FINRA Arbitration of Disputes Related to Real Estate Syndicates

Author: Staff

Real estate syndication involves multiple investors pooling funds and putting them into real estate projects, either to acquire a property completely or as an equity contribution to fund the cost of a project. But there is a great deal of variety in which types of projects are considered real estate syndication, and certain private placements may be heavily regulated.

Sometimes disputes involving real estate syndicate projects are arbitrated before the Financial Industry Regulatory Authority (FINRA), which regulates all securities firms by regulating brokers and brokerage firms and monitoring stock market trade.

In an unpublished 2015 case in a California state appellate court called Stark v. Beaton, a defendant appealed after the court denied his petition to vacate an arbitration award associated with a real estate syndication project. The case arose when the parties submitted the defendants’ claims to expedited arbitration under the FINRA rules.

The defendants had met a registered investment adviser in 2007. He made certain recommendations about what the defendants should do with the proceeds from a real property sale. The plaintiffs encouraged the defendants to invest this money, which was over $4 million, in seven tenant-in-common real estate investments. A tenant-in-common investment is a private placement retail real estate syndication.

This type of investment is offered through Financial Industry Regulatory Authority broker-dealers. The investor takes title to a percentage interest in commercial real estate but must abide by several agreements that provide for someone affiliated with the sponsor of the securities to manage the investment. In a tenant-in-common investment, up to 35 retail investors can have title in a pro rata interest.

According to the defendant, the plaintiffs advised the defendants that the operations of this investment would create income and that the defendants would get tax savings too. The written materials associated with the investments had unrealistic assumptions about what the vacancy, expenses, and rental rates would be. The defendants argued there were misrepresentations made.

The parties engaged in 14 hearings in connection with arbitration. The arbitration panel denied the claims and made certain recommendations about expunging references to arbitration from the registered investment adviser’s registration records. They made a finding that the adviser was innocent of all sales practice violations and other claimed wrongdoing in connection with the tenant-in-common investments.

The defendants petitioned to vacate this award on the ground that one of the arbitrators’ disclosures was misleading for failing to disclose various things, including his extensive involvement with other commercial real estate syndications and the fact that he had a former law partner who was a prominent real estate syndication promoter.

The defendants subpoenaed the arbitrator who had not made the disclosures for deposition. The law partner filed a motion to quash the subpoena, which was granted. In allowing the motion to quash, the court noted that the defendant’s argument was that since the arbitrator sold limited partnership securities, he could have been a target for liability under the same securities statutes that the defendant used to bring his claims and thus could be biased. The court noted that the defendant hadn’t shown enough similarities between the investments. The plaintiff’s petition to confirm the arbitration award was later granted.

The appellate court reasoned that the disclosures required by the arbitrators were covered by the Financial Industry Regulatory Authority Rules. The defendant again argued that the arbitrator failed to disclose his personal and significant involvement in commercial and residential real estate syndications.

The appellate court explained that the arbitrator was involved in a real estate syndication in its broadest sense (a group investment in real property), whereas what was at issue here were private placement real estate syndication securities that the defendants had bought. The latter were quite different, and a reasonable person wouldn’t find the arbitrator’s real estate investments with friends and family would create an appearance of bias against either party. It also affirmed the granting of the motion to quash.

You might also enjoy our article on organizing a real-estate syndicate and securities in California.

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