The Financial Industry Regulatory Authority Inc. has alerted broker-dealers to a number of shortcomings in how they communicate with investors about nontraded real estate investment trusts.
According to a Finra notice issued yesterday, broker-dealers are falling short in a number of areas, including distributing materials that contain misleading and inaccurate statements about the potentials of investing in illiquid real estate programs.
“Recent reviews by Finra of communications with the public regarding real estate programs have revealed deficiencies,” Finra said.
One issue is how dividends — or “distributions” as they are known in the $10 billion-per-year industry — are paid to investors.
Nontraded REITs begin paying investors a distribution as soon as they are sold, with the distribution often initially coming from an investors' principal or borrowed money. Such distributions are one of the most attractive elements of the product.
Broker-dealer communications “have emphasized the distributions paid by a real estate program and failed to adequately explain that some of the distribution constitutes return of principal,” the Finra notice said.
The Finra notice to members is the latest in a string of various regulators' efforts to improve sales practices around and increase transparency of illiquid REITs, which are sold almost exclusively through independent broker-dealers such as LPL Financial LLC and Ameriprise Financial Services Inc.
For example, Finra last month indicated it would recommend to the Securities and Exchange Commission more-stringent rules about how nontraded REITs are valued, and in February, LPL Financial said it would pay a $500,000 administrative fine to Massachusetts over sales of REITs that did not meet state guidelines, as well as LPL's own rules and procedures.
For its part, the REIT industry has been working with regulators to shape an array of new guidelines and rules. The Investment Program Association, an industry trade group, said it supports the new Finra notice.
“Finra notices like this recent release are models for proper investor communication protocols,” Kevin Hogan, chief executive of the IPA, said in a statement.
According to Finra, some broker-dealers are downplaying the risks associated with such REITs. “In addition, some communications have not provided sufficient discussions of the risks associated with investing in the products in order to balance the presentation of benefits.”
Disclosure should be more accurate and explain how the REITs operate, Finra said. Descriptions of the REITs in communications to clients also should be consistent with the REIT's prospectus.
Finra's notice also drew attention to how broker-dealers discuss an annualized rate of distribution with clients. Firms must wait for the REIT to pay distributions for half a year before making claims about a REIT's annualized rate of return, according to the notice.
“In order to be fair and balanced, firm communications concerning a real estate program 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,” the Finra notice said.