Although stocks and bonds often take center stage in brokerage services, riskier securities portending to offer greater yields and returns sometimes flood the market, leading brokers and investment advisers to a precarious position as these products often also appear enticing through seller commissions, fees, and other transaction charges that benefit the broker and firm, while often placing the client at a costly and unfair disadvantage. At its extreme, a client may fall prey to solicitations to purchase illiquid, non-traded Real Estate Investment Trusts (REITs). REIT-related securities fraud is on the rise due to the complexity of the product involved and financial incentives given to financial professionals to market and sell REITs
Non-traded real estate investment trusts (REITs) are a complex product that brokers may recommend to investors without fully weighing the pros and cons of its risk, or performing rigorous due diligence thanks to added payoffs in the form of upfront fees that benefit the broker or adviser, at the investor's expense.
Why are Non-Traded REITs Risky and Potentially Harmful for Customers? Non-traded REITs are illiquid securities offerings tied to an organization or trust that owns real estate (hence, the "real estate investment trust" name). The idea is simply, in theory: a group of investors pools their money into the REIT's real estate business and shares in the profits if that business produces income.
However, REITs are not so simple. These are illiquid investments which means that an investor's funds can be tied up in a REIT for quite some time, even years, before potential payoffs, may arrive. That means if an investor wishes to sell their stake in the REIT, they must sell back to the REIT itself or to another entity wishing to purchase said investment.
Illiquid REITs are notorious for suspending income distributions and investor redemptions. Investors looking to sell may not even be able to sell back to the REIT itself, meaning the selling clients are left looking at a secondary market, where the REIT may only sell for a fraction of the price the investor initially spent to purchase it.
This results in losses for investors, which can be significant. And, recalling the upfront sales charges that come with purchasing the REIT in the first place, customers' losses are even further compounded.
What is a Broker, Adviser, or Firm's Liability for Selling a Losing REIT? When selling non-traded REITs, just as is the case when selling any other securities product, a registered representative is obligated to execute its due diligence obligations to fully understand the product, determine there is a reasonable basis that the product is suitable for some class of investors, and determine the product is suitable for the actual investor. When working with an actual investor, the professional is responsible for fully inform their client as to the potential risks of the REIT, which may include both the sales charges/commissions/fees and the illiquidity issues, such as the risk of a halted redemption. For a stockbroker, they are also responsible for presenting additional investment alternatives under their Regulation Best Interest obligations.
If a stockbroker, financial adviser, or broker-dealer fails to properly disclose these risks to their customers, this may result in a customer dispute, arbitration claim, or misconduct allegation based on omissions of material fact, and misrepresentation.
As one could imagine, the significant incentive posed by substantial commissions and fees means that brokers are often placed in a position in which the draw of personal profit outweighs the concern and care a representative should generally show toward a client's best interests.
Furthermore, if the broker or adviser who recommended the REIT did so without properly assessing the customer's unique investment profile and risk tolerance preference—for instance, recommending a risky non-traded REIT product to a client whose risk tolerance is conservative/low or moderate, and the product itself is deemed high-risk—the investor who loses money as a result of the poor advice may have ample basis for a claim of unsuitable recommendations.
With over 35 years of experience in the securities field, The Law Offices of Jonathan W. Evans & Associates has successfully pursued claims against brokers, advisers, and brokerage firms for unsuitable recommendations and other misconduct pertaining to ill-fated non-traded REIT transactions in customer accounts that resulted in losses or other harm. If you have suffered damages as the result of an unsuitable non-traded REIT recommendation, please call (800) 699-1881 for an investigation and consultation with one of our experienced FINRA arbitration attorneys.