This article was originally published by Law360.com.
Law360, New York (May 25, 2017, 6:35 PM EDT) — A broker-dealer has agreed to pay $650,000 to resolve allegations that the business unlawfully sold units in non-publicly traded real estate investment trusts to unsuitable New Jersey investors and failed to make and keep adequate records for its sales, state officials announced Thursday.
New York-based David Lerner Associates Inc. reached the deal with the New Jersey Bureau of Securities to settle the alleged violations uncovered in the agency’s probe into the company’s sales of units in three non-traded REITs — Apple REIT Seven Inc., Apple REIT Eight Inc. and Apple REIT Nine Inc., officials said.
The investigation revealed, in part, that David Lerner Associates agents sold some units to investors who did not meet prospectus suitability standards and that the company’s supervisors approved those sales, officials said.
“This settlement with the Bureau of Securities holds DLA accountable for violating securities laws as well as its own supervisory procedures pertaining to the sale of these investments,” New Jersey Attorney General Christopher S. Porrino said in a statement.
Christopher W. Gerold, chief of the Bureau of Securities, noted in the statement that “because of their illiquidity and risks, non-traded REITs and other alternative products are not suitable for all investors.”
“Broker-dealers have an obligation to carefully screen prospective investors to make sure these securities meet their clients’ investment objectives,” Gerold added. “The Bureau will hold those broker-dealers that sell unsuitable products to their clients responsible for their actions.”
In a statement Thursday, David Lerner Associates told Law360 that the business is pleased to resolve the matter.
“DLA conducted its own internal investigation and reported the results of its investigation to and otherwise provided substantial assistance to the New Jersey Bureau of Securities regarding certain record keeping and supervisory issues DLA identified. Since the time period in question, DLA has updated and augmented its existing REIT sales procedures and requirements and has enhanced its operational and supervisory review relating to the sale of all illiquid products,” the company said.
“The overwhelming majority of New Jersey accounts that invested in Apple 7, 8 and 9 realized positive returns on their investment and the small handful that did not have been voluntarily made whole by DLA. The firm agreed to resolve this matter without admitting or denying the Bureau’s allegations,” the company added.
Under a consent order signed by the parties, David Lerner Associates was assessed a $700,000 civil penalty, $100,000 in investigative costs and $50,000 to be placed in a fund to be used for the bureau’s investor education program. The bureau permanently suspended $200,000 of the civil penalty due to the company’s “substantial cooperation” with the investigation, the order states.
According to the consent order, between March 2006 and December 2010, David Lerner Associates sold 364.5 million units of the three non-traded REITs and raised an aggregate $4 billion in proceeds, which were used to purchase multiple hotels.
In October 2012, the bureau received several complaints from investors in connection with the company’s sales of units in the three REITs, and the agency began its investigation, the consent order states.
After the bureau contacted David Lerner Associates about potential failures in its compliance system with regard to those sales, the business agreed to review the sales of units in the three REITs to New Jersey accounts, including contracting with a consultant, working with outside legal counsel and reporting the results of its investigation to and otherwise cooperating with the bureau, according to the consent order.
At the bureau’s direction, the consultant reviewed all 15,748 of the company’s New Jersey accounts to determine whether the investors met the three REITs’ prospectus suitability standards, the consent order states.
According to the consent order, the three REITs contained prospectus suitability standards that stated, “[E]ach purchaser of units must certify that he has either (1) a minimum annual gross income of $45,000 and a net worth (exclusive of equity in home, home furnishings and personal automobiles) of at least $45,000, or (2) a net worth (similarly defined) of at least $150,000.”
Based on the consultant’s review of the 15,748 accounts, David Lerner Associates agents sold units in the three REITs between March 2006 and December 2010 to 282 New Jersey investors who did not qualify under the prospectus suitability requirements, and the company’s supervisors approved those sales, according to the consent order.
The bureau said David Lerner Associates also violated numerous books and records requirements in connection with the sale of units in the three REITs.
“There were no available books and records regarding customer annual net worth, incomes and/or investment objective in at least 40 DLA New Jersey accounts that held the three Apple REITs,” the consent order states.
After the bureau’s investigation began, the three non-traded REITs were merged and listed on the New York Stock Exchange, providing liquidity to the affected New Jersey investors, state officials said.
–Editing by Alyssa Miller