FINRA Fines and Suspends David Lerner for Apple REIT Ten Misrepresentations

Today, FINRA fined David Lerner Associates $14 million, including $12 million in restitution to investors, for charging excessive markups and misleading investors in a non-traded real estate investment trust (REIT) known as Apple REIT Ten. They also suspended David Lerner himself for one year from the securities industry and for two more years from acting as principal for a securities firm. From the news release:

As the sole distributor of the Apple REITs, DLA solicited thousands of customers, targeting unsophisticated investors and the elderly, selling the illiquid REIT without performing adequate due diligence to determine whether it was suitable for investors. To sell Apple REIT Ten, DLA also 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. FINRA also fined DLA more than $2.3 million for charging unfair prices on municipal bonds and collateralized mortgage obligations (CMOs) it sold over a 30 month period, and for related supervisory violations.

As we've covered before, non-traded REITs have recently drawn significant attention from regulatory authorities. FINRA's complaint against David Lerner, first filed in May 2011, drew significant attention to the problems in the non-traded REIT industry generally. Our own research on non-traded REITs and other alternative real estate investments suggests that the very high commissions and fees on non-traded REITs make them relatively unattractive investments relative to traded REITs, especially given their lack of liquidity and analyst coverage.

The misrepresentations made by David Lerner regarding Apple REIT Ten may not be unique to that firm or to that REIT. Many other broker-dealers for non-traded REITs have sold these relatively long-term illiquid products to elderly and other unsuitable investors, and may misrepresent the largely constant sale prices of non-traded REITs as 'low volatility' market values. Such practices have been the subject of both FINRA and SEC warnings to investors. What is unique about the David Lerner case is that DLA was the sole distributor of the Apple REITs, whereas other non-traded REITs use more than one distributor.

FINRA's action today may be a sign of things to come as regulators begin to crack down in earnest on the non-traded REIT market.

[UPDATE October 23] The story has been picked up by the New York Times and Bloomberg. The NYT story notes that David Lerner will continue to work with the Spirit of AmericaMutual funds and that "those funds, sold by David Lerner Associates, have a total of more than $600 million in assets, and are characterized by high fees, according to Morningstar."