Schorsch empire strikes back on perception of illiquid investments

The massive alternative-investment enterprise controlled by Nicholas Schorsch is fighting what it says is a mistaken perception by state regulators that difficult-to-trade products are dangerous for investors.
Mr. Schorsch’s American Realty Capital is the largest sponsor of nontraded real estate investment trusts, an investment coveted by investors for returns that can be high and by brokers for commissions that are also generally high, typically 7%.
But investors cannot freely trade the products and, in several states, investors are limited in how much of their net worth can be locked up in nontraded REITs.
Mr. Schorsch’s representatives are pressing a case with state regulators that the restrictions do not make sense, a deputy to Mr. Schorsch said at the InvestmentNews Alternative Investments Conference in Chicago on Wednesday.
The Schorsch contingent argues that the illiquidity of nontraded REITs discourages investors from selling the products should their price drop. A sale could mean a loss for the investor, who would have an incentive to hold the product over the long run, when it may gain in value.
“It keeps investors from acting against their own interest,” said John H. Grady, chief operating officer of Realty Capital Securities, a subsidiary of American Realty Capital. “The tendency of the client is to sell assets when prices are depressed.”
Mr. Grady cited a well-known set of studies by Dalbar Inc., a consultant, which concludes that investors consistently make costly mistakes. The studies also highlight the limits of education in correcting irrational behavior.
In an interview on the sidelines of the conference, Mr. Grady said his firm is fighting a mistaken impression among regulators that illiquid products are by their very nature dangerous to investors.
“The perception is that the products are attractive to brokers because of their compensation elements and that brokers will sell more of these to their clients than would be appropriate,” he said.
But he said no one has shared evidence that brokers “overinvest” clients in the trusts.
Several states, including California, Iowa and Kentucky, impose restrictions on the amount of exposure investors can have to illiquid investments. That cap is frequently 10% of the investor’s net worth, but the details vary from state to state and product to product. States share authority over the investments with the industry-funded Financial Industry Regulatory Authority Inc.
While it is not the first time representatives of American Realty Capital have made the argument that illiquidity can help investors avoid a bad sale, the argument has taken on new urgency as regulators consider creating a uniform standard about how much exposure clients can have to illiquid investments across states.
In August, a policy group at the North American Securities Administrators Association Inc., an umbrella group of state regulators, recommended imposing a uniform “concentration limit” across states.
Now, the NASAA group — known as the DPP Policy Project Group — is discussing the scope of that proposal, according to the group’s chairman, Mark Heuerman, who is also registration chief counsel at the Ohio Division of Securities.
Once a proposal is sketched out, it will undergo a 30-day comment period among state regulators. If they give their approval, the proposal will be presented for public comment.
Mr. Heuerman said Thursday he expects a proposal to be circulated internally before the end of the year.
Industry officials remain unclear whether the proposal might limit investments in one REIT offering, all REITs or a broader swath of illiquid investments.
But Mr. Heuerman said industry officials have indicated their support for “a more uniform standard than what is currently in place.”
He added: “These programs have a number of risks. We think that it is appropriate to have some limits on the amounts that investors should put in these programs.”