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Since January 2011, David Lerner Associates, Inc. ("David Lerner Associates") has recommended and sold over $300 million of a $2 billion real estate investment trust (REIT) — Apple REIT Ten — without performing adequate due diligence in violation of its suitability obligations. Earlier Apple REITs under the same management inappropriately valued the REITs’ shares at a constant artificial price of $11 notwithstanding years of market fluctuations, performance declines, increased leverage and excessive return of capital to investors. David Lerner Associates, in its capacity as best efforts underwriter for all of the Apple REITs, continues to solicit numerous customers to purchase Apple REIT Ten without performing adequate due diligence to determine that there is a reasonable basis to recommend the security to any customer.
According to allegations made by The Financial Industry Regulatory Authority (FINRA) David Lerner Associates has sold and continues to sell Apple REIT Ten targeting unsophisticated and elderly customers to buy the illiquid security.
Since January 2011, as sole underwriter for Apple REIT Ten, David Lerner Associates has sold over $300 million of an open $2 billion offering of the REIT's shares. Apple REIT Ten invests in the same extended stay hotel properties as a series of other Apple REITs closed to investors. Apple REIT Ten and the closed Apple REITs were founded by the same individual, and are all under common management. David Lerner Associates has been the sole underwriter for Apple REITs since 1992, selling nearly $6.8 billion of the securities into approximately 122,600 David Lerner Associates customer accounts. David Lerner Associates earns 10 percent of all offerings of Apple REIT securities as well as other fees. Apple REIT sales have generated $600 million for David Lerner Associates, accounting for 60 to 70 percent of David Lerner Associates's business annually since 1996.
The FINRA complaint alleges that since at least 2004, the closed Apple REITs have unreasonably valued their shares at a constant price of $11 notwithstanding market fluctuations, performance declines and increased leverage, while maintaining outsized distributions of 7 to 8 percent by leveraging the REITs through borrowings and returning capital to investors. As sole distributor, David Lerner Associates did not question the Apple REITs' unchanging valuations despite the economic downturn for commercial real estate.
David Lerner Associates also is alleged to have failed to sufficiently investigate the valuation and distribution irregularities of the closed Apple REITs prior to selling Apple REIT Ten. As the sole underwriter of all of the Apple REITs, David Lerner Associates was aware of the Apple REITs' valuation and distribution practices. Rather than conduct due diligence into those valuations and distribution irregularities to determine that they were reasonable and that the Apple REITs were suitable, David Lerner Associates accepted the valuations and continued to record them on customer account statements.
In its solicitation of customers to purchase Apple REIT Ten, David Lerner Associates's website provided distribution rates for all of the previous Apple REITs. These distribution figures were misleading and omitted material information because they did not disclose recent distribution rate reductions or that distributions far exceeded income from operations and were funded by debt that further leveraged the REITs.
Apple REITs Six through Nine opened between April 2004 and April 2008 and all completed offerings at a price of $11 per share.2 Apple REITs Six through Nine have never changed the value of their shares from the $11 price despite (1) market fluctuations, including the economic downturn for commercial real estate in general and the hotel and hospitality industry in particular; (2) net income declines; (3) increased leverage through borrowings; and (4) return of capital to investors through distributions.
Although all of the Apple REITs are illiquid and concentrated in one subsector, extended stay hotels, a substantial number of David Lerner Associates’s customers own two or more of the Apple REITs. Many of David Lerner Associates’s customers are senior and/or unsophisticated, and David Lerner Associates solicits customers by general means such as the internet, radio, cold calling, mailings, and open invitation seminars at senior centers.
The nearly $600 million generated from Apple REIT sales has accounted for 60–70 percent of David Lerner Associates’s business annually since 1996.
When it began to recommend and sell Apple REIT Ten, David Lerner Associates was aware or should have been aware of valuation irregularities and other improprieties relating to earlier Apple REITs that should have caused it not to recommend and sell Apple REIT Ten before performing appropriate due diligence. David Lerner Associates’s due diligence into Apple REIT Ten was inadequate and has not rebutted the concerns underlying the issue of suitability of Apple REIT Ten.
Twice this year, FINRA’s Advertising Regulation Department has specifically warned David Lerner Associates not to promote Apple REIT Ten using the returns of prior Apple REITs. On March 11, 2011, FINRA’s Advertising Regulation Department issued a review letter advising the firm not to use a sales presentation David Lerner Associates submitted for review, in part because it "contains and discusses returns of REIT programs that are no longer available." As Advertising Regulation explained, "the presentation is misleading, as it promotes investment in a new real estate program based on historical results of closed programs, contrary to Rule 2210(d)(1)."
David Lerner Associates also failed to disclose material information regarding the prior Apple REIT distributions, including the fact that income from those REITs was insufficient to support the 7–8 percent returns the REITs sought to pay and that the REITs had to borrow funds to meet their distribution goals.
The website misleadingly and inaccurately characterized the source of the distributions as "net income and a return of capital, primarily in the form of depreciation" when in fact the return of capital was not primarily from depreciation.
By distributing communications with the public that contained misleading statements and omitted material information, which also violates its duty to observe high standards of commercial honor and just and equitable principles of trade, David Lerner Associates violated NASD Rule 2210(d)(1) and FINRA Rule 2010.
If you have invested in Apple REITs through David Lerner Associates, you may have a claim for the violation of the federal securities laws. For more information contact us at (877) SEC-ATTY.
Nicholas J. Guiliano, Esquire, Guiliano Law Firm, P.C. Practice limited to the representation of investors in arbitration claims against stockbrokers for fraud, the sale of unsuitable investments, breach of fiduciary duty, failure to supervise. National Practice. Contingent Fee. Free Consultation.
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