Wednesday, July 20, 2022

NASAA seeks comment on REIT guideline revisions

By Anne Sherry, J.D.

The North American Securities Administrators Association is requesting public comment on four proposed revisions to its guidelines on real estate investment trusts. The revisions would update the suitability section of the REIT guidelines by incorporating the new best interest conduct standard, adjusting financial metrics for inflation, and adding a standardized concentration limit. The proposal would also prohibit using gross offering proceeds as an investment objective or strategy to make distributions. Comments are due August 11.

NASAA’s Direct Participation Programs Project Group recommended the revisions to bring the REIT guidelines up to date. The revisions could influence updates to other sets of guidelines and allow the Business Organizations and Accounting Project Group to move forward with inaugural guidelines for business development companies.

The first recommended revision is to update the REIT Guidelines by formally incorporating the suitability standard of the SEC’s Regulation Best Interest, as well as any other updated conduct standards adopted by the NASAA jurisdictions as applied to brokers. The second, related revision would adjust for inflation to the net income and net worth figures in the suitability section of the prospectus. The last inflation update was in 2007. Under the proposal, buyers of these securities would need either a net worth of $340,000 (up from $250,000) or both a net worth and an annual gross income of $95,000 each (up from $70,000).

Thirdly, the proposal would add a specific concentration limit within the REIT guidelines. This is a repeat of a similar proposal advanced in 2017 but withdrawn in light of conduct standard proposals pending before the SEC and DOL. Despite the implementation of Reg BI, NASAA has found that many broker-dealers have not materially changed their policies, procedures, or practices on the sale of complex and risky products like non-traded REITs. At least 20 state and territorial securities regulators have imposed a concentration limit on non-traded REITs, leading NASAA to suggest a standardized limit of 10 percent of the purchaser’s liquid net worth.

Finally, the fourth proposed revision focuses on a controversial feature of some non-traded REITs, whereby sponsors reserve the right to use offering proceeds to fund regular cash distributions. According to NASAA, investors buying non-traded REITs marketed as “income-producing” or “yield-producing” may believe their money is being invested in income-producing real estate, when really the “income” or “yield” is a partial return of their initial investment. Due to this risk of confusion, NASAA recommends prohibiting the distribution-of-gross-offerings feature.

NASAA offered other criticisms of non-traded REITs that implicate investor protection. These products are heavily marketed to elderly investors despite their inherent liquidity restrictions. Offerings are also long and complex, with a typical non-traded REIT prospectus arriving at about 300 pages, not including supplements. Non-traded REITs include front- and back-end expenses that are costly to the customer, and they have significant risks. These products are a significant source of customer complaints and have resulted in criminal enforcement actions, including four federal fraud convictions this year involving the Texas REIT United Development Fund, NASAA observed.