Tenant in Common (TIC) Securities Fraud and Broker Suitability Responsibilities

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The use of Tenant-in-Common (TIC) real estate investments in conjunction with IRS 1031 exchanges greatly increased after the 2002 issuance of IRS Rev. Proc. 2002-22 which clarified issues related to the uses of TICs in like-kind exchanges.

TICs since that time have been typically sold as securities by securities salespersons registered with FINRA (formerly the NASD) which is a self-regulatory organization overseeing the securities industry. These salespersons (registered representatives) are required to be registered with a Broker-Dealer (brokerage firm) also regulated by FINRA.

The failure of securities salespersons and their firms to perform due diligence on the TIC deals they recommend, and on the sponsors of the TIC deals, can result in disastrous outcomes for their customers who follow their advice if the sponsor of the deal ultimately fails or goes bankrupt.

In addition, salespersons must engage in a suitability analysis prior to recommending TIC deals to their customers to ensure that these illiquid investments are suitable for the customer’s financial situation.

Federal and State Securities laws also prohibit the misrepresentation or omission of material facts in conjunction with the sale of a security. Many state Acts provide for the recovery of losses, attorneys fees, and interest.

The duties of a securities Broker-Dealer and its salesperson to perform due diligence on a TIC investment prior to its recommendation and sale is well-established by both NASD/FINRA guidance and federal caselaw. When performing this due diligence, the Broker-Dealer and representative may not rely upon documents from the issuer/sponsor, but instead must perform independent due diligence to follow up on red flags or irregularities.

NASD Notice to Members 03-71 was issued in November, 2003 and it set out members’ obligations when selling “non-conventional investments," which included TIC private placements. The NASD stated that in the sale of such products, members were required to:

“(1) conduct appropriate due diligence with respect to these products; (2) perform a reasonable-basis suitability analysis; (3) perform customer-specific suitability analysis for recommended transactions; (4) ensure that promotional materials used by the member are fair, accurate, and balanced; (5) implement appropriate internal controls; and (6) provide appropriate training to registered representatives that sell these products."

With regard to the required “due diligence," Notice 03-71 further requires Broker-Dealers to “ensure that their written procedures for supervisory and compliance personnel require that (1) the appropriate due diligence/reasonable-basis suitability is completed before products are offered for sale." Furthermore, “members also must document the steps they have taken to ensure adherence to these procedures."

NASD Notice to Members 05-18 confirmed that TIC investment interests were “non-conventional investments" as described in Notice 03-71, and further stated that TIC investments generally “would constitute investment contracts and thus securities under the federal securities laws."

Notice 05-18 detailed a Broker-Dealer and representative’s duties with regard to obtaining a clear understanding of the customer’s investment goals and financial status for the purposes of making a suitability determination. The representative must also take into account the illiquid nature of the TIC interest, the risks from over-concentration, and the “investment potential of the underlying real estate asset(s)."

Pursuant to federal caselaw on the issue of due diligence for securities sales, securities salespersonscannot “rely blindly on the issuer of the security for information concerning a company…" Hanley v. S.E.C., 415 F.2d 589, 597 (2nd Cir. 1969). The Hanley court further stated that “securities issued by smaller companies of recent origin obviously require more thorough investigation." supra.

Subsequent U.S. Circuit cases further explained this duty to investigate, and stated that “red flags and suggestions of irregularities demand inquiry as well as adequate follow-up and review." Graham v. S.E.C., 222 F.3d 994, 1006 (D.C. Cir. 2000) (citing Frederick H. Joseph, 51 S.E.C. 431, 438 (1993). Securities professionals must “investigate the securities he or she offers to customers," and must and further obtain a “reasonable basis" through investigation that “key representations in the statements provided to investors were truthful and complete." S.E.C. v. GLT Dain Rauscher, Incl. et al., 254 F.3d 852, 857 (9th Cir. 2001).

See also Sorrell v. S.E.C., 679 F.2d 1323 (9th Cir. 1982) where the court stated at 1327: “When a broker ignores the obvious need for further inquiry, even in reliance on assurances from other brokers or attorneys, he violates the act… Nor could Sorrell reasonably rely on advice from White, attorney for Cherokee Coal Company. A broker may not rely on counsel’s advice when the attorney is an interested party."

If you have suffered losses as a result of a TIC investment recommended by securities salesperson or Broker-Dealer, and you would like a free consultation with an attorney to discuss your claims, please contact Greco & Greco.

Additional Resources

http://securities-fraud-blog.com

Recent FINRA Arbitration TIC awards

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