The issues noted by the Securities and Exchange Commission (SEC) and Financial Regulatory Authority (FINRA) as national regulators as well as many state securities regulators over the years is that Non-Traded REIT and BDC investment products are complex, high-commission, alternative investments that are often difficult to understand and leave the financial advisors at the mercy of their firms to properly train them on these products, and leave investors at the mercy of financial advisors who are often not entirely clear on what they are selling.
For most investors, the sales pitch by the financial advisor was not “fair and balanced” and including full risk disclosures. Rarely are the clouds cleared away and a typical investor going forward with clarity and understanding as to what they are buying. In most cases, it is little more than blind trust.
If you purchased non-traded REITs or non-traded BDCs and you now realize you have suffered losses in an investment product you still do not understand, ask yourself if the financial services professional (often your fiduciary) ever fully disclosed the following to you, before you bought these investment products, and while pitching you on all the purported positives. These investments are often mis-sold (and misrepresented) as safe, conservative, income-producing investments.
10 Things You Likely Were Not Told When These Non-Traded REITs Were Sold to You
Did you also receive disclosure of the following before purchasing the non-traded REIT:
- Many of these investments are high-risk, speculative investments. Investments in complex, alternative investment products are generally considered speculative, involving a high degree of risk, and are suitable only for persons who are willing and able to assume the risk of losing their entire investment. Were you told up front that this was basically a “gamble”? Or, was it supposed to be a safe, secure segment of your retirement portfolio? Were investors ever told that there are numerous firms that refuse to sell these investment products to their investor clients? How would most investors react to the fact that there are firms on Wall Street that refuse to sell these products to retail investors? Would that not be a major red flag? Why is that material information not being disclosed?
- These are often high-commission products that involve internally high-cost structures. As it may not be a traditional commission showing up on a transaction confirmation, and it might not be fully disclosed, what exactly were you told? In most of these investment products, the sponsor and the broker-dealer firm often have selling agreements and dealer agreements and the total compensation can run from 8-12%, often around 10%. Much of that is shared with the individual financial advisor who might have an ulterior motive and clear financial incentive for strongly recommending these investments. Traditional mutual funds, exchange traded funds, or other more traditional stock or bond investments often generate far less in commissions or revenue. Would you have felt differently about the sales pitch you were getting if you knew that your financial advisor was going to earn 5x or even 10x what he/she might earn recommending another investment strategy?
- Illiquidity risk. While the lack of a public market where these investments will trade not only ties up your investment capital (sometimes for years) it also leaves you guessing as to what the real price level is and how successful or unsuccessful the fund really is performing. Financial advisors know that this is a material risk that can scare off many investors. We often see claims where the supposed risk disclosure represented that it will only be for 2-3 years, or some relative short time frame. In reality, the average based on some studies is 7 years, and that means many are illiquid much longer, and simply becoming liquid does not mean the stock price trading level is profitable for investors, it just means they can finally sell (at a loss).
Other financial advisors talk up the redemption programs offered as though they represent potential liquidity for unhappy investors. Rarely do these programs offer true liquidity. They are often limited, can be suspended or terminated, and might even require a significant undertaking on an ongoing quarterly basis to just try to liquidate a small portion of holdings, sometimes at a discount or cost (meaning a loss). What should have been made crystal clear is that this is generally considered a long-term investment and there is no true liquidity. There is no public market and none will be developed. In most cases, you will not be able to redeem or sell.
- Lack of transparency. These investments lack a hallmark of prudent investing and one that is paramount to investor protection —transparency. The information provided is often limited, sometimes incomplete and what is publicly available is often difficult to determine if it is even still current. Did your financial advisor explain these risks, that you were essentially entrusting your investment capital to a sponsor who unlike a stock, bond, mutual fund, is not going to be regularly updating information publicly and there will be no daily buying and selling price marks for you to rely upon?
- Investment strategy risk. What were you told about the actual investment manager, their track record, reputation, largest holdings, and any limitations or constraints on their decisions to change investment strategies at any time? In many instances, these investment products are sold as similar to mutual funds. In reality they are not as liquid, not as diversified, and as an investor you have no idea of Morningstar ratings or any comparison to any benchmark. Were you ever told upfront that it could be nearly impossible for you to know for certain at any given time the composition of the investment product’s portfolio, the appropriateness of the underlying investment assets, the amounts of leverage used, and the related risks related to such material issues.
- Potential risks related to use of leverage. What exactly were you told upfront about this issue? No doubt the distribution payments were part of the sales pitch, were you told that in many of these cases those are funded by loans or leverage arrangements with creditors? Were you told they could partially be funded with a return of your own principal that was invested? While there are different structures and each investment product is unique, these are material risks and important features that might have resulted in many investors deciding against these investment products if they were fully or properly disclosed upfront. Most investors understand that leverage potentially increases dramatically the risks related to investing in these products, but were they warned up front of such risks? In many cases they are given the false impression by financial advisors that by virtue of the fact that a healthy 6-7-8% distribution can be paid and could be considered supposedly sustainable that in and of itself is an indication of safety, security and success associated with the underlying strategy. In reality, it might have no bearing whatsoever and the degree of leverage and risks of the investment product may change at any time. The investor may have no control, may not know the degree of leverage or risk, or when the changes occurred, and may be unable to sell their illiquid holdings.
- What were investors told regarding diversification? Are there concentration risks that were not disclosed? Is it a REIT focused on a particular market segment, business sector, or geographic area? If there was concentration risk, was it properly disclosed? If there was no assurance of diversification in the underlying investment was that ever disclosed by the financial advisor? Did these non-traded securities represent a significant portion of the portfolio? Were those concentration risks ever discussed or disclosed? In 2015-2017 numerous state and federal securities regulators fined several broker-dealer firms and in the process pointed out that many states limit the amount of these non-traded investment products that investors can purchase. If these disclosures are made accurately, investors will surely question the risk levels and further question why they are being sold any large positions or multiple positions.
- What are the benefits? What are the risks? Investors are not provided fair and balanced disclosures. They are often told these are safe, secure, income producing investment products, and after that high level commentary, they are presented with “routine” paperwork to sign. Are the investors ever informed that their investment capital could decline 40% or more? That the redemption program could be terminated? That distributions could be reduced or suspended? While many financial advisors pitched investors by trying to describe non-traded investment products as “similar” to other investments they were already familiar with, they rarely disclosed that simply filing these investments with the SEC is not an indicia of safety, security, or comprehensive regulation, certainly not to the degree a traditional publicly traded stock, bond, or mutual funds might and other U.S. registered funds.
What were investors told about the anticipated trade-offs relating to these investments. If compared to a diversified, well-allocated, publicly traded mutual fund that is fully liquid – investors should rationally expect that the trade-offs of illiquidity, non-transparency, added risks, etc. would all translate to much higher returns as a trade-off for those sacrifices and risks. In reality, studies have shown that it is exactly the opposite of what a rational investor might expect. These investment products have a historic pattern of not succeeding in the majority of instances – was that risk ever disclosed? The securities regulators at both the state and federal level have repeatedly fined broker-dealer firms for sales practice and supervision issues related to these investment products – was that ever fully disclosed? Finally, in terms of performance, these illiquid, non-transparent investment products often underperform compared to liquid, publicly traded alternative choices that could have been offered or compared by the financial advisor. In fact, the differences are not a close call, underperformance is historically to the tune of 50% or less to the more liquid, more transparent, publicly traded counterpart. Wow! For most investors, if they thought that large loss of principal, potential suspended distributions, a terminated redemption program, and a high percentage chance of underperformance were a potential outcome, they would have run (not walked) away.
- The disclosures regarding actual or potential conflicts of interest. At one level, there should be full disclosure regarding all of the financial incentive the financial advisor might have for recommending one investment product over another, that is a potential conflict of interest. At another level, there are internal agreements, arrangements, and potential self-interested practices whereby affiliates of the sponsor or entities that are owned or controlled by one or more of the individual principals of the sponsor are responsible for providing certain services to the trust. What (if any) investigation or review did the financial advisor do? Are these arrangements, contracts, or deals being disclosed to the investor by the financial advisor, or has the financial advisor disclosed that this is often the case but he/she made no inspection of same? Are the investment managers subject to any potential conflict of interest, are the rates being paid to third-party service providers in line with market rates? In a publicly traded stock, the disclosures are out in the open and if economies of scale or market pressure could drive down overhead costs, the shareholders will not only put pressure on the board to find those cost savings, but the financials and the investment pricing will often reflect such positive efforts and increase value for shareholders. Here, with lack of a public trading market, no daily price marks and infrequent disclosures and general lack of transparency, what are the investors being told (if anything) on these matters?
- Monitoring efforts. What representations were made by the financial advisor with regard to ongoing monitoring efforts? Often the perceived stability of pricing associated with these investment products is merely illusory as it is self-servingly reported by the sponsor. With limited transparency and limited pricing information, did the financial advisor ever make it clear to the investors that the reported NAV reported on the account statements may be nothing more than an illusory figure that is not necessarily reflective of the actual current valuation of the investor’s interests? Unfortunately, for most investors, they get the exact opposite, they get financial advisors who all but “hide” behind what are often inflated and unrealistic NAV values reported on investor monthly account statements to try and avoid the reality (and perhaps the wrath of their clients). If investor clients knew the truth about the secondary market trading values on many of these investments, it would likely lead to many more customer complaints, fewer referrals, and some very unhappy investors. For a fiduciary level financial advisor, this ongoing monitoring and added level of transparency should be reported on an ongoing basis to investors. For financial advisors to not disclose or actively avoid discussing the fact that trading values on the secondary market are often half or less the value stated on customer account statements appears to be a material omission. While the secondary market trading range may not be the final word on the valuation for some financial advisors or investors, a good financial advisor (and any reasonable investor) would surely expect the free-flow of such information, especially to the extent it places the investor in a position of knowing that their original capital invested could be off by 40% or much more, how could any fiduciary undertaking best practice (or even good practice) suggest this is not material information his/her investor customer deserves to be accurately informed about?
What Should You Do Now If Your Purchased A Non-Traded REIT?
If you are an investor in non-traded REIT or non-traded BDC investment products that were sold to you by a financial advisor and you were coaxed into purchasing your investment based on promises of a stable, conservative investment product with a steady income stream, or you received inadequate (or non-existent) risk disclosures about your investment, the risks of illiquidity or the lack of transparency and you have incurred losses you should consider your options and next steps.
You can “wait and see” but keep in mind that statute of limitations and other potential laws, rules, or regulations may impact not only your ability to bring a potential claim at a later date, there may also be a practical impact in terms of the value of any potential claim, if you choose a “wait and see” approach. Thus, as with many things, not making a decision here, could still be making a decision. Be careful in making this decision, as it could prove costly.
You can consider a class action or derivative action. There may or may not be cases against the sponsor its principals, or other parties. Without getting into the potential allegations and merits of such a case, these are typically state or federal court proceedings and rules of civil procedure that will dictate the time needed and deadlines applicable to conduct the necessary discovery and set a hearing to determine whether or not class status will be certified by a court. Even then, that is essentially just the beginning of the case.
As non-traded REITs and non-traded BDCs as investment products were not safe or conservative when you purchased them, they often should not have been recommended. In fact, securities regulators considered them complex alternative investments that are difficult for most retail investors to understand. In addition to risks of illiquidity, and a lack of transparency, some investors never should have been sold these securities. A note here for senior, elderly and retired investors who purchased non-traded investment products. Some recent FINRA regulators suggest that recommendations of risky, illiquid, complex alternative investments are not always appropriate for investors who may need liquidity and who (based on their age or circumstances) are not appropriately invested in long-term, risky, illiquid complex alternative investment products.
For some investors, a better option than “wait and see” or a potential class action, is a FINRA customer dispute private arbitration claim. These customer claims are private, confidential, and quicker and more efficient than court litigation. In addition, there are typically no depositions, as it is almost entirely paper-based discovery.
If you have experienced damages in these or similar types of investments, you should contact an experienced investment fraud lawyer who might be able to assist you with these types of claims.
About Haselkorn & Thibaut, P.A.
At www.investmentfraudlawyers.com, you will find the experienced law firm of Haselkorn and Thibaut, P.A. They are a nationwide law firm specializing in handling investment fraud and securities arbitration cases. The law firm has offices in Palm Beach, Florida, on Park Avenue in New York, as well as Phoenix, Arizona, Houston, Texas, and Cary, North Carolina. The two founding partners have over 45 years of legal experience and they lead an experienced group that includes former financial advisors, certified financial planner, former Wall Street bank and broker-dealer defense lawyers, and others.
Haselkorn & Thibaut, P.A. has filed numerous (private arbitration) customer disputes with FINRA for customers who suffered investment losses relating to issues similar to those matters mentioned above. There are typically no depositions involved, and those cases are typically handled on contingency with no recovery, no fee terms-.
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