Our attorneys are investigating DeWaay Financial Network and DeWaay Capital Management for making potentially unsuitable investment recommendations in certain alternative investments such as non-traded real estate investment trusts (REITs) and private placements, oil and gas drilling deals, real estate investments, and equipment leasing deals. If you are investor who has suffered losses investing with the Dewaay Financial Network or DeWaay Capital Management, please call one of our attorneys for a free, no obligation consultation.
A “private placement” is an offering of securities that is not sold through an initial public offering, but rather one that is sold privately through pre-existing relationships. Although these securities are subject to the Securities Act of 1933, they do not have to be registered with the SEC and therefore do not pass the same level of scrutiny as a public offering of securities. Instead, companies rely on a set of rules known as Regulation D, which provide companies raising capital with an exemption from registration with the SEC.
Although private placements serve a valuable role in the capital formation process, they are by their nature very risky investments in that there is virtually no oversight from a regulatory agency. Moreover, investors in private placements often face significant problems exiting the investment as the securities they purchased in the private offering cannot be easily resold or liquidated as would be the case with a publicly traded security.
Private placements also can be fertile ground for fraud due to a lack of thorough due diligence or complete disclosure in the offering documents. Moreover, the sales process of private placements creates an inherent risk of misrepresentations, and outright fraud. Brokers who sell private placements typically have the chance to earn very high commissions, ranging anywhere from 5%-15% of the entire investment. These high commissions create a conflict with the broker’s duty to recommend only investments that are suitable for the customer. Customers need to remember that their wealth is not a proxy for an appropriate suitability determination.
Non-listed real estate investment trusts (“REITs”) are designed to allow retail investors to participate in large commercial real estate development projects, such as shopping malls, that they could not otherwise participate in. These non-traded REITs are typically managed by a founding sponsor, who earns fees for services they render such as managing or acquiring properties.
These non-traded REITs raise money for these acquisitions by selling shares in the REITs to retail investors. Nontraded REITs trend to attract unsophisticated investors who do not understand the the extent of the risks involved in the investment, such as lack of liquidity, conflicts of interest, and high fees. Brokers who sell non-traded REITs can earn anywhere from 6-7% in commissions for selling these products.
Non-traded REITs are typically sold at $10 per share, which is an arbitrarily set price that does not change unless the REIT gets revalued. Other than limited exit windows, investors can only exit the investment when the REIT lists publicly, is acquired, or if the investor can find a private buyer. Nontraded REITs are supposed to have a limited life, usually not exceed 10 years, after which they are supposed to distribute the proceeds from the investments.
Brokers selling unlisted REITs have raised more than $59 billion since 2000, which has caused regulators to examine the sales practices of those brokers. In particular, regulators are focused on whether or not the sales were suitable for investors and whether the brokers failed to fully disclose the risks, fees and liquidity of the investments.
As a result of the economic turmoil of the past few years, investors have been filing arbitration claims after being hurt by share devaluations and the suspension of buyback programs in nontraded REITs.
The “Know Your Client” rule (also known as the suitability rule) is one of the most important concepts in the securities industry. In essence, securities brokers have a duty to recommend investments that are “suitable” the investor. The general purpose of the suitability rule is to protect the client and bind the broker to a duty of care that is owed to the client.
A broker recommending the purchase or sale of a security must have a “reasonable basis” for believing that the recommendation is suitable for the client. Before making the recommendation, the broker gather certain information about the client such age, risk tolerance, investment objectives, employment, income, net worth, investment experience. The broker also has an ongoing duty to monitor these factors to make sure the investment recommendation or strategy continues to be suitable for the client.
If the broker fails to adhere to the suitability rule in making an investment recommendation, the broker breaches his or her duty of care that is owed to the client. Unsuitable investment recommendations are the most common area for broker liability. The broker making the unsuitable recommendation may be liable for any losses on investments that were unsuitable.
In addition to the duty of care that brokers owe their clients, brokers also owe a duty to warn of any risks with respect to the client’s investments or of the broker’s investment recommendation. The extent of the warning required may depend on the level of experience and sophistication of a client.