Finra asks for delay in implementing rule affecting nontraded REIT customer statements

Changes would not take effect until 18 months after SEC signs off, three times longer than originally proposed

Jul 15, 2014 @ 1:03 pm

By Bruce Kelly

Finra is asking the Securities and Exchange Commission to give the independent broker-dealer industry much longer than it originally sought to implement rule changes that would give investors a clearer picture of what it costs to buy shares of a nontraded real estate investment trust or private placement.

The Financial Industry Regulatory Authority Inc. filed the changes and also sent a letter to the SEC on Friday that contained its final proposed rule changes to rule 2340, or rules affecting customer account statements.

In the letter, Finra associate general counsel Matthew Vitek asked the SEC to give broker-dealers and nontraded REIT sponsors 18 months to adjust to the new guidelines. Finra earlier this year had proposed giving the industry just six months after the SEC approves the rule to make those changes.

The Investment Program Association, an industry trade group, earlier this year asked the SEC for more time to make the changes to how REIT valuations appear on client account statements.

“This has been as effective an effort of an industry working with the regulators as I've ever experienced,” said Kevin Hogan, president and chief executive of the IPA. “The process has been extremely collaborative. Finra worked with industry to get this right.”

The proposed rule change affecting broker-dealer client account statements would do away with the current practice of listing the per-share value of a nontraded REIT at $10, the common price at which registered reps sell them to clients.

Instead, Finra's requested rule change would take into consideration the various fees and commissions paid to brokers and dealer managers, reducing the share price for each nontraded REIT or private placement on a customer's account statement.

Nontraded REITs now don't have to show an estimated per-share valuation until 18 months after the sponsors stop raising funds, which in many cases can take two to three years. The Finra proposal speeds up the process to as little as three to six months for when investors would see a valuation of less than $10 per share.

Commissions to reps and broker-dealers, along with organizational and offering expenses, can subtract up to 12% from a client's original investment. That would bring the estimated value of a REIT sold at $10 down to $8.80 per share.

Broker-dealers also don't have to reduce the REIT's share price for over distributions if they disclose the following: “IMPORTANT – Part of your distribution includes return of capital,” according to Mr. Vitek's letter. “Any distribution that represents a return of capital reduces the estimate per share value shown on your account statement.”

Nontraded REITs have been widely criticized for returning capital to investors in the form of dividends and distributions. Such a practice erodes investors' original investment.

Finra floated the rule changes first in September 2011. It has seen two comment periods since then and several changes. If the SEC were to approve the rule changes tomorrow with the new 18-month implementation period, the industry would not be required to give investors in nontraded REITs greater clarity about the per share value of REITs until January 2016. That would be more than five years after Finra originally propose the rule changes.

A number of industry firms and groups said the additional time was necessary to limit the impact on nontraded REITs and private placements currently being sold as well as allow for adjustments in products going forward, wrote Mr. Vitek.

“Finra believes this extended timeframe will give industry participants time to make adjustments to product structures and any necessary operational changes,” he wrote.

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