Alternative Investments – Often Tainted by Sales Practice Abuses

 

Investors in search of fixed income have poured money into a variety of alternative investments, including nontraded real estate investment trusts (REITs).  Alternative investments encompass most investments other than traditional stocks and bonds and mutual funds that hold stocks and/or bonds.  There are three basic clusters of problems that investors who are considering these products need to consider: (1) many are flawed investment products, (2) some of  them have turned out to be fraudulent, and (3) regulators are concerned about sales practice abuses by brokers who sell them.

First, alternative investments are complex and tend to be illiquid, hard to value, subject to misvaluation, inordinately costly to own, and difficult for investors and investment advisers to fully understand. This makes many alternative investments flawed products, according to Larry E. Swedroe and Jason Kizer, the authors of “The Only Guide to Alternative Investments You’ll Ever Need – The Good, The Flawed, The Bad, and The Ugly.” What Every Investor Should Know About Alternative Investments.

Second, some alternative investments are beyond flawed.  The alternative investments industry is reportedly upset with the New York Times for publishing an article that referred to a “wave of investor fraud” in alternative investments, including nontraded REITs.  The CEO of the industry’s trade group countered that there has been no “finding of fraud” against anyone related to a nontraded REIT (“Nontraded REIT group in tit-for-tat with NY Times,” by Bruce Kelly, InvestmentNews).  As Mr. Kelly points out, however, he failed to mention the $2.8 billion of promissory notes issued by Medical Capital Holdings Inc. and Provident Royalties LLC, which the SEC charged with fraud.

Third, whether or not issuers of alternative investments commit fraud, sales practice violations by the brokers that sell them, who have the last clear chance to prevent harm to investors, have led to regulatory concerns and scrutiny of the alternative investment industry.  Misrepresentations and failure to disclose material risks associated with alternative investments by selling brokers, who are required by law to independently investigate the claims made by issuers and promoters, but often fail to do so, present the most direct threat to investors.  In that connection, Mr. Kelly notes the recent $2.5 million in restitution and fines that LPL Financial LLC was ordered to pay to nontraded REIT investors by the Massachusetts Securities Division.

Finally, as Mr. Kelly points out, the national media and business press have not done a good job in providing coverage of all of the problems involving alternative investments – the exception being InvestmentNews, which has been on top of that story.

Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.