Alternative Investments, which includes REITs (Real Estate Investment Trusts)
, are often sold as an alternative to more traditional stocks, bonds, and stock and bond funds. These higher-risk investments are often touted for their high returns, especially in a low interest rate environment, however those high returns are accompanied with corresponding high risk. As the old saying goes, there is no such thing as a free lunch – investors generally cannot increase their returns significantly without taking on higher risk.
In addition to their often high-risk nature, alternative investments may also have significant liquidity risk. Because they are typically not traded on an exchange, investors may not be able to determine the actual value of the investment, and further if the investment experiences problems, investors may not be able to sell or otherwise get out of the problem investment.
If Alternative investments can be high risk, then why are they often sold by financial advisors to those that cannot afford to take on such risk, such as seniors and retirees? As is often the case in the securities/investment industry, the answer is commissions/fees. Alternative investments typically pay higher fees and commissions to the brokers selling them than would be paid for a more traditional mutual fund. For example, the commissions and fees paid to the selling brokers of GWG L bonds (an alternative investment which is now in bankruptcy) totaled as high as 8%.
Registered FINRA securities firms and their brokers are not allowed to simply recommend and sell alternative investments to their customers without carrying out multiple analyses. First, they must conduct proper due diligence on the investment. FINRA (formerly known as the NASD) has issued specific guidance to member firms and advisors as to their duties to conduct due diligence on non-conventional investments. NASD Notice to Members 03-71 alerted firms that their due diligence on non-conventional investments should investigate the following:
- “The liquidity of the product
- The existence of a secondary market and the prospective transparency of pricing in any secondary market transactions
- The creditworthiness of the issuer
- The creditworthiness and value of any underlying collateral
- Where applicable, the creditworthiness of the counterparties
- Principal, return, and/or interest rate risks and the factors that determine those risks
- The tax consequences of the product
- The costs and fees associated with purchasing and selling the product”
This due diligence requirement is incorporated into the current SEC regulatory standard that has replaced the suitability rule, Regulation Best Interest (Reg BI). This duty, formerly known as reasonable basis suitability, requires brokerage firms to understand the potential risks, rewards, and costs associated with the recommendation.
Securities firms further must determine under Reg BI that an investment or investment strategy is in the best interest of a customer before they can recommend it to a customer. This analysis must take into account a variety of factors, including retired status, income, risk tolerance, other assets, other alternative investments held, etc.
Because of the risks involved with alternative investments and REITs, many securities firms have limits set in their compliance and supervisory procedures as to the amount of alternative investments which may be recommended to customers.
Greco & Greco’s securities fraud lawyers have extensive experience representing investors and retirees who have been sold inappropriate and unsuitable high risk alternative investments and other products. We represent customers exclusively, typically in FINRA arbitration, to attempt to recover losses caused by unsuitable and fraudulent sales of alternative investments. These unsuitable sales often involve retirees who cannot afford to lose their savings. Brokers in these situations may emphasize the potential benefits and income to be earned by a product without discussing the corresponding risk from the product. If you have lost a significant amount of your savings in alternative investments and would like to discuss a potential claim with an attorney, please contact Scott Greco for a free attorney consultation