On December 19, 2011, the staff of the Division of Corporation Finance of the SEC (the “Staff”) issued disclosure guidance on promotional and sales material submitted by registrants under Securities Act Industry Guide 51. Guide 5 applies to real estate limited partnerships, but in 1991 the SEC advised that Guide 5 should be considered in the preparation of registration statements for real estate investment trusts ("REITs").2 Today Guide 5 most commonly applies to offerings of securities by REITs that do not have securities listed for trading on a national securities exchange, commonly known as "non-traded REITs."3 Most of the promotional and sales material submitted to the Staff for review pursuant to Guide 5 is prepared and submitted by non-traded REITs. This memorandum summarizes the principal observations of the Staff in its review of materials submitted by registrants conducting offerings subject to Guide 5, and accordingly many of the Staff’s comments are specific to non-traded REITs.
Generally, registrants conducting securities offerings are permitted to use sales material in connection with those offerings if the sales material is accompanied or preceded by a final prospectus. Non-traded REITs often use such sales and promotional material in connection with their offerings and are required pursuant to Guide 54 to supplementally submit to the Staff prior to use (1) any oral or written sales material5 intended to be provided to investors, and (2) all marketing materials sent to broker/dealers or other sales personnel. The disclosure guidance issued by the Staff summarizes the principal observations of the Staff in reviewing these materials and focuses on comments most frequently occasioned by its review.
Staff Observations and Comments
Below is a summary of the principal areas of Staff comment.
Balanced Discussion of Risk and Reward
Enhanced risk disclosure is a frequent comment issued by the Staff. The Staff has observed that sales material often does not “present a balanced discussion of both risk and reward” as required by Guide 5. For example, a sales brochure highlighting potential investment benefits without also presenting risks that are proportionate in detail does not present sufficiently balanced disclosure. In addition, risk disclosure should be presented with the same prominence as disclosure of investment benefits. Accordingly, the Staff frequently requests registrants to ensure that:
- risk disclosure is proportional in detail to presentation of potential benefits; and
- risk disclosure is presented with similar prominence to reward disclosure in terms of graphics, color and formatting.
Disclosure Consistent with Representations in the Prospectus
Guide 5 requires that disclosure in sales material "be consistent with the representations in the prospectus."6 The Staff frequently asks registrants to update sales material that appears outdated compared to the prospectus and also to consider updating the prospectus as appropriate. However, while disclosure in the sales material and the prospectus should be consistent, the prospectus does not necessarily need to contain all of the information that is contained in the sales material (e.g. such as general industry background information).
If sales material contains information on distributions (such as the quantity and consistency of distributions as an investment highlight), the Staff requests disclosure of (1) the frequency and extent to which distributions have been funded from sources other than cash flows from operations, and (2) the primary sources of funds for such distributions, other than cash flows from operations (e.g. borrowings or offering proceeds). In addition, sales material should disclose if earnings repeatedly have been insufficient to fund distributions and newly formed registrants should not include an annualized distribution rate in sales material until distributions equal to that rate have been paid for at least two consecutive full quarterly periods.
Information about Affiliates
The Staff advises registrants to clearly differentiate any information regarding prior performance of an affiliate or of other programs sponsored by the sponsor or managed by the manager from information regarding the registrant. Any presentation of prior performance by affiliates should be balanced -- for example, information about a sponsor’s less successful programs should accompany disclosure about the sponsor’s most successful programs.
Pictures of Properties
A registrant should not include pictures of properties that it does not own. However, a mortgage REIT may include pictures of properties in which it has a security interest so long as the registrant makes clear that it does not own the property and that the property is only loan collateral. Any pictures of sponsor-owned properties should be clearly identified as such, be limited in number, and must prominently explain that the registrant’s investors will not acquire an interest in the sponsor-owned property.
Use of Market Performance Data and Use of Non-GAAP Financial Measures
Registrants should not include performance information relating to markets or asset classes that are different from those targeted by the registrant. For example, a registrant should not present historical stock performance of an exchange traded REIT to indicate potential performance of a non-traded REIT. Registrants should identify the source of any industry data used in sales material. In addition, any non-GAAP financial measures that are used in sales material must comply with Regulation G.
Redemption Programs and Liquidity Events
Redemption programs are often provided by non-traded REITs as a limited opportunity for investors to liquidate their investment. However, these programs may have significant restrictions, such as caps on the amount of shares that can be redeemed annually, limits on the amounts and sources of funds that may be used to fund redemptions and the ability of the REIT to suspend or terminate the program at its discretion. Accordingly, the Staff asks registrants to highlight any restrictions of the redemption program when the benefits of the program are also described in sales material. In addition, the Staff requests registrants who disclose an intention to list their securities or liquidate their portfolio by a certain date to clearly caution that the actual timing of such a liquidity event is subject to management’s discretion and may differ from the intended time-frame.
Unless the offering price of the registrant’s security is based on a valuation of that security, the Staff objects to statements in sales material that the registrant’s static offering price evidences a lack of volatility in the security’s value. Also, any statements that the potential investment is not subject to the volatility of the stock market must be balanced with the disclosure of the other characteristics of a non-traded security, such as limited liquidity and lack of transparency.
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Critics of non-traded REITs caution investors against lack of transparency, limited liquidity and volatility in value, among other things.7 While the Staff has provided this disclosure guidance to assist registrants in preparing promotional and sales material that is consistent with federal securities laws, more balanced disclosure by non-traded REITs precipitated by the Staff’s comments should allay concern in these areas.