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FINRA Proposes Rule Change Calling For More Transparent Pricing of Non-Traded REITs

The Financial Industry Regulatory Authority (“FINRA”) has proposed a change to NASD Rule 2340 (Customer Account Statements) which would remove a firm’s requirement to include per share estimated values for non-traded real estate investment trusts (“REITs”) on its customers’ account statements. If the firm chooses to list the estimated per share values of non-traded REITs on its account holders’ statements, the firm would be required to take into consideration various fees and expenses impacting the per share value, when determining the estimated value. If the proposed rule is approved by the Securities and Exchange Commission, it would eliminate the standard practice of firms reflecting the per share value of non-traded REITs at $10 per share.

Currently, NASD Rule 2340 mandates that brokerage firms provide account statements to its customers, on at least a quarterly basis, containing a description of any securities positions, money balances or account activity since the last statement, including the estimated per share values for non-traded REITs. As it stands now, during a non-traded REITs offering period, its annual report typically reflects its gross offering price without taking into consideration the offering expenses or cash distributions that occur during the offering period. Because a security’s initial offering period may last for three years and be extended, it is not inconceivable for a customer’s account statement to reflect the gross offering price for up to seven and a half years.

FINRA’s proposed revisions to NASD Rule 2340 would remove the requirement that firms include a per share estimated value for unlisted REITs, but any firm that chooses to include the estimated value must: 1) determine the value in a manner reasonably designed to ensure that it is reliable; 2) the firm has no reason to believe that the value is unreliable; and 3) the account statement must include specific disclosures.

The proposal submitted by FINRA includes two methodologies under which an estimated value would be presumed to be reliable: (1) net investment; and (2) independent valuation.

The net investment methodology would reflect the net investment disclosed in the issuer’s most recent periodic or current report. In its proposal, FINRA provided the example of a prospectus for a non-traded REIT containing a $10 per share offering price, disclosing selling commissions totaling 10%, and offering expenses of 2%, the amount would result in a net investment value of 88% or $8.80 per share.

The independent valuation methodology refers to the most recent valuation disclosed in the issuer’s periodic or current reports as determined by a third-party valuation expert.

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