By Suzanne Barlyn — A DOW JONES NEWSWIRES COLUMN , 6/9/2011
NEW YORK (Dow Jones)–When a regulator accuses a brokerage of improperly selling a product and questions the pricing of that product, you might think that regulator would order sales to be put on hold until the case is resolved.
Or, at the very least, that it would have and use the power to require the firm to let potential buyers know that there are some serious questions about the product, from which the brokerage earns a fat fee.
In either case, you’d be wrong.
Last week, the Financial Industry Regulatory Authority, Wall Street’s self-watchdog, alleged that David Lerner & Associates of Syosett, N.Y., is misleading some customers about a real estate-based security called Apple REIT Ten. It said Lerner solicited investors to buy shares without sufficiently checking into whether the investment was right for them. Finra also suggested that Apple REIT Ten shares may be overpriced at $11 each.
In its regulatory complaint, Finra didn’t insist that Lerner temporarily stop selling Apple REITs. And it doesn’t have the authority to order Lerner to inform customers about the complaint, which is information a potential customer could find helpful.
The company rejected Finra’s charges and plans to fight them. In the meantime, it promotes Apple REITs on a page of its website that has no mention of the Finra action. A statement elsewhere on the website says the firm’s disclosures are accurate and that it conducted thorough due diligence of Apple REIT Ten’s offering documents and audited financial statements.
The statement says Lerner “and other small firms have become the scapegoats for Finra’s utter failure to address Madoff’s fraudulent scheme,” a reference to multibillion-dollar Ponzi schemer Bernard Madoff.
A Lerner spokesman sent a copy of the same statement when asked to comment about Finra’s allegations. When asked whether and how Lerner might voluntarily disclose the Finra action to clients, the firm provided a revised statement that describes Finra’s allegations as “baseless” and says Lerner provides required SEC filings, including a prospectus, to all prospective Apple REIT Ten investors. The prospectus includes disclosure regarding conflicts of interest and fees, according to the statement.
The firm advertises extensively on radio as a source of sound investments for working- and middle-class savers. It also regularly holds live seminars. Its website promotes other types of investments, including municipal bonds, collateralized mortgage obligations, and its own family of mutual funds, according to its website.
The Finra action sent some securities lawyers into high gear, filing arbitration claims against Lerner, alleging mispresentation and breach of contract, among other things. They’re also seeking out other Lerner clients who feel they’ve suffered losses from Apple REITs. These lawyers say regulators should have halted sales or at least required full disclosure by Lerner.
Finra’s failure to demand a halt to Apple REIT Ten sales is “shocking,” says Andrew Stoltmann, a Chicago-based securities lawyer who recently filed two arbitration claims and envisions he’ll file at least another 20 in the coming weeks, based on his discussions with potential clients. “If it’s bad enough to file an enforcement action, it’s bad enough to stop it,” he says.
At least one lawyer says a temporary bar on Apple REIT sales would be going too far. Steven Toskes, a securities lawyer for Klayman & Toskes, P.A. in Boca Raton, Fla., suggests Lerner should be simply ordered to “cease and desist from doing seminars unless they give full disclosures.” The disclosure should include details about the Apple REITs’ use of debt and potential conflicts of interest related to Lerner’s fees, he says.
Finra declined to comment on the Lerner case, saying it can’t discuss litigation in progress. But it is known to reserve temporary cease-and-desist orders shutting down a firm’s business, or part of its business, for the most egregious cases.
It hasn’t sought a temporary cease and desist order against Lerner, which perhaps indicates that it doesn’t see the case as among its most serious. That hesitation, however, can expose some investors to unnecessary risk, says Barbara Roper, director of investor protection at the Consumer Federation of America, a Washington, D.C.-based advocacy group.
Regulators do need to know for sure they have the facts before interfering with a company’s business, she says. “On the other hand, if they have strong reason to believe that investors are being harmed, delay in acting is hard to justify,” she says. “It’s a difficult balancing act.” Roper declined to comment specifically on the Lerner case.
Apple REIT Ten is the latest in a series of real estate investment trusts that all carried the Apple name and that all invest in the same extended-stay hotel properties. The trusts are not traded on exchanges, making them harder to sell, and earlier versions in the series are now closed to new investors. Finra says Lerner collects a 10% fee on every sale.
Shares of the REITs have been valued at $11 since 2004, despite changes in the real estate market and an increased amount of debt in the investment, Finra says. It alleges that Lerner didn’t sufficiently re-examine those valuations before selling investors Apple REIT Ten. So far, Lerner has sold over $300 million of a $2 billion offering of Apple REIT Ten since January 2011, according to Finra.
The firm is the sole underwriter of Apple REITs since 1992, according to Finra, selling nearly $6.8 billion of the securities into some 122,600 customer accounts.
Lerner has had run-ins with regulators before. Finra censured the firm and fined it $115,000 in a 2005 settlement to resolve allegations of misleading advertising and promoting REIT programs at seminars without adequately disclosing limitations on investors’ ability to redeem their shares, among other things. Lerner didn’t admit or deny the charges, but agreed not to run seminars for 30 days as part of the settlement, according to regulatory filings.
(Suzanne Barlyn writes Compliance Watch, a column that focuses on compliance and regulatory issues affecting financial advisers. She can be reached at 212-416-2230 or by email at email@example.com.)