Alternative Investments

Once more, they are almost always more expensive to hold and pay brokers exponentially higher commissions for selling them. Commissions, fees, due diligence allowances, and marketing expenses for Alternative Investments can exceed 15% of the investment amount. Examples of alternative investments include:

• Regulation D Private Placements
• Regulation A Private Placements
• Non-Traded Real Estate Investment Trusts (REITs)
• Non-Traded Business Development Corporations (BDCs)
• Hedge Funds
• Options strategies
• Unrated and private fixed income bonds
• Oil and Gas Limited Partnerships
• Promissory Notes
• Conservation Easements and tax shelters

These investments are non-traded, which is a primary difference between them and traditional stocks and bonds.  An investor cannot go on a website to pull the ticker symbol and share price information for a Non-Traded REIT because they do not trade and do not “mark to market.” The price investors see on statements for these alternative investments are whatever the issuer of the investment says it is. These prices can be extremely deceiving and lull investors into believing their alternative investment is at or near whatever they paid for it, when in reality, they could be worth only a fraction of that price.  Further, this lack of liquidity means an investor is almost always stuck with the investment until its exit. This can take several years. These exit plans are usually disclosure in complicated and length private placement memoranda, but are also frequently changed and amended with no feedback from investors. Most of the time, the exit plan for these alternative investments, referred to as coming “full circle” or “full cycle” involves “going public” or liquidating and distributing whatever cash there is to investors pro rata.

Regulators and securities industry regulations make clear there are heightened duties owed by brokerage firms and financial advisors when they recommend Alternative investments to their clients.  The first rule that comes into play when financial advisors consider recommending alternative investments is FINRA Rule 2111.05 – the Reasonable Basis Suitability Rule.  This rule requires brokerage firms to act as a “gatekeeper” and determine, based on a due diligence investigation, whether a specific investment offering is suitable for at least some clients.  Compliance with this rule requires brokerage firms to examine the issuer, the investment, verify representation made in the offering documents, evaluate the business plan and its likelihood of success, interview key personnel, perform site visits, amongst other investigatory measures. If the offering doesn’t meet the firm’s standards, then the brokerage firms simply decline to enter into a selling agreement with the issuer and the brokerage firm moves on to the next alternative investment.  Many of these due diligence steps are memorialized in FINRA Regulatory Notice 10-22 and many brokerage firms incorporate this Regulatory Notice into their compliance and procedures manuals. NASD Notice to Members 05-26 discusses brokerage firms responsibilities to vet “new investments”, of which most alternative investments would qualify.  Likewise, NASD Notice to Members 03-71 cautions brokerage firms about ensuring firms perform adequate due diligence on “non-conventional investments.”  In NASD Notice To Members 03-07, FINRA warned brokerage firms about vetting hedge funds before recommending them to clients.  See also Ginzkey v. National Securities Corp., 2021 U.S. Dist. LEXIS 80699 at *7 (W.D. Wash. Apr. 27, 2021) where the federal court sitting in Seattle, ruled that brokerage firms can be sued for negligence in the event there is a failure to abide by FINRA rules in connection with due diligence on private placements and alternative investments, in a class action context.