, 2012

Apple REIT Arbitration: FINRA Rules Against David Lerner Associates in First of Hundreds of Cases, Stockbroker Fraud Blog, May 26, 2012

David Lerner Associates Must Pay $14M Over Apple REIT Ten Sales and Allegedly Excessive Markups Involving CMOs and Municipal Bonds—$12M to Go to Investors, Institutional Investor Securities Blog, October 22, 2012