While Morningstar’s coverage of non-traded REITs may improve the availability of information concerning non-traded REITs, that coverage will have no effect on the sales practice issues associated with the sale of non-traded REITs to retail investors or the numerous structural problems with non-traded REITs. The two primary selling points for non-traded REITs are (1) by purchasing non-traded REIT shares a retail investor may avoid the volatility of the stock market, and (2) retail investors will obtain an above-market yield on their investment. Both selling points are bogus.

Non-traded REIT share prices do not change because there is no market for the shares. The lack of a market for non-traded REIT shares does not equate to lack of volatility. Sponsors do not want them to change, i.e., lower, share prices during the offering period because of the adverse impact that would have on sales of non-traded REIT shares.

As the May, 2011, FINRA enforcement complaint against David Lerner & Associates, Inc. (“Lerner”), reveals, Apple REITs Six through Nine maintained a 7-8% distribution to retail investors on Apple REIT shares by borrowing money to pay those distributions and by returning investor capital to retail investors. According to the FINRA enforcement complaint, the annual aggregate amount of distributions for Apple REITs Six through Nine exceeded by a significant margin funds from operations, effectively, net income, for the years 2008 through 2010. What that means is that Apple REITs Six through Nine were paying out more in distributions than their net income for the years 2008 through 2010, eroding the value of retail investors’ shares in those REITs. The so-called “above-market yield” used as a selling point with retail investors for non-traded REIT shares is a fiction, at best.

Johnson, Pope, Bokor, Ruppel & Burns, LLP, the law firm with which Scott Ilgenfritz has been affiliated for 27 years, has offices in Tampa and Clearwater, Florida. The firm’s attorneys have in excess of 60 years experience representing institutional and individual investors nationwide seeking to recover losses suffered by retail investors as the result of the negligence or fraud of financial professionals and their firms.

According to the enforcement complaint, DLA acted as the best-efforts underwriter for all of the Apple REIT offerings. FINRA alleges that the offerings of the shares of Apple REIT Six through Nine were all completed at the price of $11 per share, despite a dramatic down turn in the commercial real estate, hotel, and hospitality markets; declines of net income in the REITs; increased leverage through borrowing; and the return of capital to investors through distributions. FINRA asserts that DLA knew or should have known that the $11 per share valuation was artificial and was a red flag which required DLA to conduct additional due diligence before recommending the purchase of Apple REIT Ten shares. The enforcement complaint explains that distributions were artificially maintained at 7% to 8% through the use of leverage and return of capital to investors for Apple REITs Six through Nine. For Apple REITs Six through Nine during the years 2009 and 2010, the total amount of distributions exceeded funds from operations, according to the complaint.

In summary, FINRA alleges that DLA knew or should have known that additional due diligence by it was necessary with respect to Apple REIT Ten for it to determine whether the shares of Apple REIT Ten passed the reasonable basis suitability test, or, in other words, were suitable for sale to any investor.

Based on the allegations made in the enforcement complaint filed by FINRA, investors who were sold shares in any of the Apple REITs Six through Ten by David Lerner Associates or any other broker/dealer may have legitimate claims to seek the rescission of their purchases or to recover their investment losses.

The securities arbitration and litigation attorneys of Johnson, Pope, Bokor, Ruppel & Burns, LLP, represent investors across the nation who have been victims of the negligence or fraud of stockbrokers, broker/dealers, and investment advisors. The firm’s securities arbitration and litigation attorneys have in excess of sixty years experience in representing institutional and individual investors nationwide, seeking to recover losses caused by the negligence or fraud of financial professionals and their firms.

In a speech at the CCOutreach Broker/Dealer National Seminar, Richard Ketcham, Chairman and CEO of FINRA, stated that FINRA was looking into retail sales of private placement securities. Mr. Ketcham said that FINRA’s examinations and investigations had identified significant failures in broker/dealers’ compliance with suitability, supervision, and advertising rules. Mr. Ketcham also emphasized the obligations of broker/dealers to conduct reasonable investigations of private placement offerings before they are made available to customers of broker/dealers.

As a follow-up to his February 2, 2011, article, Bruce Kelly, of the Investment News, reported on February 15, 2011, that FINRA had issued a Wells notice to National Securities Corp. According to the article, the Wells notice placed National Securities on notice of potential violations of product suitability rules, email supervision rules, and standards of commercial honor and principles of the trade rules with respect to the sale of private placement securities.

Johnson, Pope, Bokor, Ruppel & Burns, LLP, the law firm with which Scott Ilgenfritz has been affiliated for 27 years, has offices in Tampa and Clearwater, Florida. The firm’s attorneys have in excess of 60 years experience in representing institutional and individual investors in securities-related litigation and arbitration claims across the country.

Many broker/dealers and brokers marketed auction rate securities to their customers as cash equivalents to be used for cash management purposes, similar to treasury securities, money market securities, or commercial paper. In other words, auction rate securities were marketed as safe, secure, liquid investments. However, such presentations misrepresented the characteristics of auction rate securities, including, among other things, liquidity risk and credit risk. Other facts that brokerage firms and brokers failed to disclose included the substantial financial support that was being provided by brokerage firms in buying up auction rate securities at auctions so that auctions would not fail and the virtual certainty that auctions would fail on a wholesale basis if brokerage firms stopped supplying such financial support.

After the auction rate securities market imploded in February, 2008, state and federal regulators brought enforcement proceedings against a number of large brokerage firms and otherwise pressured major players in the auction rate securities market to repurchase the auction rate securities sold to their customers at par. Most of the major brokerage firms in the auction rate securities market entered into settlement agreements with the regulators and repurchased auction rate securities sold to customers at par. However, some of those settlements did not include customers of securities firms with accounts having a value in excess of $10 million. There were other limitations on customers included in the settlements. Some brokerage firms, including Charles Schwab, ETrade, and Raymond James, have refused to repurchase any auction rate securities from customers.

It has not been almost three years since the failure of the auction rate securities market. Investors still holding auction rate securities need to be aware of the effect that statutes of limitation could have on their auction securities claims. Statutes of limitation vary from state to state and from claim to claim. For example, there may be different statutes of limitation applicable to fraud, breach of fiduciary duty, negligence, and breach of contract claims. Investors still holding illiquid auction rate securities need to be aware that the statute of limitations clock is ticking and that action by investors through filing of an arbitration proceeding may well be necessary to recover their frozen funds. If investors do not know what statute of limitation time periods apply to their claims, they should consult with a securities arbitration lawyer as soon as possible.

Johnson, Pope, Bokor, Ruppel & Burns, LLP, the law firm with which Scott Ilgenfritz has been affiliated for 27 years, has offices in Tampa and Clearwater, Florida. The firm’s attorneys have in excess of 60 years experience in representing institutional and individual investors in securities-related litigation and arbitration claims across the country.

Rule 2090 is new and is patterned after former NYSE Rule 405(1). The new rule requires member firms to use reasonable diligence, with respect to the opening and maintenance of every account, to know and retain the essential facts concerning every customer and concerning the authority of each person who is acting on behalf of the customer. The former NYSE Rule 405(1) applied only to FINRA members who are also members of the NYSE. The incorporation of the new rule into the FINRA consolidated rulebook will make it applicable to all FINRA member firms.

The new suitability rule, Rule 2111, is based upon the former NASD Rule 2310 – recommendations to customers. Rule 2111 is a substantial improvement over Rule 2310. Rule 2111 expressly applies to recommendations of investment strategies, as well as individual investment transactions. The rule also broadens the reasonable diligence requirements of member firms and associated persons to develop a customer’s investment profile. In addition to a customer’s other holdings, financial situation and needs, tax status and investment objectives, member firms and associated persons must gather and evaluate information concerning a customer’s age, investment experience, time horizon, liquidity needs, and risk tolerance. The phrase “investment strategy involving a security or securities” is to be interpreted broadly and includes, among other things, an explicit recommendation to hold a security or securities. The new rule requires that members and associated persons use reasonable diligence to both obtain and analyze all of the components of an investor’s profile, unless the member or associated person documents with specificity the reasonable basis to believe that one or more of the components is not relevant to the customer’s profile. Finally, the new rule expressly incorporates and describes the three primary suitability obligations of brokerage firms and their associated persons: reasonable-basis, customer-specific, and quantitative suitability.

Johnson, Pope, Bokor, Ruppel & Burns, LLP, the law firm with which Scott Ilgenfritz has been affiliated for 27 years, has offices in Tampa and Clearwater, Florida. The firm’s attorneys have in excess of 60 years experience in representing institutional and individual investors in securities-related litigation and arbitration claims across the country.

In the marketing of reverse convertibles to investors, brokerage firms and banks have often failed to inform investors of the risks associated with the reverse convertibles or substantial fees charged by issuers of reverse convertibles.

A recent article by Zeke Faux of Bloomberg states that the SEC is examining whether brokers overcharged investors for reverse convertible notes. According to the Bloomberg article, some of the brokerage firms and banks significantly involved in the sale of reverse convertibles over the last several years are Barclays, UBS, Royal Bank of Scotland, H&R Block Advisors, now Ameriprise Financial, Royal Bank of Canada, Citigroup, and JPMorgan Chase.

In February, 2010, FINRA issued a regulatory notice to its members reminding brokerage firms and associated persons of their sales practice supervisory obligations with respect to the sale of reverse convertibles. FINRA also fined H&R Block Financial Advisors $200,000 for failing to establish adequate supervisory procedures with respect to the sale of reverse convertibles.

Reverse convertibles are complex products which expose investors not only to the risk of default and inflation risk on the note component, but to additional risks associated with the decline in value of the referenced asset and losses associated with that decline. Investors who have been sold reverse convertibles may have valid claims to recover losses suffered on these products based upon the unsuitability of the products for the investors and/or the misrepresentation or omission of material facts concerning reverse convertibles.

Johnson, Pope, Bokor, Ruppel & Burns, LLP, the law firm with which Scott Ilgenfritz has been affiliated for 27 years, has offices in Tampa and Clearwater, Florida. The firm’s attorneys have in excess of 60 years experience in representing institutional and individual investors in securities-related litigation and arbitration claims across the country.

The most common claim asserted in securities arbitration proceedings is the recommendation of investments that are unsuitable for the investor.  When an investor opens an account through a stockbroker at a securities broker/dealer, the stockbroker and the firm for which he works have an affirmative obligation to get to know their new customer.  They have an affirmative obligation to gather such information as new customer’s employment status, source of income, purpose for investing, net worth, liquid net worth, tax bracket, and, most importantly, risk tolerance and investment objective.  Risk tolerance is generally expressed as “conservative”, “moderate”, or “aggressive”.  Investment objectives are frequently expressed by terms such as “preservation of capital”, “income”, “income and growth”, “long-term growth”, “trading profits”, and “speculation”.

Once this financial, risk tolerance, and investment objective information has been gathered from a new customer, the stockbroker and the stockbrokerage firm for which he works have an affirmative obligation to recommend to the customer only those investments that are suitable or appropriate for the customer based on his or her profile.  These obligations are set forth in NASD Conduct Rule 2310, “Recommendations to Customers”.

One way to prove a negligence claim against a stockbroker and the firm for which he works is for an investor to establish that the investments recommended by the stockbroker were too risky or aggressive for the investor based on his or her profile and the investor suffered losses as a result.  Such claims can be based upon unsuitable individual investments, the over concentration in a single investment or a sector of the stock market, or an overly aggressive asset allocation.

For example, as investors grow older, generally speaking, the allocation of their investments among the three major asset classes, cash, fixed income investments, and equities or stocks, should become more conservative.  Older investors are less able to tolerate the volatility of the stock market.  Thus, when a retired investor suffers losses as a result of an overly aggressive allocation, the investor may well have a basis to assert a negligence claim against the stockbroker and/or the firm for which he or she works.

It is important to note that included in a stockbroker’s duties to investors is assuring that each investor understands and appreciates the risks associated with the investments or asset allocation recommended by the stockbroker and that the investor is in a financial position to tolerate the risks associated with the investments or asset allocation recommended by the stockbroker.  Violations of the duties imposed on a stockbroker and his or her brokerage firm by the suitability rule can afford investors the opportunity to seek to recover their investment losses.

There were numerous conflicts of interest between Hartman REIT shareholders and the REIT’s original sponsors, management company, and operating entity.  As a result of poor performance and these conflicts of interest, in October, 2006, the board of trustees of the REIT terminated its management and advisory agreements with entities affiliated with the REIT’s principal sponsor and later renamed the REIT, “Whitestone REIT”.  Years of costly litigation followed.

While entities related to principal sponsor had been managing the REIT, cash distributions to shareholders, or dividends, were in excess of the REIT’s funds from operations or cash flow.  For fiscal years 2005 and 2006, dividends paid to shareholders were 128% and 143%, respectively, of adjusted funds from operations.  This practice continued through 2008.  The practice of paying dividends to shareholders from sales proceeds raised from later shareholders or with borrowed funds has caused some commentators to regard non-traded REITs as being similar to ponzi schemes.

To halt the payment of dividends from sources other than cash flow, Whitestone REIT cut dividends.  The net effect on Whitestone REIT shareholders was that dividends were reduced from 7% to .95% as of the second quarter of 2010.  Whitestone REIT also suspended the shareholder redemption program, leaving investors stuck in the Whitestone REIT shares until some liquidity event occurred.

The offering of Whitestone REIT shares to the public closed in October, 2006.  The board of trustees of Whitestone REIT waited over two years from the close of the offering before providing estimated valuation information to shareholders other than the $10 per share offering price.  In January, 2009, the board of trustees of Whitestone REIT notified its shareholders that shares that they had paid $10 each for were now only worth $5.15, roughly a 50% decline in value.

Investors who had the Whitestone REIT shares foisted on them when the REIT was named Hartman Commercial Properties REIT with the promise of a 7% dividend stream and a $10 per share price were stuck in shares worth about half of their original value and paying a dividend of .95%. 

In late August, 2010, the board of trustees of Whitestone announced an initial public offering of Class B common shares at $12 per share and a reverse one to three split for existing shareholders owning Class A common shares.  The prospectus for the initial public offering of the Class B common shares announced that after February 25, 2011, shareholders owning Class A common shares would be offered a one for one exchange opportunity to convert their illiquid Class A shares to publicly traded Class B shares.

On December 14, 2010, Whitestone REIT shares were trading on the New York Stock Exchange at $14.19 per share with a dividend of 11.81%.  If that is the per share price when the exchange offer is made to the original purchasers of Whitestone REIT shares, the shares that they purchased at $10 will have a market value of $4.73 per share.  If the dividend remains the same, the original 7% dividend will equate to a 3.94% dividend.

Although non-traded REITs like Whitestone REIT, are sold to investors as securities that are immune from the volatility of the stock market and pay a higher rate of return than other income producing investments, those sales presentations are all too often far from accurate in reality.

Shares of publicly traded REITs trade daily on stock exchanges and share prices for publicly traded REITs are established by the market.  Because publicly traded REITs trade on stock exchanges, they are liquid investments from which investors can exit at any time.

Unlike publicly traded REITs, the shares of non-traded REITs do not trade on any stock exchange.  Non-traded REITs are illiquid investments with very limited potential exit opportunities for investors.  One potential exit opportunity for investors is the redemption program described in the prospectus for a non-traded REIT.  However, non-traded REIT sponsors limit redemption programs each year to a small percentage of investors, and prospectuses for non-traded REITs allow non-traded REIT sponsors to suspend redemption programs.  A second potential exit opportunity for non-traded REIT investors is attempting to sell their non-traded REIT shares on a secondary market.  To liquidate non-traded REIT shares on a secondary market, non-traded REIT investors must do so at a very deep discount to the price that they paid for their non-traded REIT shares.  The final potential exit opportunities for non-traded REIT investors are the liquidation of the REIT assets, the sponsor of the REIT arranging for a public offering of the REIT shares, or a private sale of the REIT shares.  Liquidation of the assets in a non-traded REIT is often not required until seven to twelve years after the REIT shares are initially offered to investors.

The illiquidity of non-traded REIT shares is just one aspect of this investment which makes it a disaster for investors.  Non-traded REIT shares are often presented to retirees and those nearing retirement as investments providing a higher dividend than other income-producing investments and as a means to escape the volatility of the stock market.  Both of these frequently touted so-called benefits of non-traded REITs are bogus.

Non-traded REIT sponsors retain the right to reduce dividends.  According to reitwrecks.com, a website that provides analysis of the REIT market, several non-traded REIT sponsors have reduced dividends.  The non-traded REITs which have reduced dividends include Beringer Harvard REIT I, Beringer Harvard Opportunity REIT I, Cole Credit Property Trust II, Grubb & Ellis Apartment REIT, Inland American REIT, Inland Western REIT, and the Whitestone REIT.  Thus, higher dividend yield, typically in the six to seven percent range, is subject to the discretion of REIT sponsors.

Non-traded REIT share prices do not change because there is no market for securities.  Typically, non-traded REIT shares are priced in the offering documents at $10 per share.  Offering expenses associated with non-traded REIT shares frequently are between ten and fifteen percent of the total offering proceeds.  Thus, of every dollar invested by an investors, only eighty-five to ninety cents is available to invest in real estate assets.  Stockbrokers do not generally tell their investor clients about the effect of offering expenses on the underlying value of their REIT shares.  Non-traded REIT sponsors do not want to reduce the share value or the rate at which dividends are paid during the offering period because that would negatively affect sales of the REIT shares.  The Financial Industry Regulatory Authority (“FINRA”) has taken the position in Regulatory Notice 09-09 that it “may be reasonable” for the value of non-traded REIT shares reflected on investors’ account statements to remain at the offering price during the offering period and for eighteen months after the close of the offering period.  Sponsors’ refusal to adjust non-traded REIT share valuations during the offering period and FINRA’s failure to require sponsors to comply with its rules and do so deprives non-traded REIT investors of the truth – that their REIT shares are worth ten to fifteen percent less than they paid for them just after the REIT shares are sold to them and that the value of those shares may well decline further during the offering period.

The illiquidity of non-traded REITs, the high transaction costs associated with non-traded REITs, the lack of transparency of non-traded REITs, and the absence of any accurate share valuation information make non-traded REITs investment disasters for investors.