Finra: REIT information misleading

The Financial Industry Regulatory Authority Inc. has alerted broker-dealers to a number of shortcomings in how they communicate with investors about nontraded real estate investment trusts. According to a Finra notice issued last Thursday, broker-dealers are falling short in several areas, including distributing materials that contain misleading and inaccurate statements about the potential of investing in illiquid real estate programs. “Recent reviews by Finra of communications with the public regarding real estate programs have revealed deficiencies,” Finra said. One issue is how dividends — or “distributions” as they are known in the $10 billion-per-year industry — are paid to investors. Nontraded REITs begin paying investors a distribution as soon as they are sold, with the distribution often initially coming from an investors' principal or borrowed money. Such distributions are one of the most attractive elements of the product. The Finra notice to members is the latest in a string of various regulators' efforts to improve sales practices and increase transparency of illiquid REITs, which are sold almost exclusively through independent broker-dealers such as LPL Financial LLC and Ameriprise Financial Services Inc.

REIT valuations

For example, Finra last month indicated that it would recommend to the Securities and Exchange Commission more-stringent rules about how nontraded REITs are valued. In February, LPL Financial said it would pay a $500,000 administrative fine to Massachusetts over sales of REITs that did not meet state guidelines, as well as LPL's own rules. For its part, the REIT industry has been working with regulators to shape an array of new guidelines and rules. The Investment Program Association, an industry trade group, said it supports the new Finra notice. According to Finra, some broker-dealers are downplaying the risks associated with such REITs. Disclosure should be more accurate and explain how the REITs operate, Finra said. Descriptions of the REITs in communications to clients also should be consistent with the REITs' prospectuses. Finra's notice also drew attention to how broker-dealers discuss an annualized rate of distribution with clients. Firms must wait for the REIT to pay distributions for half a year before making claims about a REIT's annualized rate of return, according to the notice.