Non-traded real estate investment trusts and non-traded business development companies have generated more customer suitability claims, over a longer period, than virtually any other category of retail product. The product features that make them attractive to customers — current income, exposure to private real estate or middle-market credit, low correlation with public markets — are also the features that make the recurring sales-practice issues so reliable.
The fundamental problem is structural: these are illiquid, long-duration, high-fee products sold to a retail audience that is often unprepared to bear the illiquidity, the duration, or the fees. The recurring suitability claims fall into a small number of patterns, all of them well-known to FINRA, well-known to the firms, and yet still common in the supervisory record.
The Liquidity Disconnect
The defining feature of a non-traded REIT or BDC is that the security is not listed on a national exchange and has no continuous secondary market. Customers who buy the security expect to be able to sell it through the sponsor's share repurchase program, but those programs are typically subject to quarterly limits, sponsor discretion to suspend, and in many cases tender at prices below the prevailing net asset value.
The disconnect between how the product is sold (often as a steady income product) and how the liquidity actually works (typically as a long-hold, illiquid product) is the central suitability issue. A customer with a "moderate" risk tolerance, a 3- to 5-year time horizon, and "high" liquidity needs is not appropriately matched to a product that requires a 7- to 10-year hold and offers redemption only at the sponsor's discretion.
What we routinely see in the documentary record: new-account forms reflecting moderate-or-conservative risk tolerance and high liquidity needs, paired with purchases of non-traded REITs and BDCs in significant proportions of the account. The firm's own concentration guidelines often flag these positions explicitly; the supervisory file often does not.
The Fee Structure
The fee structure of a non-traded REIT or BDC is unusually high for a retail product. Commissions and offering-related costs at the point of sale often total 8% to 12% of the customer's investment. Ongoing management fees and incentive fees are typically high relative to public-market alternatives. The combination means that the customer's effective net asset value at the moment of purchase is substantially below the offering price.
FINRA Regulatory Notice 15-02 required broker-dealers to report the estimated per-share value of non-traded REITs on customer account statements within 150 days after the second anniversary of the broker-dealer's first sale of the security. The point of the rule was precisely to address the gap between what customers paid and what the underlying interest was worth. In practice, the disclosure has not solved the problem. Customers continue to be surprised to see meaningful step-downs in valuation that reflect, in part, the loading of fees at the front end.
For purposes of customer claims, the fee structure is relevant in two ways. First, it bears on suitability and the Reg BI care obligation — a high-cost product imposes a correspondingly higher requirement to demonstrate that the product was reasonably available and in the customer's best interest. Second, it bears on the firm's incentive structure, which is often where conflicts-of-interest claims and Reg BI conflict-obligation claims originate.
The Sponsor-Affiliate Issue
Many non-traded REITs and BDCs are sponsored by, advised by, or otherwise affiliated with the broker-dealer recommending them. The sponsor pays the broker-dealer offering-related compensation; the same sponsor or its affiliate manages the underlying assets and collects ongoing fees. This is not, in itself, improper — but it is the kind of conflict that Reg BI requires firms to identify, disclose, and in some cases eliminate, and that the IA Act fiduciary duty similarly addresses.
Customer claims involving sponsor-affiliated non-traded products often combine a suitability allegation with a conflict-of-interest allegation. The suitability allegation focuses on the mismatch between the customer's profile and the product. The conflict allegation focuses on the firm's economic incentives to recommend the product over alternatives. Together, the two theories present a stronger case than either presents alone.
The Distribution-Funded-by-Capital Issue
Non-traded REITs and BDCs typically pay distributions that customers experience as "income." But during the early years of a non-traded vehicle's life — and sometimes for longer — those distributions may be funded in part by return of capital, by borrowings, or by reductions in net asset value rather than by operating cash flow.
The distinction matters. A customer who is told the product produces "current income" and who has a corresponding income-oriented investment objective may believe that the cash distributions reflect operating performance. When in fact a meaningful portion of the distribution is return of capital, the product is not producing income in the conventional sense; it is, in part, returning the customer's own money and characterizing the return as yield. The disclosure documents typically address this. The sales practice often does not.
The Time-of-Recommendation vs. Time-of-Failure Problem
One of the more important features of the suitability analysis for these products is that suitability is assessed at the time of recommendation, not at the time of subsequent valuation declines. This means that the customer cannot prevail simply by showing that the product turned out badly. The customer must show that the recommendation was unsuitable at the time it was made.
The documentary record at the time of the recommendation is therefore critical. The relevant comparison is between the customer's documented investment profile at the time of the purchase and the documented characteristics of the product at the time of the purchase. Many of the strongest non-traded REIT and BDC cases are built on contemporaneous prospectus disclosures showing risk factors that should have ruled out the recommendation given the customer's then-documented profile.
What to Preserve
If you hold or held non-traded REITs or BDCs and are considering whether you have a claim, the most useful records to preserve are the new-account form in effect at the time of the recommendation, the prospectus and any supplements, the trade confirmation, account statements showing the position and any subsequent valuation marks, any correspondence with the representative about the product, and any sponsor-issued reports or communications you received. The firm has all of these. The custodian has many of them. But the customer-side preservation matters because some of these documents are routinely retained by customers and are easy to produce; whereas firm-side production can be incomplete or delayed.