A putative class action was filed Monday against Behringer Harvard REIT I, a $4.4 billion real estate investment trust in U.S. District Court for the Northern District of Texas by any investor who purchased 1,275 shares of the trust from 2004 to 2008.
Behringer Harvard is one of more than a half dozen large non-traded REITs that has seen its value decrease significantly in the wake of the real estate collapse. It is currently valued at $4.64 per share, versus the $10 per share price of its three offerings in 2003, 2005 and 2006.
The complaint however does not seek damages for fraud or federal securities fraud in connection with the sale of these securities to the investing public through brokerage firms. Instead the complaint alleges that the company and its directors violated tender offer laws and engaged in self-dealing in connection with the rejection of two tender offers by third parties.
The complaint also alleges that members of the REIT’s board made false and misleading statements in recommending that investors reject offers by outside funds looking to buy shares of the REIT for as little as $1.80 per share.
Invests in real estate-related assets located in and outside the United States on an “opportunistic basis” and also in collateralized mortgage-backed securities and mortgage, bridge, or mezzanine loans.
There is also no public market for these shares, and except for redemptions upon a stockholder’s death or qualifying disability, including confinement to a long-term care facility, the company is under no obligation to repurchase these securities, and on March 30, 2009, suspended all other redemptions.
Behringer Harvard has consistently paid distributions to its shareholders, it has never covered paying them out of real operating cash flow. Instead, it has covered dividends out of offering proceeds
In March 2009, Behringer Harvard suspended its shareholder redemption program under which shareholders could sell their shares back to the Company.
Instead of suing the company Behringer Harvard, which is unlikely to yield any real results for investors, investors would be better advised to bring actions against the brokerage firms that sold them these securities based upon the theory that the brokerage firms may have misstated the risks associated with these investments or failed to perform their due diligence with respect to the Behringer Harvard REIT.
For example, one company that performed due diligence on the Behringer Harvard REIT in 2008, before that brokerage firm sold any shares warned that the assumptions underlying Behringer Harvard’s projected dividend payout were unsupported and that following a 3.2% distribution in 2007, the Company’s dividend could “never again rise above 4.0%.”
With respect to private placements, such as the Behringer Harvard REIT, FINRA has also reminded its members that:
In the context of a Regulation D offering, Rule 2310 requires broker-dealers to conduct a suitability analysis when recommending securities to both accredited and nonaccredited investors that will take into account the investors’ knowledge and experience. The fact that an investor meets the net worth or income test for being an accredited investor is only one factor to be considered in the course of a complete suitability analysis. The BD must make reasonable efforts to gather and analyze information about the customer’s other holdings, financial situation and needs, tax status, investment objectives and such other information that would enable the firm to make its suitability determination. A BD also must be satisfied that the customer “fully understands the risks involved and is…able…to take those risks.”
Failure to comply with this duty can constitute a violation of the anti-fraud provisions of the federal securities laws and, particularly, Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. It also can constitute a violation of FINRA Rule 2010, requiring adherence to just and equitable principles of trade, and FINRA Rule 2020, prohibiting manipulative and fraudulent devices.
FINRA Notice to Members 10-22 (April 2010). FINRA Notice to Members 10-22 also provides that a broker dealer must conduct a reasonable investigation into each offering, must maintain supervisory procedures under Rule 3010 that are reasonably designed to ensure that these securities are suitable for particular customers, and retain records documenting both the process and results of its investigation
FINRA Reminder
FINRA has also reminded its members that “In order to ensure that it has fulfilled its suitability responsibilities, a BD in a Regulation D offering should, at a minimum, conduct a reasonable investigation concerning:
- the issuer and its management
- the business prospects of the issuer
- the assets held by or to be acquired by the issuer
- the claims being made
- the intended use of proceeds of the offering
- A BD must conduct a reasonable investigation in connection with each offering, notwithstanding that a subsequent offering may be for the same issuer.” (Id. at 5).
As the Securities & Exchange Commission, in its approval of the consolidated FINRA Suitability Rule recently observed:
Reasonable-basis suitability requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.
In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the firm’s or associated person’s familiarity with the security or investment strategy.
A firm’s or associated person’s reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy.
See Securities Exchange Act Release No. 63325 (November 17, 2010).
FINRA Reminder
With respect to the supervision of the sale of private placements, FINRA has reminded its members that “A firm that engages in Regulation D offerings must have supervisory procedures under Rule 3010 that are reasonably designed to ensure that the firm’s personnel, including its registered representatives:
- engage in an inquiry that is sufficiently rigorous to comply with their legal and regulatory requirements
- perform the analysis required by NASD Rule 2310
- qualify their customers as eligible to purchase securities offered pursuant to Regulation D
- do not violate the antifraud provisions of the federal securities laws or FINRA rules in connection with their preparation or distribution of offering documents or sales literature.
FINRA Notice to Members 10-22 at 7 (April 2010).
Guiliano Law Group
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