FINRA Moves in Right Direction on Non-Traded Reits Sold by David Lerner Associates

In a sudden move in the right direction, the Financial Industry Regulatory Authority (FINRA) filed a Complaint against David Lerner Associates, the sole underwriter for Apple REITs.

The complaint alleges, among other things, several violations in David Lerner’s due diligence and suitability obligations. FINRA contends that although Apple REITs are illiquid and heavily concentrated in one sub-sector, namely extended stay hotels, a substantial number of David Lerner Associates customers own two or more Apple REITs.

Since 1992, David Lerner Associates has sold investors more than $6 billion dollars’ worth of Apple REITs shares. Since most non-traded REITs, including Apple REITs, offer commissions that range between 10 percent and 15 percent, David Lerner Associates has seen profits from the sale of Apple REITs of approximately $600 million since 1996, according to FINRA.

The FINRA Complaint also warns that all Apple REITs have not adjusted their $11 per share valuations despite “substantial market fluctuations;” especially in the area where Apple REITs invest, namely commercial real estate. This is particularly troubling due to the fact that performance on these REITs has declined considerably. For example, according to the 2009 annual report, Apple REIT Six showed a 27 percent decrease in its funds from operations compared to 2008; Apple REIT Seven’s funds from operations declined 20 percent in 2009.

But even more shocking is the fact that the FINRA Complaint acknowledges that a substantial portion of distributions paid by all Apple REITs comes from loan proceeds. To top it off, all Apple REITs also include, as part of the distribution, a return of capital. In other words, part of the distribution all Apple REITs promote as income, is actually a return of the investor’s initial investment.

Even though there is no formal relationship between the Apple REIT companies and David Lerner Associates, it is hard to understand why Apple REITs continue to conduct business exclusively with David Lerner.  For the past 20 years, David Lerner Associates has received numerous penalties and fines.

In May 2004, the Securities and Exchange Commission issued a cease and desist order, which included a $50,000 fine for the recommendation and sale of illiquid Lerner-underwritten REIT securities that were unsuitable for customers on margin. Just a year later, David Lerner Associates was fined $115,000 by the NASD (now FINRA) for misleading advertising and sales literature that did not have factual support, making the statements “exaggerated, unwarranted, or misleading,” according to the NASD order of settlement.

At Vernon Litigation Group we continue to investigate non-traded REITs sold by David Lerner Associates and others and we’ve filed a number of claims on behalf of investors.

To see the FINRA release about Tuesday’s complaint, click here.

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