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Monthly Archives: October 2011

Exchange-Traded Funds Face SEC Scrutiny

Exchange-traded funds (ETFs) are the latest investment product to find themselves in the hot seat with the Securities and Exchange Commission (SEC). At a Senate Banking subcommittee hearing held today, the SEC announced that it was launching a sweeping review of exchange-traded funds.

Among other things, the SEC says it will be looking at investor disclosures, the transparency of the underlying instruments in which ETFs invest, liquidity levels, fair valuations, and the potential impact of ETFs on market volatility.

The SEC’s review also entails “gathering and analyzing detailed information about specific products,” said SEC Investment Management Director Eileen Rominger.

Recent scrutiny of exchange-traded products has been fueled, in part, by the growth of more complex exchange-traded products that many experts contend are far too complex and confusing for the average retail investor. In particular, regulators are concerned about leveraged and inverse ETFs – funds designed to amplify short-term returns by using debt and derivatives.

The Hidden Dangers of Non-Traded REITs

An analysis of the “distributions” of non-traded REITs sold by broker/dealer David Lerner Associates reveals that the property investments of the REITs in question largely underperformed at the level required to pay promised dividends to investors, according to an Oct. 16 story by Investment News.

The analysis went on to show that the products, known as Apple REITs, consistently “borrowed from a line of credit and used distributions that investors were recycling back into the REITs to meet the targeted dividend payout.”

A class-action lawsuit has since been filed against Lerner over the Apple REITs. According to the Financial Industry Regulatory Authority (FINRA), Lerner allegedly provided misleading performance figures for Apple REITs and implied that future investments could be expected to achieve similar results.

The Apple REIT lawsuit also sheds light on some of the potential problems concerning non-traded REITs in general. As in the case of the Apple REITs, a number of investors who have purchased non-traded REITs thought they were getting into safe, conservative investments that would protect their savings from the volatility of the stock market.

In reality, non-traded REITs can be highly risky. The products do not trade on a national stock exchange and are therefore illiquid. They also lack transparency, include limited and lengthy redemption periods, and come with exceptionally high commissions and other upfront fees and charges.

Another potential risk of non-traded REITs concerns their dividends, which are not guaranteed to investors. In the past year, a growing number of non-traded REITs have either suspended their dividends or halted them altogether.

Among those that did just that: Behringer Harvard REIT I, Cole Credit Property Trust, Hines REIT and Wells Real Estate Investment Trust II.

Bond Funds Contain Hidden Junk

Since the end of April, when the stock market began to fall, investors have withdrawn about $75 billion from U.S. equity funds. At the same time, they’ve put about $42 billion into bond funds.  Why? Because they perceive them to be safer than the stock market.

But beware. Some of these bond funds contain huge investments in junk bonds that, in turn, can blow up under certain circumstances. Moreover, all of these funds will drop once interest rates rise. It may take a few years, but make no mistake – they eventually will drop. And as we’ve witnessed in the past, the junk will rise to the top.

FINRA Cautions Investors on Non-Traded REITs

Their names include Behringer Harvard REIT I. Inland Western. Cole Credit Property Trust I.  Wells Real Estate Investment Trust II. Desert Capital. These and other non-traded REITs have become a bone of financial contention for countless investors.

The Financial Industry Regulatory Authority (FINRA) issued an investor alert on non-traded REITs in September in which it outlined potential risks of the products. Among the downsides cited: illiquidity, lack of transparency, and high commissions and other upfront fees.

Another risk associated with non-traded REITs concerns dividends, which are a key component to attracting investors. Known as “distributions” in the industry, these dividends “are not guaranteed and may exceed operating cash flow,” according to FINRA.

As a result, distributions can be suspended for a period of time or halted altogether.

That’s exactly what happened to some of the biggest non-traded REITs, including Apple REIT 10, Behringer Harvard REIT I, Cole Credit Property Trust, Hines REIT and Wells Real Estate Investment Trust II.

A posting on REIT Wrecks, a Web site that follows the non-traded REIT industry, describes what many investors are feeling these days about their non-traded REIT investments.

“I’ve been burned by Behringer Harvard. I sent my request for distribution in on February 10th of 2009. They denied me (and others) without any notice at their next board meeting (after making me resend the damn thing because I needed a special medallion signature stamp from my bank!). I wasn’t getting my money for any reason other than I’d been unemployed since June of 2008 and needed money to live! To find out I could only get my money out if I died was so morose and in bad taste that I wrote appeal after appeal to the board…only to be told to die or become disabled…and then ‘get in line with everyone else’.!

No one ever told me that this thing wasn’t liquid or would ever have these kinds of issues. No one ever told me that the valuation was completely a fiction. They just raised another few hundred million and then closed the doors on everyone!”

Elder Financial Abuse: Know the Signs

Elder financial abuse is a growing crime, with one in four seniors in the United States becoming a victim. In most cases, elderly victims are taken advantage of by someone them know – a family member, caregiver, neighbor, or financial advisor or broker.

A June 2011 study from MetLife Mature Market Institute shows that elderly financial abuse costs its victims nearly $3 billion a year. Women are twice as likely as men to become victims of elder financial abuse, according to the MetLife study, with most individuals between the ages of 80 and 89, living alone, and requiring some level of help with either health care or home maintenance.

Some of the warning signs of potential elder financial fraud and abuse include:

  • Unexplained bank withdrawals.
  • Unauthorized use of a credit or ATM card.
  • Stolen or misplaced credit cards or a checkbook.
  • Unexplained withdrawals from brokerage accounts.
  • Checks written as “cash,” “loan” or “gift.”
  • Abrupt changes in a will or other documents.
  • Unexplained transfer of assets to a family member or someone outside the family.
  • Disappearance of valuables.
  • Sudden appearance of a previously uninvolved relative claiming a right to an elder’s affairs or possessions.
  • New signers on accounts.

The bottom line: If you, a loved one or an elderly neighbor or friend has become a victim of financial abuse, it’s important to contact the authorities. Financial abusers count on silence of their victims to continue their crime.

Non-Traded REITs Remain On FINRA Radar

High fees and a lack of liquidity are just two reasons that non-traded REITs are in the hot seat with the Financial Industry Regulatory Authority (FINRA). Yesterday, the regulator issued an alert to investors, outlining the potential drawbacks and risks that non-traded REITs contain.

Non-traded REITs do not trade on a national exchange, are generally illiquid and sold exclusively through independent broker/dealers. In addition, early redemption of shares in a non-traded REIT is extremely limited, and commissions for non-traded REITs can be as high as 15%.  By comparison, front-end underwriting fees in the form of a discount may be 7% or more of the offering proceeds for exchange-traded REITs.

Despite these drawbacks, non-traded REITs have become increasingly popular in recent year, as investors search for alternative investment vehicles that can offer high yields. As reported Oct. 4 by Investment News, investors bought close to $4.6 billion in non-traded REITs through June 30.

In September, FINRA issued a rule proposal aimed at changing how the value of non-traded REITs appear on client account statements, as well as brokers’ commissions and other upfront costs.

FINRA’s recent investor alert on non-traded REITs outlined several issues with the products, including the fact that the periodic distributions that help make non-traded REITs so appealing can, in some instances, be heavily subsidized by borrowed funds and include a return of investor principal. This is in contrast to the dividends investors receive from large corporations that trade on national exchanges, which are typically derived solely from earnings.

Lack of a public trading market creates illiquidity and valuation complexities. As their name implies, non-traded REITs have no public trading market. However, most non-traded REITS are structured as a “finite life investment,” meaning that at the end of a given timeframe, the REIT is required either to list on a national securities exchange or liquidate, says FINRA.

Moreover, even if a liquidity event takes place, there is no guarantee that the value of your investment will have gone up-and it may go down or lose all its value. Indeed, valuation of non-traded REITS is complex. Many factors affect the pricing, including the portfolio of real estate assets owned, strength of the trust’s balance sheet (assets versus liabilities), overhead expenses, cost of capital and more. The boards and managers of non-traded REITs might even rely on third-party sources to estimate a per-share value.

Finally, properties may not be specified in a non-traded REIT. Most non-traded REITS start out as blind pools, which have not yet specified the properties to be purchased. Others may specify a portion of the properties the REIT plans to acquire, or they may be in various stages of acquisition.

Self-Directed IRAs a New Concern for Regulators, Investors

Concerns about potential risks, lack of transparency, liquidity and possible fraud of self-directed individual retirement accounts will likely lead to tougher restrictions by regulators on broker/dealers that market and sell the products. On Sept. 23, both the Securities and Exchange Commission (SEC) and the North American Securities Administrators Association issued an investor alert warning about investing through self-directed IRAs.

As reported Oct. 2 by Investment News, self-directed IRAs are different from traditional IRAs because they allow owners of the products to invest their retirement savings in a variety of unusual investment vehicles. Those vehicles can include real estate, promissory notes, tax lien certificates, and private-placement securities. Investors in traditional IRAs are generally limited to stocks, bonds and mutual funds.

Private placements in particular have become a cause of concern for investors recently. In 2009, the SEC filed fraud charges against two issuers of failed private placements: Medical Capital Holdings and Provident Royalties LLC. Investors who held private placements in the two entities lost hundreds of millions of dollars. Meanwhile, the placements were allowed to be recommended into IRAs.

According to NASAA, there has been a noted recent increase in reports or complaints of fraudulent investment schemes that utilized a self-directed IRA as a key feature. State securities regulators also are investigating numerous cases where a self-directed IRA was used in an attempt to lend credibility to a fraudulent scheme.

Similarly, the SEC has brought numerous cases in which promoters of fraudulent schemes steered investors to self-directed IRAs.

While self-directed IRAs can be a safe way to invest retirement funds, investors should be mindful of potential fraudulent schemes when considering a self-directed IRA. The SEC says fraudsters often exploit self-directed IRAs because owners are allowed to hold unregistered securities in them, and custodians often fail to performed adequate due diligence on the offerings.

Moreover, because there is a penalty for making early withdrawals from an IRA, investors caught in a scheme might actually be encouraged to keep the money in the account even longer.

Many big broker/dealers have already imposed restrictions or increased their due diligence on investments made through self-directed IRAs. A number of smaller and midsize firms have yet to follow suit, according to the Investment News article.

The reason is because of the higher profit margins that typically come with riskier product offerings.


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