Bad Apple: REITs fined $1.5 million for disclosure violations

CEO and COO also ordered to pay $175,000 in penalties

By Bruce Kelly

Feb 13, 2014 @ 7:48 am (Updated 3:27 pm) EST

A series of nontraded real estate investment trusts called the Apple REITs failed to make a number of key disclosures to investors in the years after the credit crisis, resulting in $1.5 million in civil fines issued by the Securities and Exchange Commission.

The Apple REITs failed to value the REITs properly, disclose numerous related-party transactions and divulge executive compensation of four REITs, according to a SEC cease-and-desist order, which was a settlement between the SEC and the various respondents.

The order was disclosed Wednesday evening.

The nontraded REITs – Apple REIT Six Inc., Apple REIT Seven Inc., Apple REIT Eight Inc. and Apple REIT Nine Inc. – violated SEC rules between 2008 and 2011, immediately following the global collapse in the real estate market. The one broker-dealer that sold the Apple REITs, David Lerner Associates Inc., wasn't named in the SEC order.

Glade M. Knight, the chairman and chief executive of the four Apple REITs, was ordered to pay a civil penalty of $125,000. The chief financial officer of the REITs, Bryan F. Peery, was ordered to pay a civil fine of $50,000.

“We are pleased to have resolved this matter, which we neither admit nor deny, consistent with standard SEC practice,” Apple REIT spokeswoman Kelly Clarke wrote in an e-mail. “The settlement does not impact any of the Apple REITs' financial statements, and we have addressed the disclosure concerns of the SEC, as we have understood them, over the past several years.”

Each of the REITs was sold to investors at $11 a share. Investors of such REITs often reinvest dividends, and that is where the Apple REITs valuation disclosure and methodology fell short, according to the SEC order.

“Despite receiving internal and third-party analysis indicating a value below $11 per unit and despite significant decreases in operating performance, [Apple REITs Six, Seven and Eight] collectively sold more than 25 million [dividend reinvestment plan] units following the 2008 global financial crisis while maintaining that the arbitrarily established initial offering price of $11 constituted 'fair market value' of those REIT shares, according to the SEC order.

The SEC order didn't disclose what the appropriate valuation of those REITs was at the time.

The four Apple REITs also "failed to disclose numerous related-party transactions involving short-term transfers between REITs to meet cash needs and commercial loans personally guaranteed by Knight between 2008 and 2011," according to the order.

The four REITs "further failed to disclose significant compensation paid by the [REIT] advisers and Knight to their executive officers between 2008 and 2010," according to the order.

The Apple REITs owned full-service, limited-service and extended-stay hotels.

REITS Six, Seven and Eight each raised about $1 billion, starting in 2004 and ending in 2008.

REIT Nine raised $2 billion from 2007 to 2010.

Apple REIT Six had a “liquidity event” last year, merging with an unrelated entity.