Client Alert: Recent Real Estate Syndication SEC Actions
DISCLAIMER: The following is not legal advice and does not create attorney-client privilege. It’s purpose is to educate you on newsworthy events. You are advised to contact an attorney for legal advice.
Dear Clients and Friends,
Last week, we received several calls and emails from concerned syndicators regarding SEC letters and subpoenas recently sent to several prominent syndicators.
The subpoenas surround an investigation around one specific company and several related persons and companies related to that company. Passive investors in certain deals relating to the syndicators have also received letters asking that the investor preserve evidence and refrain from deleting or destroying certain materials.
Although the SEC is vague in its communications, we believe the main issue in the investigation appears, at this time, to be the “co-GP” or “capital raiser” issue—i.e., the compensation and inclusion of third parties into the sponsor or management group (or GP). Previously, some syndicators believed that merely including a third party into the management group whose sole purpose or job was to raise capital would not require broker-dealer licensure under the “issuer exemption.”
While this initial investigation is limited so a few specific parties, we do believe that the SEC investigation may lead to further enforcement against additional parties based on widespread practices we’ve been seeing in the real estate industry.
WHAT TO DO!
Syndicators (generally): We’ve been told by many over the past several months that “everyone else is raising capital this way and I haven’t heard of anyone getting in trouble.” Well, this is our heads up to you that people are now potentially in trouble. So please heed the warning—don’t use third party capital raisers, limit the number of folks involved in your syndication, and make sure that EVERYONE in your sponsor group has legitimate, on-going roles in the syndicator other than raising capital, investor relations, and due diligence.
If this issue sounds new to you, you can read our previous client advisory on this topic here. We also recorded a Q&A session on this issue with the former Western Regional Director of FINRA (the agency that regulates broker dealers) here.
If none of this applies to you, then keep calm and carry on. You’re doing great ?
Syndicators who have received a subpoena (none of our clients, since we’d never let you): If you know a syndicator who has receive a subpoena, you should tell them to lawyer up immediately. Friends don’t let friends respond, communicate, or contact the SEC without having a lawyer. Once your friend has a lawyer, the SEC knows that it mustcommunicate with your friend through that lawyer. Your friend also should not hire any regular lawyer—they should hire someone who specializes in defending against SEC enforcement actions and does this on a daily basis. Bonus points if this person was formerly a regulator. While our firm does not do this, we know folks who do, and are happy to give referrals.
Passive investors (generally): One question we’ve gotten is whether its still safe to invest with the parties under investigation. Well, that’s up to you. You should know going into any future deals that these syndicators may be spending a lot of time and resources dealing with the investigation for the foreseeable future. Additionally, they MUST disclose in their offerings that they are under investigation. Basically there’s going to be a lot of extra trouble due to legal risks.
In terms of what happens from here on out (and what options are available to you), you must remember that you invested in private securities, so these securities are not publicly tradable and hence are generally illiquid. If you want to exit the deal, you could attempt to sell them via a secondary transaction, but know that 1) you can only sell these 12 months after investing, 2) you would need to disclose the investigation to the buyer, 3) it’ll cost a significant amount of money to do the legal paperwork that transfers the securities (and you need to consult the original offering documents to see if it’s even allows), and 4) it will likely be at a discount.
It’s hard to say where to go from here because there are a lot of pieces in play. The SEC could do nothing or could merely order that any compensation received by capital raisers be given up. They could also go further and order rescission (the return of capital) to investors, amongst a number of other remedies. State regulators may feel inclined to get involved. Co-investors could file a civil suit (which may end up with investors footing the legal defense bill depending on the indemnification clause in the offering documents).
Passive Investors who have received letters: You should follow the instructions on the letter. We have also gotten questions about whether it’s a good idea to call the SEC, since they invite you to communicate with them. In general, it is never a good idea to talk to any law enforcement without an attorney.
Other than that, we’ll be posting updates on the issue as things evolve on our social media channels. Otherwise, stay healthy and compliant, my friends.
All the best,
Amy Wan, Esq.