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The North American Securities Administrators Association extended the public comment period on proposed amendments to its guidance on non-traded Real Estate Investment Trusts, in response to industry requests for more time.
But regulators want to know why consumer complaints connected to REITs continue to rise, even after the implementation of the Securities and Exchange Commission’s Regulation Best Interest rule, according to Ohio Securities Commissioner Andrea Seidt, who also serves as the chair for NASAA’s Corporation Finance Section Committee.
“Part of what we’ve heard is that a lot of complaints are just bad apples in the industry,” Seidt said. “If that’s the answer, that there are just bad apples out there, the follow up is, why are there so many bad apples attracted to this product compared to the other products out there?”
The comment period on the amendments was originally scheduled to end on Aug. 11, but NASAA extended it to Sept. 12. According to Seidt, industry trade associations asked for the delay in an Aug. 2 letter.
The new guidelines are needed to update rules to align with Reg BI, as well as setting a new concentration limit of 10% to apply to individuals investing in these products, according to Seidt.
She said NASAA first proposed suitability standards (and new concentration limits) in 2016, but delayed it after industry participants asked them to wait for the Department of Labor’s fiduciary rule (which was later invalidated), and the SEC’s potential conduct standard rules (which eventually became Reg BI).
State regulators waited to see whether the new rules would cause consumer complaints to decline, but that wasn’t the case, according to Seidt.
“Non-traded REITs are one of the products where complaints have actually increased after Reg BI, when other complex and high-risk products have stabilized or even gone down,” she said. “Investor complaints continue to tick up, so the rules have not resolved those investor protection concerns.”
However, industry trade associations, such as the Institute for Portfolio Alternatives (IPA), worry about the proposal. IPA Senior Vice President for Government Affairs and General Counsel Anya Coverman says it could have a “big chilling effect” on investors’ ability to access alternative products.
Coverman also cautioned the rule would result in a “nightmare scenario” for brokers, with concentration limits that could extend beyond REITs to other products, as well as new standards on net worth and income limitations, and the possibility that advisors would have to comply with divergent standards from state-to-state.
“The first and most important thing is making sure we’re not widening the wealth gap, and (we’re) giving retail investors access to private real estate, public and private credit and what we call portfolio diversifying assets or alternative assets, in a time when their needs for those types of assets are even greater,” she said.
Coverman says NASAA based its justification for the proposal largely on an analysis conducted in the wake of Reg BI, but she cited a report by Greenwald Research that was critical of NASAA’s assessment. The Greenwald report found that NASAA’s conclusions “cannot be relied upon as accurate measures of firm behavior, compliance with Reg BI, the impact of the regulation, or the extent to which the interest of investors are well-served.” The report was conducted at the request of a group of trade organizations, including IPA.
“NASAA doesn’t have any economic analysis or cost-benefit analysis to justify this proposal; they don’t discuss instances of over-concentration or investor harm that would lead to the conclusion of this report,” Coverman said. She said the idea that guidelines needed to be updated in light of Reg BI was “not true.”
But Seidt argued many of the original 2016 concerns still applied, as REITs remained comparatively high-cost with significant financial incentives for b/ds. She said progress was too slow on reducing REIT illiquidity, with many investor complaints stemming from misunderstanding illiquidity positions. This could lead to situations where investors are locked into assets when they need cash. She cited the plight of elderly investors who might need to access money to pay for health care or nursing home facilities.
“They find out they can’t liquidate their investments in order to pay for those critical expenses,” she said. “That liquidity risk remains a big issue for retail investors, and that has not gone away; it’s still there in 2022.”
Setting concentration standards to 10% of investors’ liquid net worth will severely limit their ability to purchase REITs, according to Gina Gombar, a vice president of government affairs and associate general counsel at the IPA. Additionally, though the guidelines suggest a 10% net worth standard as a cutoff, administrators in each jurisdiction would have discretion to increase or decrease it as desired.
“It’s going to exacerbate the lack of uniformity rather than standardize it across the states when you have unlimited discretion to choose,” she said.
But NASAA feels the lack of uniformity is a problem now, with Seidt saying 20 different states already impose concentration limits on non-traded REITs in a non-uniform fashion. While the proposed guidelines allow for flexibility to account for different situations, she argued the guidelines would promote more uniformity with its 10% threshold (a threshold she said largely mirrored what was already in place in states with concentration limits on the books).
“Should it be a different percentage than proposed, and should it apply more narrowly or broadly than proposed? We’re waiting to hear what commenters think,” she said. “But we’re using real state standards as our template.”
Both Coverman and Gombar believe the language of the guidance means it could be used as a reference for additional product guidelines in the future. Even the wording of the concentration limits themselves were drafted “so broadly and without proper limitations” that it would extend beyond REITs to any offering by a major asset manager, according to Coverman.
“So, the potential for the future is, ‘we’re planning to take this whole package of updates and apply it to many other types of products,’” she said.
Seidt said NASAA would confer with industry participants about the issue before a final rule was released.
“I’m hoping that can be handled amicably through the comment process,” she said.
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