Limits on the amount of money clients could invest in nontraded real estate investment trusts and curbs on paying distributions to investors from REIT offering proceeds are among new rules state securities regulators are considering — moves that could ultimately limit how lucrative they are for advisers who sell them.
The North American Securities Administrators Association Inc. has been circulating to industry regulators and representatives a list of 33 proposed changes to its REIT policy that are designed to better protect investors.
One of the recommendations has to do with limitations on how much of a client's net worth can be invested in nontraded REITs.
“We're looking into a uniform diversification standard, or concentration limit,” said Dan Matthews, a lawyer with the Washington State Securities Division and a member of NASAA's direct-participation-program project group. “With varying standards among states, we believe it would be useful to have a uniform standard.”
States that do limit the amount of a portfolio that can be invested in nontraded REITs tend to use a figure of 10%.
“But what is the appropriate scope?” Mr. Matthews asked. “Is the percentage related to the immediate offering, all REITs or all direct participation programs? Our challenge is to find one standard that all parties can agree to, with our focus being uniformity and investor protection.”
Another of the topics under consideration addresses restrictions on paying distributions from offering proceeds.
Lawrence Solomon, director of investments and financial planning at OptiFour Integrated Wealth Management, said the current practice of paying dividends out of investment capital as projects are ramping up should be curbed.
“It's not a dividend at all,” Mr. Solomon said. “They don't want all of these REITs operating as a Ponzi scheme.”
State regulators are not targeting fees that brokers can charge for selling nontraded REITs, Mr. Matthews said.
“Any effect that brokers might feel is secondary to what we're doing here,” he said. “None of the 33 topics we've set has a direct effect on those percentages.”
But the sale of nontraded REIT shares produces high commissions for advisers, a payout that could curbed by NASAA's initiative. For example, if limits are placed on the percentage of an investor's portfolio that could be invested in nontraded REITs, commission revenues could decline.
NASAA first circulated the list of proposed changes in August of last year. The Wall Street Journal last week was the first to report that NASAA was considering changes to its REIT policy.
State regulators have not yet reached consensus on any formal proposals, Mr. Matthews said, and the panel's timeline for the recommendations is uncertain.
“We're meeting regularly and trying to push on this, but it's difficult to know when it will be proposed — as soon as it's feasibly possible,” he said.
Any future agreed-to proposals would update the policy statement on REITs NASAA adopted in 2007. Individual states would have to adopt their own REIT rules.
“We support guidelines that promote transparency and uniformity for investors and a level playing field for sponsors and broker-dealers,” said Kevin Hogan, president of the Investment Program Association, without getting into specifics on the 33 topics. He did make the point that NASAA is updating previous REIT guidance rather than coming up with a new program.
So why all the attention on these particular products?
“I don't know that nontraded REITs are necessarily a bad product,” said Linda Riefberg, a partner at the law firm Cozen O'Connor and a former chief counsel for enforcement at the Financial Industry Regulatory Authority Inc. “The question is: Do investors understand what they're dealing with? These products can be managed to be a good component of a portfolio as long as there's good disclosure.”
Peter Maftieu, a compliance consultant and principal at Sound Compliance Services, said REITs are ripe for reform, and Finra, the industry-funded broker regulator, should be doing more to police them.
“These products are not simple; they are complex,” Mr. Maftieu said. “Unfortunately, Finra punted. It shouldn't be left to state regulators.”
Brokers who sell nontraded REITs are monitored both by Finra and by state regulators. Finra has proposed a rule that would make more transparent the costs of purchasing shares of a nontraded REIT.