Our law firm is actively pursuing claims against LPL Financial (“LPL”) in the arbitration forum established by the Financial Industry Regulatory Authority (“FINRA”) on behalf of investors who sustained losses as a result of investing in Inland Western REIT, n/k/a Retail Properties of America (NYSE: RPAI), Inland American REIT, as well as other REITs and direct investment products. LPL is America’s largest organization of independent financial advisors. LPL offers various services, training, and research to approximately more than 13,000 financial advisors and approximately 685 financial institutions nationwide.
Massachusetts Files Complaint Against LPL for Sale of Non-Traded REITs
In December of 2012, the Secretary of the Commonwealth William Galvin charged LPL Financial with a failure to supervise registered reps who sold the nontraded REITs in violation of both state limitations and the company’s rules. The Securities Division also charged LPL Financial with dishonest and unethical business practices.
The charges stem from sales of $28 million of nontraded REITs to almost 600 clients from 2006 to 2009. Of those transactions, the Securities Division found that 569 had regulatory violations. Those included sales made in violation of Massachusetts 10% concentration limits; sales made in violation of prospectus requirement; and sales made in violation of LPL compliance practices.
The firm received gross commission of $1.8 million for those sales, according to the complaint.
Of the REITs listed in the complaint, the largest amount of sales was for Inland American Real Estate Trust Inc., the largest nontraded REIT in the industry, with $11.2 billion in real estate assets. Massachusetts investors put at least $20.1 million in Inland American, which is currently the focus of a fact-finding investigation by the Securities and Exchange Commission.
Massachusetts’ investigation “revealed significant and widespread problems with LPL’s adherence with product prospectus and (state) requirements,” according to the complaint. By testimony of LPL reps, the Securities Division “uncovered similar issues with other nontraded REITs. In many ways, the division’s investigation unearthed a boat with many holes.”
“On paper, LPL set forth stringent requirements for the sale of nontraded REITs,” according to the complaint. “In practice, LPL failed to review properly sales of nontraded REITs. While purporting to conduct a thorough review of offering documents, LPL overlooked prospectus requirements in numerous sales of nontraded REITs.”
“LPL’s supervision employees had only a cursory understanding of specific state requirements, including Massachusetts concentration requirements,” according to the complaint. Many nontraded REIT prospectuses contain a 10% concentration limitation, designed to cap an individual investor’s purchase to 10% of his or her liquid net worth, the complaint stated.
A copy of the Complaint against LPL can be found by clicking here.
LPL’s Relationship with Banks and Credit Unions
According to the 2012 10-K filing for LPL’s parent company, LPL Financial Holdings, this includes “support to over 2,200 advisors at approximately 670 banks and credit unions seeking to provide a broad array of services for their financial advisors.” Many LPL registered representatives maintain their license with the firm, and at the same time operate their own Registered Investment Advisory firm, where they operate as Registered Investment Advisers (“RIA”), registered with the U.S. Securities and Exchange Commission (“SEC”).
We believe that many customers of these banks and credit unions were contacted by LPL representatives who had access to their banking information to solicit them to invest in non-traded REITs. However, if the salesperson is registered with LPL, the securities products sold are offered through LPL, not the bank. Accordingly, LPL would be responsible for any sales practice violations committed in connection with the sale of the investment products.
These types of arrangements, where LPL brokers or financial advisors are working in a bank branch office with no on-site supervision, are referred to as “satellite offices.” In the securities industry, while regular branch offices require reasonable supervision, a satellite office requires vigilant supervision by the broker-dealer and therefore greater scrutiny is required to ensure compliance with the securities rules and laws. The SEC has specifically commented on the issue of supervision of satellite offices. SEC Staff Legal Bulletin No. 17: Remote Office Supervision provides that “small, remote offices require vigilant supervision.” The bulletin describes certain supervisory tools that, based on Commission staff examinations and SEC enforcement cases, are characteristic of good supervisory procedures, including the use of unannounced onsite inspections. When brokerage firms fail to vigilantly supervise satellite offices, it opens the door to possible violations, including the rendering of unsuitable investment advice.
According to our investigation, securities are offered through LPL at the following banks and credit unions (“CU”). This is not a complete list, but rather examples of financial institutions where securities are offered through LPL. If you purchased Inland Western REIT, Inland American REIT, or other REITs or private placements at these or other financial institutions, you may have a potential claim to recover your damages from LPL.
SAFE CU
Sovereign Bank
United Heritage CU
Alliance Bank
San Diego County CU
PyraMax Bank
Bank Atlantic
Webster Bank
Peoples Bank
America’s First Federal CU
Del Norte CU
Washington State Empl. CU
1st Mariner Bank
Provident Bank
MidWestOne Bank
Seattle Metropolitan CU
Credit Union ONE
New York Community Bank
First National of Crystal Falls
Kinecta Federal CU
Omni American Bank
Quail Creek Private Bank
The Golden 1 Credit Union
Northwest Federal CU
Southbridge Savings Bank
Oklahoma Fidelity Bank
Citizens Business Bank
Stanford Federal CU
Western Federal CU
First Midwest Bank
Los Alamos National Bank
Artisan’s Bank
C&F Bank
Oconee State Bank
Security Federal Bank
Easthampton Savings Bank
Stephenson National Bank & Trust
Asheville Savings Bank
United Bank & Trust
New Peoples Bank
Brokerage Firms Are Required to Make Suitable Recommendations and Disclose All Risks
Under FINRA Rules, brokerage firms, including LPL, have an obligation to make only suitable recommendations and to fully disclose all risks associated with a recommended product, including the fact that REITs are illiquid products and subject to declines. Moreover, brokerage firms have a duty to conduct a reasonable investigation of the issuer and the securities they recommend. In the case of Inland REITs, investors have reported that many LPL brokers or advisers represented that they were investments which carried little to no risk, often comparing them to bank investments or Certificates of Deposit. Unfortunately, this information was inaccurate and many investors were burned as a result of misrepresentations made by their advisors. Brokers and brokerage firms have a lot of incentive to sell these products, as commissions can be as high as 10%.
Participating in Dividend Re-Investment Plans, or “DRIP”, Served To Exasperate Damages
Some brokers failed to advise their customers of the risks associated with reinvesting dividends. Those REIT investors who reinvested dividends have experienced even greater losses than those who withdrew the dividends. Many REIT investors who did not need the income generated by the REITs reinvested dividends back into the REITs, rather than sweeping the money to a separate account. This was typically accomplished through Automatic Dividend Re-Investment Plans, also known as a “DRIP.” Automatically reinvesting dividends appeared attractive to many investors given that they were advised that these REITs were low risk, safe investments. Further, given the higher yield being generated by the REITs, it seemed that putting the money back in the REIT rather than placing it in a savings account was the prudent thing to do. All the advantages of dividend reinvestment that work well when a securities product is stable or rising in value will work in reverse if the security is falling. In this situation, the increased position that dividend reinvestment provides also serves to increase and investor’s exposure to losses. While the market is strong and those securities are performing well, that arrangement will be a plus. But if those securities fall out of favor, the losses will be that much greater. Further, reinvesting dividends and increasing a long position in the underlying security can serve to eventually over-concentrate an investment portfolio in that single security. Over time, if the value of the security remains stable or rises, and the number of shares held in the account is increasing, a sharp decline in value of those shares can create significant losses to the investor.
To make matters worse, we believe that reinvested dividends actually purchased shares of the REITs at artificially inflated prices. Even though the United States experienced a widespread reduction in real estate values over the past several years, the share prices of many non-traded REITs remained at or near their initial offering levels during that time period. This in turn gave investors a false sense of preserved value and low price volatility. However, once the REITs were properly valued, the share prices of many REITs declined substantially, meaning that the reinvested dividends purchased shares of the REITs at prices nowhere near to their true value.
Non-traded REITs are a very different investments from REITs that trade on the open market. The most important difference is that, the market price of a non-traded REIT does not truly show the value of the REIT’s holdings, nor does it factor in the prospects for future dividend pay outs. In an open market, the price of a security moves in line with investors’ expectations of the securities’ future value. The share price reflects information concerning investors’ beliefs about growth, expected dividends and value, and it can be effected by market sentiment and news events. The prices of non-traded REITs are not affected by this type of information because they are not openly trade. The prices reported to investors are set at the discretion of management, and can be very misleading as they can be unrelated to the value of the REIT or its holdings. A more accurate measure of a non-traded REIT’s value would be the net asset value of its holdings.
FINRA Rules Regarding REITs
KlaymanToskes has successfully obtained recoveries for clients over the last several years in these same types of illiquid investment products. The danger of clients investing in illiquid products like these is that they are not freely tradable in the market place, but instead are dependant on valuation procedures which may not properly value the securities. Over the years, these valuation procedures have created conflicts of interest. This conduct appears to repeat itself as we have seen this many times before.
In October of 2011, FINRA issued a new Investor Alert called Public Non-Traded REITs-Perform a Careful Review Before Investing to help investors understand the benefits, risks, features and fees of these investments. While investors may find non-traded REITs appealing due to the potential opportunity for capital appreciation and the allure of a robust distribution, investors should also realize that the periodic distributions that help make non-traded REITs so appealing can, in some cases, be heavily subsidized by borrowed funds and include a return of investor principal. Additionally, early redemption of shares is often very limited, and fees associated with the sale of these products can be high and erode total return.
According to FINRA, “Confronted with a volatile stock market and an extended period of low interest rates, many investors are looking for products that offer higher returns in turbulent times. However, investors should be wary of sales pitches that might play up non-traded REITs’ high yields and stability, while glossing over the lack of liquidity, fees and other risks.”
REITs pool the capital of numerous investors to purchase a portfolio of properties—from office buildings to hotels and apartments, even timber-producing land—which the typical investor might not otherwise be able to purchase individually. There are two types of public REITs: those that trade on a national securities exchange and those that do not. FINRA’s alert focuses on publicly registered non-exchange traded, or simply non-traded REITs.
Public Non-Traded REITs outlines the features, complexities, risks and costs associated with non-traded REITs.
• Distributions are not guaranteed and may exceed operating cash flow. In newer programs, distributions may be funded in part or entirely by cash from investor capital or borrowings. Distributions can also be suspended for a period of time or halted altogether.
• Lack of a public trading market creates illiquidity and valuation complexities. Most non-traded REITs are structured as a “finite life investment,” meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate. Many factors affect the valuation of non-traded REITs, including the portfolio of real estate assets owned, strength of the trust’s balance sheet, overhead expenses and cost of capital.
• Early redemption is often restrictive and may be expensive. Most non-traded REITs place limits on the amount of shares that can be redeemed prior to liquidation. These limits can be as restrictive as 5—or even 3—percent of the weighted average number of shares outstanding during the previous year. Additionally, the redemption price is generally lower than the purchase price, sometimes by as much as 10 percent.
• Non-traded REITs can be expensive. State and FINRA guidelines limit front-end fees to 15 percent, but a 15-percent front-end fee on a $10,000 investment means that only $8,500 is going to work for an investor.
Public Non-Traded REITs-Perform a Careful Review Before Investing also warns investors about private REITs—generally sold only to accredited investors—which not only do not trade on an exchange, but are also generally exempt from Securities Act registration. FINRA cautions that it is extremely difficult for investors to make an informed decision about private REITs due to their lack of disclosure documents.
If you sustained losses by investing in Inland Western REIT, Inland American REIT or other REIT or private placement purchased from LPL Financial, please contact our law firm to discuss your legal options, and to discuss the differences between filing an individual securities arbitration claim and class action. A lawsuit against the brokerage firm where you held accounts may help your recover your investment losses.