In March 2013, FINRA submitted a proposed rule change to NASD Rule 2340 (Customer Account Statements) and FINRA Rule 2310 (Direct Participation Programs) to the Securities and Exchange Commission that would “modify the requirements relating to the per share estimated values for unlisted DPP and REIT securities included in customer account statements.”
Through its proposed rule change, FINRA hopes to require brokerage firms that have sold such non-traded REITs as Behringer Harvard, CNL Lifestyle Properties, KBS, NetREIT, and Dividend Capital, to provide their customers more reliable estimates of the current value of their holdings. Specifically, FINRA proposes to require brokerage firm to choose one of three valuation methods:
- for two years after breaking escrow, “net investment,” consisting of gross offering price less any cash distributions to investors and “organization and offering expenses” (as defined by Rule 2310) that are funded through borrowing or offering proceeds (a firm may rely on the issuer’s periodic reports for this information);
- at any time, a valuation performed by an independent valuation service, which (under a proposed amendment to Rule 2310) the issuer must commit to provide and must perform at least once every three years; and
- a periodic valuation by any program that provides them according to a methodology disclosed in the prospectus.
Unfortunately, FINRA’s proposal is not calculated to make any difference whatsoever as most every firm already uses option 3 and would continue to do so. Option 3 is problematic because the operators of non-traded REITs have every incentive to use a methodology that overstates the current value of the REIT stock: the more the operator says the stock is worth, the more stock the operator will be able to sell going forward, and the more up-front commissions the REIT’s sponsor will get paid.
A rule that would actually help provide more transparency would require brokerage firms to employ a standardized methodology for determining estimated value based upon the entities’ financial data. To be of any real value, the formula would need to take into account the REIT’s performance in a far more sophisticated manner than method 1 above, but there is no doubt that an adequate formula could be developed.
Blau & Malmfeldt is a law firm that represents investors across the United States in disputes with financial industry members. If you have suffered losses through non-traded REITs, please call us at 312-443-1600 for a free consultation.