An effort by state securities regulators to reform sales of real estate investment trusts is drawing strong opposition from the alternatives industry even before the rapidly approaching comment deadline arrives.
Earlier this month, the North American Securities Administrators Association released proposed revisions to REIT policies and began a 30-day public comment period that ends on Aug. 11. It’s the first effort to update state-level REIT rules since 2007.
The reforms include raising the broker standard of conduct related to nontraded REIT sales to incorporate Regulation Best Interest, increasing the net income and net worth thresholds for investors who purchase nontraded REITS, imposing a purchase limit on nontraded REITs and other illiquid direct participation programs that does not exceed 10% of an investor's liquid net worth, and prohibiting nontraded REIT issuers from using gross offering proceeds to fund distributions.
State regulators, the Securities and Exchange Commission and the Financial Industry Regulatory Authority Inc. have been increasing regulatory scrutiny of complex products like nontraded REITs. They are concerned that investors — and sometimes financial advisers — don’t understand the risks associated with products and can be harmed by purchasing them.
As trade associations representing the alternative investment sector race to file their comment letters, here’s a spoiler alert: They hate the approach NASAA is taking.
“Under the banner of investor protection, NASAA is waging a war of investor prevention,” said Anya Coverman, senior vice president of government affairs and general counsel at the Institute for Portfolio Alternatives. “At a time of high inflation and market volatility, the proposal is severely limiting the ability of investors and their financial advisers to access alternative products. It has a chilling effect on investors to be able to decrease their risk profile and properly diversify their portfolio.”
Andrea Seidt, Ohio securities commissioner, countered that the 10% concentration limit on nontraded REIT investments — which applies to purchases from an issuer, its affiliates and other nontraded direct participation programs — does not impose a burden on the alternative sector. She said such investments are meant to be used in small amounts in a portfolio.
“I don’t think this is going to have that limiting effect that they fear,” Seidt said. “It’s not that they can’t sell to investors. They just can’t get more than 10% of that investor’s net worth.”
The concentration limit would establish a uniform policy across all states at a time when at least 20 states have set individual ceilings. The increase in the net-income and net-worth thresholds for nontraded REIT investments update those policies to reflect inflation since 2007, NASAA said. In order to purchase a nontraded REIT, an investor would have to make $95,000 annually and have a minimum net worth of $95,000 or an overall net worth of $340,000. Those numbers are up from the current $70,000 and $250,000.
The proposed reforms are described in a 44-page request for comment, with 10 pages describing the changes and the rest of the document containing exhibits. It’s too much to digest and respond to in 30 days, said John Grady, chief operating officer at ABR Dynamic Funds.
“We see this as a fairly complex and far-reaching set of proposals that go beyond updating REIT guidelines,” said Grady, who is co-chair of the legislative and regulatory committee at the Alternative and Direct Investment Securities Association. “That cries out for discussion, dialogue and input. A comment-letter process doesn’t seem to be the best forum for that kind of exercise.”
Grady is calling on NASAA to extend the comment deadline. But NASAA doesn’t appear to be leaning toward granting more time.
“I don’t see that it is complex,” Seidt said of the REIT request for comment. “Everything that is in this notice are issues that NASAA and the industry have worked on for years. I’m confident they understand and can comply with that 30-day comment period.”
Coverman and Grady also question the data NASAA relies on to support its proposed reforms. In the request for comment, NASAA cites its ongoing study of Reg BI, which shows that brokerages have not reformed their policies and practices for selling complex products. The financial industry has disputed those findings.
“The proposals are not supported by the facts and are subject to profound bias,” Coverman said.
Seidt said NASAA stands by the studies, which are based on responses to surveys the organization sent to financial firms.
“If the data isn’t good, it’s because the firms are not being transparent in that data,” she said.
The tension between regulators and the alternatives industry is likely to continue beyond the NASAA comment request, as substantial market losses bolster arguments for and against using complex products to augment a portfolio.
“It is often the kind of income that’s useful from a diversification standpoint,” Grady said. “Give us a chance to tell our side of the story, not just through comment letters but through public dialogue.”
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