## Wednesday, December 12, 2012

### Massachusetts Securities Regulators Getting Tough on Non-Traded REITs

By Tim Husson, PhD

LPL Financial, the largest independent broker-dealer in the US, is being sued by Massachusetts securities regulators for "numerous regulatory violations in connection with the sale of non-traded REITs."  We have covered non-traded REITs extensively on this blog, as well as in a detailed working paper (PDF), and it appears that many of the problems that have been identified with these products are finally attracting attention from regulators.

According to the complaint (PDF), the action is specifically targeted at LPL's sales of Inland American, one of the largest and most well-known non-traded REITs.  However:
The Enforcement Section's investigation revealed significant and widespread problems with LPL's adherence with product prospectus and Massachusetts requirements. Through LPL Representative testimony, the Enforcement Section uncovered similar issues with other non-traded REITs. In many ways, the Division's investigation unearthed a boat with many holes.
It's important to note that the state's action is not directed at Inland American or any other non-traded REIT sponsor or affiliate; rather, it is directed at a major broker-dealer who sold those products to retail investors without proper training or supervision.  According to the complaint, LPL sold approximately $28 million of Inland American shares to Massachusetts residents from 2006 through 2009, accumulating$1.8 million in gross commissions.  Apparently a whopping 569 out of the 597 transactions involving Inland American were in violation of prospectus requirements.

It is our opinion that non-traded REITs are fundamentally flawed and have many features that make their basic economics untenable.  But unlike private placement investments or hedge funds, non-traded REITs can be sold to retail investors under certain conditions which were designed to help ensure that investors had an appropriate risk tolerance and no immediate liquidity needs.  LPL Financial will have to prove it followed these restrictions.

While it's encouraging to see actual enforcement of these protections, we think it is worth asking whether non-traded REITs are suitable for anyone.