By Saabira Chaudhuri and Caitlin Nish
Wall Street’s self-regulator said Monday it has ordered David Lerner Associates Inc. to pay about $12 million in restitution to customers who purchased shares in a non-traded $2 billion real estate investment trust the firm sold and to customers who were charged excessive markups.
The Financial Industry Regulatory Authority, which said the firm used “unfair practices” to sell the shares, also fined David Lerner Associates more than $2.3 million for charging unfair prices on municipal bonds and collateralized mortgage obligations it sold over a 30-month period and for related supervisory violations.
The Syosset, N.Y., firm, known for its frequent radio advertisements, and its founder and chief executive David Lerner, neither admitted nor denied the charges, but consented to Finra’s findings.
Finra said that as the sole distributor of shares in Apple REIT Ten, David Lerner Associates solicited thousands of customers, targeted unsophisticated investors and the elderly, and sold over $442 million of the illiquid REIT last year without performing adequate due diligence to determine whether it was suitable for investors.
Apple REIT Ten is the latest in a series of Apple REITs that invested almost exclusively in the same extended-stay hotels. Finra said the approximately $600 million generated from Apple REIT sales has accounted for 60%-70% of the firm’s business annually since 1996 and that it has earned over $42 million in commissions and marketing allowances related to sales of Apple REIT Ten shares alone.
Joseph Pickard, senior vice president and general counsel for the firm, said in a statement Monday that there “were no charges nor findings that any of the investments were not in fact suitable for any of the individual investors.” The firm decided to settle with the regulator to “move the company past these distractions,” he said, noting that Finra’s charges have been “very costly to defend and very distracting.”
Finra’s action is likely to be followed by others related to non-traded REITs. The regulator has taken a close look at numerous retail sellers of the products in 2011 and 2012 and has found several instances where firms failed to conduct reasonable due diligence, a Finra executive said at a recent industry conference.
“Finra has a number of open investigations related to the sale of these products,” Susan Axelrod, executive vice president of member regulation sales practice, said last month.
Finra said Monday that in connection with the REIT’s sale, David Lerner Associates used misleading marketing materials that presented performance results for the closed Apple REITs without disclosing to customers that income from those REITs was insufficient to support the distributions to unit owners. In addition, Mr. Lerner personally made false claims regarding the investment returns, market values, and performance of the Apple REITs at numerous investment seminars and in letters to customers, Finra said.
In November 2011, for instance, Mr. Lerner told 400 attendees at a seminar at a Long Island Marriott that the closed Apple REITs were “‘quality’ investments that sophisticated investors such as ‘Warren Buffett’ would buy,” and claimed “that buying Apple REITs is ‘what the wealthiest people in the world do,'” according to the settlement.
Finra fined Mr. Lerner $250,000, and suspended him for one year from the securities industry, followed by a two-year suspension from acting as a principal.
In Mr. Lerner’s absence, Mr. Pickard said the firm will move forward under the leadership of thirty-three year veteran John Dempsey. Mr. Lerner will become more involved with other non-broker/dealer businesses, such as the Spirit of America mutual funds, Mr. Pickard added.
Finra said it also sanctioned the firm’s head trader, William Mason, $200,000, and suspended him for six months from the securities industry for his role in charging excessive municipal bond and CMO markups. The settlement finalizes a hearing panel’s decision in April against Mr. Mason and the $2.3 million fine against the firm, which originally appealed it.
Finra required David Lerner Associates to retain independent consultants to review and propose changes to its supervisory systems and training on sales of non-traded REITs and also on pricing of CMOs and municipal bonds. In addition, it said the firm agreed to revise its advertising procedures, including videotaping sales seminars attended by 50 or more people for three years, and is required for one year to pre-file all advertisements and sales literature with Finra at least 10 days prior to use.
The publicity surrounding settlements such as this one often leads to a spike in investors filing claims for damages in Finra’s arbitration forum. And lawyers say it is likely to help persuade arbitrators.
“This will provide a plethora of evidence because Finra’s investigatory files will now be subject to discovery,” said Lawrence L. Klayman, senior partner at Florida-based firm Klayman & Toskes, which has a handful of cases already in arbitration. “Investors will be able to establish these products were improperly sold.”