The following story appeared in Investment News on September 30, 2011.
Regulator wants commissions subtracted right away from value shown on statements; ‘pendulum has swung too far’
A new Finra proposal would drastically change how the value of nontraded real estate investment trusts appears on client account statements — a nettlesome issue for independent broker-dealers that sell the products and the sponsors that create them.
The Financial Industry Regulatory Authority Inc. today proposed changes to its Rule 2340, which governs customer account statements. Finra’s new proposal takes aim at brokers’ commissions and other upfront costs.
It would require that “all per-share estimated values, including those that are based on the offering price, reflect a deduction of all organization and offering expenses (net value).”
That means that the customer of a broker who buys a nontraded REIT for par, typically $10 a unit, would receive an initial account statement, minus the broker’s commissions and other expenses. In such instances, those nontraded REITs would be valued at $8.70 a unit.
Broker-dealers and sponsors of nontraded REITs have long anticipated the rule proposal, but the proposal’s emphasis on immediately deducting brokers’ and firms’ commissions from the value on a client’s account statement alarmed at least one industry consultant.
“Once again, the pendulum has swung too far,” said Bryan Mick, a due-diligence consultant who evaluates nontraded REITs and private placements. “Nontraded REITs have significant upfront or sunk costs, and the initial costs should be amortized over the holding period of the REIT, which spans years, not by its second day.”
Nancy Condon, a Finra spokeswoman, had no comment about Mr. Mick’s comments.
The Finra rule proposal includes both potential changes for nontraded REITs and direct participation programs that broker-dealers sell, usually in the form of limited partnerships. Both are illiquid investments that garnered the attention of securities regulators during and after the credit crisis.
Finra has been zeroing in on the issue of nontraded REIT valuations recently.
Currently, broker-dealers have a lengthy grace period during which nontraded REITs can remain at par before an estimated market value is established. Par value for most nontraded REITs is $10 a share, and a typical offering period is two years.
That $10-a-share value is listed on client account statements for those two years.
But REIT sponsors commonly extend the offering period to sell more shares to investors, pushing the deadline for an updated market valuation. Given the initial 18-month grace period, four or five years can pass before a nontraded REIT has to be given a market valuation, industry observers said.
And in 2009, Finra issued a notice to members that reminded them of their obligation to list an estimated value on client account statements 18 months after the offering is closed to new investors, rather than list the price or par value at which it was sold to investors.
In its new rule proposal, Finra would lesson that requirement. Its new amendment would require that an estimated per-share value to be no less current than the data in the offering’s most current annual report.
Firms and other industry officials have until Nov. 12 to comment on Finra’s proposal.