Finra seeks greater transparency in nontraded REIT statements

Proposed rule would require brokers to factor in fees and commissions when listing share prices

Feb 3, 2014 @ 2:30 pm

By Bruce Kelly

Finra proposed rule changes Monday that would give investors a truer picture of what it costs to buy shares of a nontraded real estate investment trust.

If approved by the Securities and Exchange Commission, the rule change would do away with the practice of broker-dealers listing the per-share value of nontraded REITs at $10, the common price that brokers sell them to clients.

Instead, the Financial Industry Regulatory Authority Inc.'s potential rule change would take into consideration the various fees and commissions paid to brokers and dealer managers, reducing the share price on each customer account.

The nontraded REIT industry, which saw sales last year double to $20 billion from 2012, has been anxiously waiting for the Finra rule proposal. Whether a change in per-share valuation disclosure would hurt or slow down nontraded REIT sales has been hanging over REIT sponsors and the independent broker-dealers that sell the product.

Many broker-dealers had record revenue from nontraded REIT sales last year as a number of REITs had “liquidity events,” meaning that they merged with another company or were listed on an exchange.

(See also: Nontraded REIT rules roiled by appraisal issue)

John McInerney, a spokesman for the industry trade group the Investment Program Association, declined to comment Monday when asked about the Finra rule proposal.

The proposed rule has two methodologies that broker-dealers can use when an estimated value is presumed reliable, according to the 268-page Finra proposal.

Those methodologies are net investment and independent valuation.

For example, the net investment methodology could be used for two years following the nontraded REIT's breaking of escrow, or when the issuer is permitted to access the offering proceeds to buy real estate.

“For example, if the prospectus for an offering with a $10 offering price per share disclosed the selling commissions totaling 10% of the offering proceeds, and organizational and offering expenses of 2%, the amount available for investment would be 88%, or $8.80 per share,” according to the Finra rule proposal, which was posted on the regulator's website Monday.

Nontraded REITs don't have to show an estimated per-share valuation until 18 months after the sponsors stops raising funds, which in many cases can take two or three years. The Finra proposal drastically speeds up the process by which investors would see a valuation less than $10 a share.

The second method is independent valuation and could be used at any time, according to the Finra proposal.

It would consist of the most recent valuation disclosed in the issuer's periodic or current reports and would require a third-party-value expert's or experts' determination.

The proposed rule changes, which have been in the works at Finra since 2011, is now in the lap of the SEC. The effective date of the proposed rule change will be announced no later than 90 days following the SEC's approval.

The specific rule that Finra is proposing to change is NASD Rule 2340, regarding customer account statements.

It relates to the per-share valuation for nontraded REITs and other "direct participation program" investments such as oil and gas partnerships.

Finra has shifted its stance on nontraded REIT valuations since its initial rule proposal was published in September 2011. In that proposal, Finra considered requiring that every customer account statement present a valuation of a nontraded REIT or “direct participation program” security.

In the proposal that is heading to the SEC, Finra is not requiring broker-dealers to list an estimated value per share for each security. Finra has doubts about “reliable” valuation, it said in its proposal.

“Finra has determined not to explicitly require the presentation of a valuation in customer account statements because it could interfere with the objective of ensuring that valuations are reliable,” according to the rule proposal.

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