The Securities Litigation Expert Blog

FINRA has issued NTM 13-18 Communications with the Public, providing guidance on communications with the public concerning unlisted REITs and DPPs.  (NTM 13-18)  Several things are of note:

1. As always, providing a prospectus does not satisfy the required disclosures in written and oral communication.

 Providing risk disclosure in a separate document, such as the prospectus, does not substitute for the required disclosure, even if a communication is accompanied or preceded by a prospectus.

2. Firms may not state the distribution rate is a "yield" or "current yield".  This is because distributions have historically included a return of principal.

3.  Firms may not imply that the values of the fund are stable just because they are offered at the initial offering price.

 The fact that a program offers its securities at par value, or at another relatively stable price, does not evidence stability in the value of the underlying assets.  A communication also may not state that the price at which the program is offered is stable or that its volatility is limited without disclosing that price stability does not indicate stability in the value of the underlying assets, which will fluctuate and may be worth less than the real estate program initially paid, and that the investor may not be able to sell the investment.

4. Firms may not compare the performance of an unlisted REIT to a listed REIT.

Compliance and supervisory personel would be wise to implement this guidance when conducting their reasonable basis suitability determinations, review of advertising, Registered Representative communications, and customer specific suitability.  Especially in light of investor's yield chasing.

A Finra news release yesterday reported the regulator fined David Lerner Associates $12 million for sales of Apple REIT 10.  (Finra)  The funds will go towards restitution for the Apple REIT 10 customers.  The release quoted Brad Bennett, Executive Vice President and Chief of Enforcement:

David Lerner and his firm targeted unsophisticated and elderly customers, grossly failing to comply with basic standards of suitability in selling Apple REIT 10 to thousands of customers.  Firms must conduct a thorough suitability analysis before selling products, and make accurate disclosures of risks and features at the point of sale, especially with alternative investments such as non-traded REITs.

Finra seems to be more focused on reasonable basis suitability these days, which ties in to the new Suitability Rule 2111.

The Order Accepting Offer of Settlement directly addressed the reasonable suitability issue (Order):

93. In addition to its customer-specific suitability obligation, DLA and its registered representatives have a duty to perform reasonable due diligence ot understand the potential risks and rewards associated with a security it recommends to customers, and to determine whether the recommendation is suitable for at least some investors based upon that understanding.

94.  Based upon sales and account maintenace of all issued Apple REITs, DLA management was or should have been aware of red flags indicating that management of Apple REIT Ten may adopt improper valuation practices and may unreasonably leverage the REIT in order to continue to issue returns unsupported by the REITs performance.

95.  Especially in light of these red flags, and DLA's role as sole underwriter, DLA personnel did not conduct reasonable due diligence to understand the potential risks and rewards of Apple REIT Ten before recommending the security to customers.  As a result, DLA was not in a position to determine whether Apple REIT Ten would be suitable for any investor prior to recommending it to customers.

96.  By failing to conduct adequate due diligence to fulfill its reasonable-basis suitability obligation, which also violated its duty to observe high standards of commercial honor and just and equitable principals of trade, DLA violated NASD Rule 2310 and Finra Rules 2310(b) and 2010.

See our coverage of suitability here.

The May 27, 2011 Finra Complaint against DLA can be found here.

Finra also fined David Lerner personally $250,000 and suspended him for one year from the securities industry and for two years after that from acting as a principal.