What is an Alternative Investment?
“Alternative investment” is a broad term that describes securities that are not offered for sale through a public exchange. Rather, they are considered private placements, which are securities that do not have to be registered with the U.S. Securities and Exchange Commission and are offered only to select investors. Alternative investments are also illiquid, meaning they are not easily converted into cash like traditional investments, such as stocks and bonds.
Types of Alternative Investments
Alternative investments can include a wide variety of offerings. Some of the most common ones include non-traded real estate investment trusts (REITs), business development companies, and private equity funds. Non-traded alternative investments are issued under Regulation D under the Securities Act of 1933. Regulation D provides exemptions from the more rigorous SEC registration requirements and allows companies to offer and sell securities without extensive disclosures. The absence of standard disclosure requirements often creates conflicts of interest.
Non-Traded Real Estate Investment Trusts
A REIT is an investment company that raises capital from investors for the purpose of acquiring real estate. Some REITs are publicly traded and can be easily bought and sold in the stock market. Other REITs are privately held and referred to as “non-traded.”
Non-traded REITs are securities that do not trade on a public securities exchange. For this reason, non-traded REITs can be illiquid, meaning investors may be unable to sell their investments on demand. The underlying collateral of the REITs consists of income-producing residential or commercial real estate. Typically, the commissions generated on non-traded REITs are higher than industry norms (approximately 7%) and the investments themselves may be subject to extreme volatility due to associated risk factors. Non-traded REITs are suitable only for investors with a long-term investment horizon who are willing to accept higher levels of risk in their investments.
The prospectus for non-traded REITs confirm that these securities carry a high degree of risk and that their income stream is subject to fluctuation or suspension. In recent years, non-traded REITs have been oversold by brokerages and many of them have suspended dividends. When this occurs, the principal value of these securities is impacted. Because non-traded REITs are illiquid, investors have no way to sell the investment and limit their loss.
Business Development Companies
Business development companies, or BDCs, are private, closed-end investment companies that help small companies meet their capital needs. BDCs originated in the 1980s to fuel corporate growth during periods of time when interest rates were high and small companies were unable to obtain cost-effective financing.
BDCs make loans to small businesses and finance those loans through capital raised from investors. BDCs are suitable only for investors with a long-term investment horizon who are willing to accept higher levels of risk in their investments. If any of the companies default on their loan repayment obligations, that risk is shifted to investors.
Much like non-traded REITs, the prospectus for BDCs confirm that these securities carry a high degree of risk and that their income stream is subject to fluctuation or suspension. In recent years, BDCs have been oversold by brokerages, and many of the BDCs have suspended dividends and their principal value has declined. BDCs are also illiquid, preventing investors from selling their interest and limiting their loss.
Private Equity Funds
Private equity funds are a class of privately held securities that do not trade on a public exchange. They are often created as investor pools with the purpose of buying underperforming companies that are later sold at a profit. Like other high-risk alternative investments, there are no guarantees with private equity. The SEC does not require thorough financial disclosure. Accordingly, private equity investments are not measured and valued each day, so investors do not know what their investment is worth at any given time. Lack of disclosure in private equity investments often leads to fraud, and investors may lose some or all their investments.
Our attorneys have extensive experience handling claims involving alternative investments. If you believe that you were improperly sold an alternative investment or fraud was involved in your investment loss, contact Wolper Law Firm at 800.931.8452 for a free consultation and case evaluation.
Disadvantages of Alternative Investments
While alternative investments may be profitable, they also come with risks. A major risk is that they are often not registered by the SEC, which means they are not being regulated either.
Another issue is that most alternative investments are illiquid and difficult to value. For example, let’s say you were sold an antique item or other collectible and only a few of those items were made at the time. It may be difficult to determine how much that collectible is actually worth, not only for the item itself, but also for its relative value to a potential buyer.
For these reasons, alternative investments will often require high upfront minimums and be accessible only to accredited investors. An accredited investor is one who has an annual income of more than $200,000 or a net worth that exceeds $1 million. This net worth does not take into consideration the value of an investor’s residence.
When an alternative investment becomes accessible to a non-accredited investor, there is usually a reason why. Either the financial advisor in question is attempting to defraud the investor in some way, or the alternative investment isn’t what it seems to be. In either case, the investor can endure considerable losses as a result of these alternative investments.
Fraud and Negligence Related To Alternative Investments
In order to recover your losses after purchasing an alternative investment, you must be able to prove that your financial advisor or firm wronged you in some way. There are a number of different ways this could have happened, but in many cases, it is because of one of the following:
- Investment fraud. In his or her desire to profit, your broker did not do their due diligence in investigating the security and its issuer.
- Unsuitability. Your broker recommended an alternative investment that was not suitable for your portfolio or goals.
- Failure to supervise. The brokerage firm did not adequately train or oversee the broker who offered the alternative investment that cost you money.
- Selling away. Your broker recommended an alternative investment that was not approved by their brokerage firm.
- Misrepresentation. The investment and its risks were misrepresented by the broker.
If you have lost money on alternative investments for any of these reasons, you may be able to initiate a FINRA arbitration claim against your financial advisor and firm and possibly recover these losses.
About FINRA Arbitration
FINRA arbitration is similar to going to court, with several exceptions. First, once a decision has been reached in arbitration, it cannot be appealed. The second is the amount of time it takes to settle your case. In court, it could be years, if ever, that you receive financial restitution. But if you go to arbitration, a decision can often be reached much more quickly. The average length of arbitration that goes to hearings is 16 months. If you win, the respondent must repay you within 30 days of the decision.
For these reasons, investors are often willing to move forward with arbitration in order to recover their losses rather than waste time in lengthy court proceedings. Our alternative investment lawyer can assist you with filing a claim for arbitration.
Why You Should Turn to Our Alternative Investment Lawyer for Help
Our attorneys have recovered money in more than 99% of investment loss claims we have handled. While we exclusively represent investors who have been wronged by brokers and other financial professionals, prior to opening his law firm, Matt Wolper defended the very brokerage houses that he now goes up against in arbitration and court. This unique insight into both sides of the investment industry serves to benefit our clients, because it allows us to predict the actions of brokers/brokerage houses and their attorneys and stay a step ahead.
Get experienced representation when you have lost investment money. Reach out to Wolper Law Firm today.
Broker Due Diligence and Alternative Investments
The SEC, federal courts, and FINRA have all found that brokerage firms have a duty to conduct a reasonable investigation concerning the private placement issuer’s representations concerning the security. A brokerage’s firm’s due diligence obligation also stems from suitability obligations requiring the broker to have reasonable grounds to believe that a recommendation to purchase, sell or exchange a security is suitable for the customer.
In order to meet the due diligence obligation, the brokerage firm and/or financial advisor must make reasonable efforts to gather and analyze information about the:
- Private placement
- Issuer and its management
- Business prospects of the issuer
- Assets held by or to be acquired by the issuer
- Claims being made by the issuer in the offering materials
- Intended use of proceeds of the offering.
The failure to determine these things and other material information would necessarily preclude a financial advisor from disclosing to a customer the material aspects of a transaction. If the advisor does not disclose these aspects and the customer loses money on the investment, the advisor may be held responsible.
FINRA Focus on Alternative Investments
Alternative investments have been a focus of FINRA for many years because of the opaque and esoteric nature of these products. FINRA has regularly provided guidance to its members about their responsibilities in offering these complex investments.
Notice to Members 03-71
Specifically, FINRA Notice to Members 03-71 states the following:
In the aftermath of the recent downturn in the equity markets, NASD (National Association of Securities Dealers) reviewed the services and products offered by members and observed that retail investors were being offered an array of different investments as alternatives to conventional equity and fixed-income investments. These alternative investments do not fall under a common category; the staff review indicates that brokers and retail investors have shown increased interest in products such as asset-backed securities, distressed debt, and derivative products (for ease of reference these products are collectively referred to as non-conventional investments or “NCIs”). NCIs often have complex terms and features that are not easily understood.
This notice goes on to say:
Members must establish sufficient internal controls, including supervision and training requirements that are reasonably designed to ensure that sales of NCIs comply with all applicable NASD and SEC rules. Members must ensure that their written procedures for supervisory and compliance personnel require that (1) the appropriate due diligence/reasonable-basis suitability is completed before products are offered for sale; (2) associated persons perform appropriate customer-specific suitability analysis; (3) all promotional materials are accurate and balanced; and (4) all NASD and SEC rules are followed. In addition to establishing written procedures, members also must document the steps they have taken to ensure adherence to these procedures.
Regulatory Notice 12-03
FINRA Regulatory Notice 12-03 requires member firms to implement “heightened supervision of complex products.” Specifically, it provides:
[Product] complexity adds a further dimension to the investment decision process beyond the fundamentals of market forces. This may be the case even though the complexity of some products may arise from features that seek to reduce the probability of investment losses in particular situations. Regulators have expressed concern about complex products because the intricacy of these products can impair the ability of registered representatives or their customers to understand how the product will perform in a variety of time periods and market environments and can lead to inappropriate recommendations and sales.
Reasonable diligence must provide the firm or registered representative ‘with an understanding of the potential risks and rewards associated with the recommended security or strategy.’ This understanding should be informed by an analysis of likely product performance in a wide range of normal and extreme market actions. The lack of such an understanding when making the recommendation could violate the suitability rule. Firms should have formal written procedures to ensure that their registered representatives do not recommend a complex product to a retail investor before it has been thoroughly vetted. Those procedures should ensure that the right questions are answered before a complex product is recommended to retail investors.
These due diligence obligations are further codified in FINRA Regulatory Notice 10-22, which “reminds broker-dealers of their obligation to conduct a reasonable investigation of the issuer and the securities they recommended in offerings …. [A] BD ‘may not rely blindly upon the issuer for information concerning a company,’ nor may it rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation…. [F]irms are required to exercise a ‘high degree of care’ in investigating and independently verifying an issuer’s representations and claims. … The fact that a BD’s customers may be sophisticated and knowledgeable does not obviate the duty to investigate.”
Learn About Your Legal Options
As you can see, FINRA makes it clear that brokerage firms have an affirmative obligation to conduct comprehensive due diligence before recommending alternative investments. This is the case even when making alternative investment offerings to experienced investors. When this does not happen and brokers and their firms do not comply with their due diligence obligations, they can be held liable in FINRA arbitration or other legal action. Contact the effective attorneys at Wolper Law Firm to learn about your legal options.
The complexities of alternative investments make them ripe for fraud and negligence. Wolper Law Firm helps investors recover when brokers recommend unsuitable investments or do not perform their due diligence. Call 800.931.8452 to arrange a free consultation.
Get Help from an Alternative Investment Lawyer
To learn more about what the next steps should be in your alternative investment claim, reach out to an aggressive investment fraud attorney at Wolper Law Firm to discuss the individual details of your case. Complete the online contact form below or call 800.931.8452 to schedule a free, no-obligation complaint review. We help wronged investors nationwide.