In January 2014, the Financial Industry Regulatory Authority (FINRA) proposed revised rules regarding disclosures and valuations of unlisted real estate investment trust (REIT) and direct-participation program (DPP) securities. On October 10, the Securities and Exchange Commission (SEC) approved the revised rules, which are expected to increase the accuracy and transparency of information available to investors.
We’ve written about REITs before, but we haven’t really discussed the difference between publicly traded REITs and what are commonly referred to as “unlisted” or “nontraded” REITs, which are sold by broker-dealers rather than on a stock exchange. Because there is no open market for nontraded REITs, they are both less liquid and more difficult to value than publicly traded REITs, and the associated fees and commissions can be quite high. Similarly, a DPP allows direct participation in the cash flow (both gains and losses) and tax benefits of investment in assets such as real estate or energy, typically in the form of a limited partnership or limited liability corporation.
Brokerage firms have typically listed a per-share price of $10 for nontraded REITs without any regard to their true value. The new rules will eliminate this arbitrary practice. Amended National Association of Securities Dealers, Inc. (NASD) Rule 2340 requires brokerage firms to develop a “reasonably reliable” per-share estimated value for an unlisted DPP or REIT and report that value on customer account statements.
The valuations can be prepared using either of two methods proposed by FINRA: the net investment method or the appraised value method. The net investment method requires that firms provide the net investment amount reported in the issuer’s most recent periodic report based on the “amount available for investment” percentage shown in the DPP or REIT’s offering prospectus. If the prospectus does not report the “amount available for investment,” the net investment number should be based on an equivalent disclosure that shows the estimated percentage deducted from the total number of shares for sale to the public to cover commissions, fees, and other expenses.
The appraised value method requires that firms use the appraised value of the DPP or REIT’s assets and liabilities shown in the issuer’s most recent periodic report. These valuations must be performed at least annually in accordance with standard industry practice and be conducted or verified by a third-party valuation expert. Greenfield Advisors is particularly qualified to perform or validate these valuations.
The new rules also mandate that customer account statements disclose that nontraded REITs or DPPs (1) are not listed on a securities exchange, (2) are generally illiquid, and (3) if sold, the price received may be less than the per-share estimated value reflected on the account statement.
While we haven’t seen an implementation date specified, FINRA submitted an amendment in July proposing that implementation be required no sooner than 18 months after the SEC’s approval to allow the industry sufficient time to prepare for the changes. The SEC’s approval order granted that amendment and was published in the Federal Register on October 17, so we would expect to see the revised rules implemented in April 2016 or shortly thereafter.
What do you think about these changes? Do you have any questions about the new rules? Let us know in the comments.