FINRA warns about misleading investors in nontraded REIT sales

Fri May 3, 2013 9:30am EDT

May 3 (Reuters) - The Financial Industry Regulatory Authority (FINRA) is cautioning brokerage firms about the way they market some real estate investment trusts after a review by the Wall Street watchdog revealed problems, according to a regulatory notice.

Some brokerages are giving investors information about nontraded REITs, which invest in commercial real estate, that include inaccurate or misleading statements about the potential benefits of investing in such programs, FINRA said in a notice posted on its website late Thursday.

The Wall Street self-regulatory organization said some communications promote REIT distributions that are paid to the investor as income but fail to adequately explain that those distributions include some return of principal.

REITs invest in commercial real estate, such as hotels and strip malls, allowing investors to profit from rising property values. Nontraded REITs often have higher fees for investors than publicly traded REITs.

Since nontraded REITs do not trade on securities exchanges, they can be illiquid or difficult to sell in secondary markets.

Some communications that brokerages give to investors to promote the securities do not adequately explain such risks to balance the presentation of benefits, FINRA wrote in the notice.

FINRA has been honing in on improper sales of nontraded REITs for at least several years. In October, the securities regulator announced a settlement with a Syosset, New York-based brokerage, David Lerner Associates, which agreed to pay about $12 million to customers that bought into a $2 billion REIT. [ID: nL3E8LM6OL]

The regulator's concerns also extend to unlisted direct participation programs, or DPPs, a type of security that allows investors to participate in the cash flow and tax advantages of an underlying investment, include real estate.

FINRA's guidance does not mention the brokerages it reviewed or how many.

It told the brokerage industry, however, that descriptions of the real estate securities they offer must be consistent with information included in the prospectuses for those securities.

Details about distribution rates must also be "fair and balanced," FINRA wrote. For example, brokerages cannot describe them as a "yield," which may improperly suggest the investment is a bond. They also must explain, among other things, that distribution payments are not guaranteed.

In addition, brokerages may not "cherry pick" historical performance information about REITs affiliated with current products they are pitching. Brokerage should include, with "equal prominence," all information about affiliated or related REITs, FINRA said.

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