Tuesday, May 28, 2013

Massachusetts Fines Five Brokerage Firms for Sale of Non-Traded REITs

By Tim Dulaney, PhD and Tim Husson, PhD

Secretary of the Commonwealth of Massachusetts William Galvin, who has previously come out swinging on behalf of investors in both warehoused CLOs as well as leveraged and inverse ETFsannounced yesterday  that the state has settled with five independent brokerage firms regarding improper sales of non-traded REITs.  Non-traded REITs are pooled real estate investments that have become notorious for high fees, lack of liquidity, and numerous potential conflicts of interest, as we detail in our working paper.

The settlements amount to about $6 million in restitution to investors and fines of $975,000, and are available here.*  The five brokerage firms, with respective restitution and fines, are:

Firm Restitution Fine
Ameriprise Financial Services Inc. $2.530 million $400,000
Commonwealth Financial Network $2.074 million $300,000
Securities America Inc. $0.778 million $150,000
Lincoln Financial Advisors Corp. $0.504 million $100,000
Royal Alliance Associates Inc. $0.059 million $25,000
$5.945 million $975,000

In December of last year, Massachusetts also charged LPL Financial (PDF) for similar abuses related to the sale of non-traded REITs, a matter which was settled in February for $2 million in restitution and $500,000 in fines.  Regarding the most recent action, Secretary Galvin noted that:
Our investigation into the sales of ­REITs, triggered by investor complaints, showed a pattern of impropriety in the sales of these popular but risky investments on the part of independent brokerage firms where supervision has historically been difficult to maintain.
Non-traded REITs have been sold to retail investors based on potentially misleading representations.  For example, because they are non-traded, these REITs do not have market prices and historically have been held at cost in client portfolios, even through the worst of the real estate collapse in 2008.  This lack of price transparency, however, was for a time actually touted as a feature (a purported 'lack of volatility'), rather than a deficiency.  Such claims are now specifically prohibited by the SEC.

Sales commissions on non-traded REITs can also be very high, up to 7% of offering proceeds.  This could be a reason why brokers might push non-traded REITs rather than diversified real estate mutual funds or traded REITs, which may offer similar exposure at significantly lower cost.

* It should be noted that most news outlets covering this story report a restitution of $8.6 million and a fine of $975,000.  The first of these numbers, however, includes the $2 million in restitution and $500,000 in fines stemming from the LPL Financial settlement.

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