Nontraded REITs want delay in Finra’s proposed disclosure rule

The nontraded real estate investment trust industry wants to wait until the end of next year to implement new securities industry rules that would provide investors more accurate information about the valuation of nontraded REITs and other illiquid investments known as direct participation programs.
The Financial Industry Regulatory Authority Inc. proposal would implement the rule change closer to the end of this year — six months after the date the Securities and Exchange Commission approves it. The SEC is considering the rule and Wednesday was the last day for the industry to submit comment letters about Finra’s proposal.
The Investment Program Association, an industry trade group, wants the SEC and Finra to slow any changes to how REIT valuations appear on client account statements and give more time to nontraded REIT sponsors and the broker-dealers that sell the products to adjust.
“The IPA respectfully submits that an implementation period of 18 months is essential to avoid adverse consequences not only for industry participants and the industries which rely upon unlisted DPPs and REITs for capital, but more importantly for investors,” according to a letter posted to the SEC’s website Wednesday and written by Mark Goldberg, chairman of the IPA and president of Carey Financial.
Uncertainty around the proposed rule has already slowed REIT sales, he wrote.
“The IPA believes that the perceived pendency of the changes proposed by Finra has had a chilling effect on unlisted DPP and REIT new offerings,” Mr. Goldberg wrote.
“For example, as of Jan. 1, 2014, there were approximately $65.6 billion of unlisted REIT securities in registration,” he wrote. “Of this amount, only $3.4 billion was placed into registration in the fourth quarter of 2013, approximately 38% below the ‘replacement rate’ of new offerings required to preserve the amount of potential equity fundraising of the unlisted REIT industry.”
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After three years of sounding out the securities and REIT industries, Finra proposed rule changes to the SEC last month that would give investors a truer picture of what it costs to buy shares of a nontraded REIT. If approved by the SEC, the rule would do away with the practice of broker-dealers listing the per-share value of nontraded REITs at $10, the common price at which brokers sell them to clients.
Instead, the Finra rule would take into consideration various fees and commissions paid to brokers and dealer managers, reducing the share price on each customer account.
Independent broker-dealers nearly are the only vendor of nontraded REITs, sales of which reached nearly $20 billion last year, double in 2012. Indeed, nontraded REIT sales have been booming at independent broker-dealers, and that boom has been generating more commission for representatives and their firms.
Reps typically earn a 7% commission on sales of nontraded REITs and other illiquid investment products, making nontraded REITs one of the more profitable products sold by brokers.
The largest independent broker-dealer, LPL Financial, “is one of the largest distributors of [direct participation programs] and REITs to the retail investor marketplace,” according to a comment letter posted on the SEC’s website Wednesday by Steven Morrison, LPL’s associate counsel. “In 2013, LPL sold in excess of $3.7 billion in REITs and DPP products.”
The nontraded REIT industry backs the increased disclosure, including the deduction of commissions to reps and dealer manager fees from the $10-a-share price on the client’s account statement.
“Net investments” should be “determined based only on the deduction of sales commissions and dealer manager fees, thereby conforming to the ‘point of sale’ cost deduction approach taken for other securities and providing equitable treatment for unlisted DPPs and REITs,” Mr. Goldberg wrote.
But a significant limitation in the proposed rule change is including less concrete or estimated aspects of the REIT’s valuations to be listed on the customer account statement, according to several comment letters by industry executives.
“There are some aspects of the proposal which introduce complex and unreliable methodologies to arrive at an estimated price, which will have the unintended consequence of confusing customers,” wrote David Bellaire, executive vice president and general counsel of the Financial Services Institute Inc., the lobbying organization representing independent broker-dealers and financial advisers. “Financial advisers who advise clients with respect to these products may also experience challenges when explaining how these estimated valuations are calculated and what they mean to the investor.”