Many investors are not aware that the broker-dealer firm with whom their financial advisor is registered has a legal obligation to reasonably supervise its employees. Accordingly, firms that fail to adequately supervise agents may be fined and penalized by regulators.
News arrived recently that LPL Financial has once again run afoul of the agency that regulates the US securities industry, FINRA (Financial Industry Regulatory Authority). This time, LPL was slapped with a whopping $950,000 fine for allegedly failing adequately to supervise sales of alternative investment products like non-traded REITs (Real Estate Investment Trusts), oil and gas partnerships, business development companies (BDCs), hedge funds, and managed futures.
Alternative Investments Have Concentration Limits
FINRA found that from January 1, 2008 to July 1, 2012, LPL Financial was deficient in its supervision and review of especially the concentration limits for investors set forth by the alternative investments themselves, as well as limits that LPL internally set for itself. In their offering documents, many alt investments like REITs will describe concentration and suitability recommendations/requirements for investors. Unfortunately, according to FINRA, LPL’s manual process, its automated system, and its supervisory staff all failed to properly take into consideration suitability standards when evaluating alternative investments.
In addition to the $950,000 penalty, FINRA has directed LPL to conduct a complete review of its policies and procedures, oversight, supervision, and training related to alt investments.
As FINRA pointed out it in its press release about the disciplinary action against LPL Financial, broker-dealers who sell alt investments to customers must evolve a supervisory system to ensure that these customers are not exposed to undue risk in their accounts. They must also meet the suitability requirements obtaining in each state, for each product, and for their own company.
Lack of supervision of this kind is a very common form of broker misconduct. If you or anyone you know has suffered losses due to unsupervised alternative investments such as REITs, you may be able to recover through the FINRA arbitration process. Please contact us immediately for a free consultation at 1-877-462-3330 or via email by clicking here and sending us a note.
This week, a FINRA arbitration panel in Florida turned some heads with a $900,000 award to investors who had lost money in two non-traded REITs offered by Inland American Real Estate Trust, Inc. One of the nation’s largest real estate trusts, Inland American controls more than $11 billion in real estate assets. The REITs at issue in the case were Inland Western Real Estate Investment Trust and Inland American Real Estate Investment Trust.
Maybe you’ve heard of REITs already. They’re real estate trusts that pool investor money in order to control large assets such as shopping malls, apartment complexes, even timber land. There are two basic kinds of REITs that are publicly registered (as well as something called a “private REIT” or “private placement REITs” which we we’ll talk about another time): exchanged-traded REITs and non-exchanged-traded REITs. In the case of traded REITs, they are similar to more familiar securities like stock in that their shares are listed on a national securities exchange and they can be sold rather easily on the secondary market.
Non-traded REITs are different. Their shares are not traded on a national securities exchange, they demand high fees, and they are highly illiquid. Often, investors will not be able to get their money out of a non-traded REIT for 8 years or more. Finally, distributions thrown off by a REIT are subject to reductions or stoppages by the issuer of the REIT if they deem it necessary--and there’s nothing you can do about it. These factors make REITs, and especially non-traded REITs, rather risky investments, especially for novice investors who do not fully understand the liquidity issues involved.
In summer 2012, FINRA dedicated one of its “Investor Alerts” to the subject of non-traded REITs. For more information, please click here. Below you’ll find a helpful chart provided by FINRA that helps describe and distinguish between traded and non-traded REITs:
We’ve litigated numerous cases in which brokers seeking higher fees placed unwitting investors in non-traded REITs without informing them of the risks involved, especially the risks related to liquidity. Years later, when the REITs stop issuing distributions or the investors want out, they find themselves stuck in a product they don’t understand and that is not appropriate for them. Because there is no secondary market for such securities, investors simply have nowhere to go.
If you or anyone you know has been the victim of broker misconduct or investment fraud, please contact us immediately at 1-855-462-3330 for a free consultation.
xtended periods of uncertainty in the stock market along with low interest rates can drive investors seeking higher returns into the arms of products that they may not fully understand or that may not be appropriate for their financial situation or risk tolerance. Take non-exchange traded real estate investment trusts (REITs), usually referred to as "non-traded REITs." A particularly egregious case we're currently handling reminded us that we needed to get the word out once again about the danger of buying into non-traded REITs if you don't fully grasp how they work. Of course, it's not the customer who would generally consider purchasing such sophisticated financial products; rather, brokers are pitched on such products by REIT representatives; and, seduced by promises of low-risk and high-return, the brokers in turn pitch their clients on them.
(Very quickly, if you're not familiar with the concept of a "REIT:" a REIT is a trust or company that pools individual investments to purchase large portfolios of income-producing real estate. A very large percentage of the income from these properties is then disbursed annually to shareholders in the form of their distribution or return.)
Before you agree to the purchase of a non-traded REIT at your broker's suggestion (if it's not too late already), bear in mind three very important things:
- hares of non-traded REITs by definition do not trade on any national securities exchange
- arly redemptions of the shares you own in a non-traded REIT are strictly limited and in any case come with high fees that cut deep into your potential return
- Unlike in publicly traded companies, the distributions or returns ou get from non-traded REITs often come from borrowed funds or investor principal
1) The first item means that it can very difficult to determine the value of your investment in the REIT, especially if it starts to go bad. Since the REIT is not part of any actual market or exchange, its valuation is assigned internally and can often be inaccurate or manipulated by those running the fund. Moreover, until the shares are actually sold, the valuation of those shares is pure speculation. It's like a company going public for the first time: the value of its shares can fluctuate wildly in the initial offering and more often than not fails to correspond to projections, even by the experts.
2) Non-traded REITs are an illiquid investment. Be prepared to have your money locked up in a REIT for at least 8 years, possibly longer. In the meantime, if your financial situation changes, and you need to get out of the REIT, you face steep fees and losses.
3) A unique feature of non-traded REITs is that he distributions or returns you get from them do not come out of earnings or profit, but rather from heavily subsidized debt or initial investor principal. When things go bad, and a non-traded REIT starts losing money, this can look a lot like a Ponzi scheme in that new investors are paid distributions from early investor principal. In some cases, a failing REIT will suspend distributions entirely, n which case not only will an investor be stuck in an illiquid product but it's an illiquid product that provides them with no return whatsoever.
In investing, as in much else, knowledge is power. Know what you're getting into if you agree to purchase shares in a non-traded REIT. And if you don't know what you're getting into, ask your broker to explain everything to you--along with why he or she thinks this financial product is good for you. For more on non-traded REITS, consult FINRA's tip sheet here.
f you or anyone you know has been the victim of broker misconduct related to the purchase of non-traded REITs or any other financial product, please contact us for a free consultation.