Too many firms continue to skirt Regulation Best Interest requirements when recommending non-traded real estate investment trusts to clients, according to a new analysis from the North American Securities Administrators Association.
The report marked the latest step in the organization’s Coordinated National Regulation Best Interest Initiative, intended to track registrants’ adherence to the SEC’s rule that took effect in 2020 (the first analysis of exams took place in 2021).
The association’s Broker/Dealer Section Committee analyzed results from more than 200 exams that questioned firms on Reg BI compliance, with an emphasis on complex products like non-traded REITs and private placements.
In general, while examiners found some firms relied heavily on “suitability policies” in place before Reg BI, most firms had updated policies to focus on Reg BI obligations (though more specific instructions were needed).
When it came to risky products like private placements and non-traded REITs, firms were largely imposing product-specific restrictions. Nearly all examined firms limited non-traded REIT sales based on one or several factors, including a client’s age, their risk profile, need for liquidity and time-horizon (though firms were more likely to have limitations as opposed to outright sales prohibitions).
Additionally, some firms limited sales to accredited investors, and most firms disallowed more than 10% of a client’s liquid net worth to be invested in such products. But too many firms failed to recommend lower-cost or lower-risk products for clients in lieu of REITs, including individual equity purchases of a real estate company, a real estate-focused mutual fund or ETF, or a publicly-traded REIT.
“Unlike the more compelling explanations that firms offered for recommending non-traditional ETFs over lower-risk options, firms tended to offer vague and generic explanations why nontraded REITs were recommended in lieu of lower-cost and lower-risk alternatives,” the report read.
As with non-traded REITs, firms typically had net income and worth standards and concentration limits in place for private placement recommendations and sales, with all analyzed firms adhering to federal laws restricting private placement sales to accredited investors.
Concentration limits typically mirrored those for non-traded REITs, but like those products, firms tended to put limits on private placement sales rather than outright bans, according to NASAA. NASAA believed the limits were essential, with the regulators calling private placements “a primary source” of customer complaints and enforcement actions.
But like non-traded REITs, some firms had no formal investing requirements beyond the accredited investor limit, and many firms didn’t require brokers to consider or offer lower-cost or lower-risk alternatives to private placements.
NASAA stressed that firms making most of their money from alts needed to ensure they weren’t sticking with suitability forms and questionnaires in place long before Reg BI, without updating them. Too many firms didn’t update policies or product approval forms to remind registrants they’re required to “consider reasonably available alternatives,” according to the report.
Examiners on the federal level are also focused on high cost and illiquid products like non-traded REITs, according to the SEC’s annual Exam Priorities report. Examiners specifically focused on how sales and recommendations of these kinds of products violated Reg BI.
But advisors are warming to alts investments despite the scrutiny, according to an annual report from the Financial Planning Association. As of this year, more than half of advisors’ allocation recommendations included funds investing in various “alternative” strategies, while one in five advisors were making direct investments.
The number of registrants using non-traded REITs jumped from 13.2% to 16.8% between 2019 and 2023, although the report also found that individually traded REIT recommendations went down from 20.3% to 16.8%, according to the FPA. The analysis found that only 3.1% of respondents expect to recommend them within the next year.
