Foot-dragging on rules harms investors

The debate over whether regulation is good or bad will never end. But in cases in which rules either could help investors make better decisions or prevent them from making critical mistakes, rules are not a bad thing. The problem, of course, is that in many, if not most cases, the side being regulated sees little need for more rules, arguing that all they do is drive up costs to the very investors the rules are supposed to protect. And with the help of lobbyists and by other methods, they keep regulations from taking effect as long as possible. Ideally, they get the regulators to water down rules so much that they lack any teeth when they finally take effect. Regulators are notorious for dragging their feet, as well. The latest example of a possible new set of rules comes from the North American Securities Administrators Association Inc., which has been circulating to regulators and representatives in the real estate investment trust industry a list of 33 proposed changes to its REIT policy. Most notably, the group would seek limits on the amount of money that clients could invest in nontraded REITs. Some states currently have such concentration limits, but there is no uniform standard, which is what NASAA is seeking. Dan Matthews, a lawyer with the Washington State Securities Division and a member of NASAA's direct participation-program policy group, told InvestmentNews' Mark Schoeff Jr. that such a standard would be useful. “Our challenge is to find one standard that all parties can agree to,” he said, “with our focus being uniformity and investor protection.” And there's the rub: Finding a standard to which all parties can agree. Indeed, even on the state level, regulators have not agreed on any formal guidelines.

LONG OVERDUE

Technically, NASAA's guidelines are not new but simply updates, which are long overdue, since the original policy statements outlining REIT standards were first adopted in 2007. Over the intervening seven years, the nontraded REIT business has suffered through the financial crisis but recovered and rebounded nicely. In fact, by some estimates, the industry is on track to post its second straight year of $20 billion in sales or more. And the $19.6 billion in sales last year was double the amount in 2012. Aided by low interest rates, a wave of mergers and listings, and solid supply-demand dynamics, nontraded REITs once again have become popular vehicles for yield-starved investors. For much of this year, nontraded REITs have been producing yields on average of 6.4%.

FAT COMMISSIONS

As those yields attract investors, the fat 7% commissions attract brokers and that's where the risk of overconcentration could come into play. If the investment is producing a return that can't be matched elsewhere and I'm getting a nice commission, what's a few more percentage points in a client's portfolio? Everyone will be happy. To be sure, the industry has done a good job over the last few years in working to bolster the transparency of nontraded REITs and bring a new level of understanding to investors. And it backs NASAA's efforts. “We support guidelines that promote transparency and uniformity for investors and a level playing field for sponsors and broker-dealers,” Kevin Hogan, president of the Investment Program Association, told Mr. Schoeff.

WORDS WITHOUT ACTION

That's good to hear, but words without action are empty. NASAA's 33-point list of updates has been floating around for a full year. While many are technical and not all of them relate directly to investor protection, it's imperative that both industry representatives and especially regulators, keep — or get, as the case may be — this ball rolling. But we have reason to be skeptical. Three years ago, in September 2011, the Financial Industry Regulatory Authority Inc. floated a potential rule change that would benefit investors by giving them a clearer picture of what it costs to buy shares of nontraded REITs and other direct-placement programs. Fast forward to last month when, for the second time this year, Finra extended its deadline for the Securities and Exchange Commission to act on the proposed change to customer account statements. Industry executives had expected the commission to vote on the revamped client account statement rule by this month. Along with asking the SEC to put off action, Finra asked the regulator to give the industry more time to make the changes, once enacted. Specifically, 18 months, up from its original proposal of six. That means that if the SEC OKs the rule changes and follows Finra's guidance, investors who own nontraded REITs and other illiquid in-vestments won't see changes in their account statements until April 2016, more than four and a half years after the proposal was initially floated. That's far too long. Investors deserve better than that.