Guidelines for Communicating with the Public regarding Unlisted Real Estate Investments
FINRA recently concluded that communications made by broker-dealer firms (“firms”) to potential investors regarding unlisted real estate programs often fall short of FINRA Rule 2210, which requires that such communications be fair, balanced, and not misleading. As a result, FINRA has developed guidelines to assist firms when communicating with investors about two common types of unlisted real estate programs: real estate investment trusts (REITs) and direct participation programs (DPPs).
To comply with Rule 2210, a firm must provide potential investors with an accurate description of the programs it offers and must explain how the programs operate. Toward this end, a firm must:
- state a program’s objectives, a plan by which to reach those objectives, and the possibility, if any, that those objectives will not be met;
- disclose that an investor’s investment is an investment in a program rather than a direct investment in the real estate or other assets underlying a program;
- indicate whether a program that is being marketed as an REIT has or has not yet qualified as an REIT under the Tax Code; and
- create a balance between the risks and benefits of investing in a program by presenting risks in a clear and prominent manner consistent with its presentation of a program’s benefits.
Rule 2210(d)(1)(B) prohibits a firm from misrepresenting the amount or composition of a program’s distribution rates. Toward this end, a firm must:
- neither imply that a program’s distribution rate is a “yield” nor promote a program as a fixed income investment opportunity;
- disclose that a program’s distribution payments are not guaranteed and that any payments may be modified per the program’s discretion;
- include a breakdown of the distribution rate, indicating which percentages of the rate constitute investment cash flows, returns on principal, or borrowings;
- include a breakdown of the time periods during which distributions are funded by cash flows, returns on principal, and borrowings; and
- disclose that returning principal to investors may lead to a lower overall return for a program, and that borrowing funds may lead to an unsustainable distribution rate.
Stability and Volatility
Rule 2210(d)(1)(A) requires a firm to provide a sound basis for any claims it makes about a program. Toward this end, a firm must:
- not assert or imply that a program’s investment volatility is limited without providing evidence to such claim;
- not assert or imply that an offering made at par value demonstrates the stability of the offering’s underlying assets; and
- disclose that an investor may not be able to sell his or her investment depending on the volatility of a program.
Redemption Features and Liquidity Events
Rule 2210(d)(1)(A) also prohibits a firm from omitting material facts or qualifications in communications if such omissions would cause investors to be misled. Toward this end, a firm must:
- not omit the existence of any restrictions or limitations on a program’s redemption feature;
- not omit that a program has discretion in modifying or terminating a redemption feature; and
- not omit that liquidity events do not have guaranteed dates; and
- not omit that a program has discretion in modifying a liquidity event’s date.
Performance of Prior or Related Unlisted Real Estate Programs
A firm must not reference information about prior or related programs in an unbalanced manner. If a firm uses information from prior or related programs to imply that the past performance of those programs is an indication of the expected performance of an advertised program, the firm must include both the benefits and the risks associated with the prior or related programs.
The Use of Indices and Comparisons
Rule 2210(d)(2) requires that a firm, in comparing different investment programs in a communication to potential investors, disclose all material differences between each program, including:
- differences in the objectives or goals of each program;
- differences in the costs and expenses associated with each program; and
- differences in the stability and safety of each program.
Pictures of Specific Properties
A firm may include pictures of the real estate or other assets in a program’s portfolio, but a firm must not use pictures and other illustrations of assets that are not directly associated with an advertised program, even if the assets are similar to those in an advertised program’s portfolio.
A firm may include the capitalization rates for the assets in a program’s portfolio if a firm also explains how each asset’s capitalization rate is calculated and discloses the information from which each capitalization rate is derived. A firm must not, however, blend the capitalization rates for a program’s assets and advertise the blending as an entire program’s capitalization rate.