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Published: November 1, 2007
Author: Jonathan Schuster
On November 9, 2007, the Securities and Exchange Commission ("SEC") issued Release No. 34-56779, a notice of application and request for comment (the "Notice") regarding the National Association of Realtors ("NAR") request for exemption from certain provisions under the Securities Exchange Act of 1934 (the "Exchange Act") governing broker-dealer registration and reporting requirements. NAR's application would permit, subject to the conditions of the Notice (as discussed below), licensed real estate brokers who are predominately engaged in and have substantial experience in the commercial real estate market and their firms to receive compensation in connection with the sale of securitized tenant in common ("TIC") offerings.
Background
The Internal Revenue Service ("IRS") issued Revenue Procedure 2002-22 ("Rev Proc 2002-22"), which established guidelines to determine, at least for tax purposes, whether or not a TIC interest constitutes "real estate" rather than a "security." The former determination would permit tax-deferred exchange treatment pursuant to Section 1031 of the Internal Revenue Code of 1986, as amended (a "Section 1031 Exchange"), while the latter would not. The SEC, on the other hand, has largely considered TIC interests "securities" otherwise subject to federal securities regulation. The SEC has expressed this view in a number of no-action letters and the NASD (now FINRA) has issued notices on TIC interests to its members.
Under the Exchange Act, a "broker" engaging in interstate commerce to effect "securities" transactions is required to register with the SEC. A "broker" includes "any person engaged in the business of effecting transactions in securities for the account of others." Absent an exemption, a licensed commercial real estate agent, broker and firm would be required to register as a broker-dealer with the SEC in connection with the sale of securitized TIC interests.
Application for Exemption
The Notice sets forth a request for exemption of the Exchange Act provisions that would otherwise require registration, reporting and compliance of securities broker-dealers to permit any licensed real estate agent or broker who is predominately engaged in and has substantial experience in the sale of commercial real estate, and their firms, to receive a real estate advisory fee from a purchaser of a securitized TIC interest. The following describes certain key, defined terms and conditions in connection with the Notice:
Substantial Experience. NAR's application defines "substantial experience" to include commercial real estate professionals who (1) have received a Certified Commercial Investment Member designation from the Commercial Investment Real Estate Institute or an Accredited Land Consultant designation, (2) have education and transaction experience that is equivalent to those required to obtain those designations, or (3) have participated in at least five commercial real estate transactions having an aggregate value of at least $3 million in the prior five years or at least 10 commercial real estate transactions having an aggregate value of at least $10 million in the prior 10 years, including three transactions in the prior three years. In the alternative, NAR proposes that commercial real estate professionals could satisfy the "substantial experience" requirement based upon a combination of at least two of the following factors: education in commercial real estate; the length of time during which the persons engaged in commercial real estate transactions; the dollar value of commercial real estate transactions in which the individuals have participated; and the number of commercial real estate transactions in which the individuals have participated.
Commercial Real Estate. "Commercial real estate," for purposes of determining the experience requirement, would include all real estate categories, such as office, retail, raw law, multi-family (e.g., more than four dwellings), industrial and others. It would not include TIC interests and single-family and one to four residential dwellings.
Real Estate Advisory Fee. The commercial real estate professional would be able, under the proposed exemption, to receive a real estate advisory fee, which would be paid by the purchaser directly or on behalf of the purchaser by the sponsor or issuer of the securitized TIC interest. As proposed, it is contemplated that the real estate advisory fee would reduce the commission otherwise received by a registered securities broker-dealer.
TIC Interests. The exemption would only relate to securitized TIC interests that are generally offered as replacement property in connection with Section 1031 Exchanges, regardless of whether or not the investor is purchasing the securitized TIC interest for that purpose. As such, each investor would receive a deed at closing and such sales must be effected through registered broker-dealers.
In addition to the foregoing, the Notice contemplates that the client would enter into a written buyer's agreement with the commercial real estate professional before discussing a specific securitized TIC offering. The buyer's agreement would, among other things, obligate the commercial real estate professional to solely represent the client in connection with the purchase of a securitized TIC interest.
The commercial real estate professional would be prohibited from, among other things, listing or advertising the availability of TIC interests, handling client funds, negotiating the terms and conditions of the purchase, representing the client as a purchaser representative, or assisting the client with obtaining financing. In connection with the transaction, the registered securities broker-dealer must perform a suitability analysis and otherwise comply with reporting requirements.
Ramifications of Exemption
NAR believes that the requested exemption would allow a potential purchaser to benefit from the real estate experience of a commercial real estate professional while also receiving the protections under applicable securities laws. If the SEC grants the exemption, professionals in the TIC industry expect an increased awareness of the benefits of Section 1031 Exchange opportunities and, accordingly, a broader distribution network for securitized TIC offerings.
While business relationships between commercial real estate brokers and securities broker-dealers may develop under the proposed exemption, the Notice leaves open how the activities of the parties would interact to avoid engaging in general solicitation or advertising, which is otherwise prohibited under private placements under Rule 506 of Regulation D. Further, the Notice leaves open how a "prior business relationship" between the securities broker-dealer and potential investor would be established and the risk and fee sharing arrangements between commercial real estate brokers and securities broker-dealers.
There is a 30-day comment period during which time interested parties may provide feedback to the SEC on the Notice. Any such comments should reference File No. S7-26-07 and be submitted to the SEC Branch of Records Management. Electronic comments may be submitted by email to rule-comments@sec.gov.
Jonathan Schuster is a partner with Axley Brynelson, LLP, focusing his legal practice on general corporate law, corporate finance and securities, mergers and acquisitions, and private equity matters. He has advised issuers and underwriters in connection with the offer and sale of securities under the Securities Act of 1933, reporting companies on compliance with the Securities Exchange Act of 1934 and broker-dealers, investment companies and investment advisors on regulatory matters.
Mr. Schuster holds several professional credentials, including the CFA, CPA, CMA and CFM designations. He is an adjunct professor at the University of Wisconsin Law School where he teaches the course on securities regulation. Mr. Schuster received a B.B.A. (with honors), an M.B.A., and a J.D., magna cum laude, degrees from the University of Wisconsin-Madison. He may be contacted at 608.283.6769 or by email at jschuster@axley.com.
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