Division of Corporation Finance
Securities and Exchange Commission
CF Disclosure Guidance: Topic No. 3
Staff Observations in the Review of Promotional and Sales Material Submitted Pursuant to Securities Act Industry Guide 5
Date: December 19, 2011
Summary: This guidance summarizes the Division of Corporation Finance’s observations in the review of promotional and sales material submitted by registrants under Securities Act Industry Guide 5.
Supplementary Information: The statements in this CF Disclosure Guidance represent the views of the Division of Corporation Finance. This guidance is not a rule, regulation or statement of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved its content.
The Commission approved Securities Act Industry Guide 5 for publication in 1976 to provide disclosure guidance for preparing registration statements relating to offers and sales of interests in real estate limited partnerships.1 While Guide 5, by its terms, applies only to real estate limited partnerships, in 1991 the Commission stated that “the requirements contained in the Guide should be considered, as appropriate, in the preparation of registration statements for real estate investment trusts and for all other limited partnership offerings.”2 Continuous offerings conducted by real estate investment trusts (REITs) that do not have securities listed for trading on a national securities exchange, often referred to as “non-traded REITs,” are the most common types of offerings that are subject to Guide 5.3
Registrants are permitted to use sales material in connection with their offerings if the sales material is accompanied or preceded by a final prospectus.4 Item 19.B of Guide 5 defines sales material to include any memoranda, summary descriptions, graphics, supplemental exhibits, media advertising, charts and pictures relating to the offering of the security and proposed to be transmitted to prospective investors. Item 19.D provides that any sales material that is intended to be furnished to investors orally or in writing should be supplementally submitted to the staff prior to its use.5 Item 19.D also provides for all marketing memoranda sent by the registrant or its affiliates to broker/dealers or other sales personnel, including material labeled “for broker/dealer use only,”6 to be submitted to the staff prior to its use. The staff of the Division of Corporation Finance may review and, when appropriate, comment on all such sales material.
In an effort to assist registrants in preparing their sales material in a manner consistent with the federal securities laws, the Division has compiled this summary of comments frequently raised in its review of sales material submitted in response to Item 19 of Guide 5. Registrants may wish to consider the issues identified in this summary when preparing their sales material. These issues represent a substantial majority of our comments and repeatedly arise in our review of sales material. Because most of the sales material submitted to the staff in response to Item 19 of Guide 5 is prepared by non-traded REITs, many of the comments in this summary are specific to non-traded REITs. This summary does not address all issues that the staff may comment on in its reviews. Each registrant may wish to consider the rules and regulations under the Securities Act and its own facts and circumstances when preparing sales material.
Item 19.A – Balanced Discussion of Both Risk and Reward
Item 19.A of Guide 5 states that sales material “should present a balanced discussion of both risk and reward.” We frequently ask registrants to enhance their risk disclosure when their sales material presents the potential benefits of purchasing the registrant’s securities but does not present the material risks associated with the investment in a balanced way.
In our comments, we often ask registrants to ensure that the level of detail in the risk disclosure is proportional to the level of detail in the presentation of the potential rewards. For example, where the registrant submits a one or two page brochure highlighting the potential investment benefits of a security, we often suggest that the presentation of risks be similar in detail to the list of risks provided on the cover page of the prospectus. On the other hand, where the registrant submits a multi-page promotional slide deck that includes a detailed description of the potential investment benefits, we often suggest that the presentation of risks be similar in detail to the risk factor discussion that might be found in the prospectus summary.
We frequently ask registrants to present risk disclosure in their sales material with the same prominence as information about the benefits of the investment. In our comments, we ask registrants to consider the location of risk and reward disclosure within the sales material as well as the format, including font size and graphic features, when assessing the prominence of their risk disclosure. As appropriate, we have asked registrants to reformat their sales material to relocate risk disclosure from the last page of the materials to a more prominent location, to present the risk disclosure within the text rather than a footnote, or to increase the font size of risk disclosure so it is not smaller than the font used to describe the potential benefits of the investment.
Item 19.A – Consistent with the Representations in the Prospectus
Item 19.A of Guide 5 states that the contents of the sales material “should be consistent with the representations in the prospectus.” In our comments, we frequently ask registrants to update sales material that appears outdated when compared to the current prospectus and to consider the need to update the prospectus to include material information about the registrant or the offering that is included in sales material. Although Guide 5 calls for sales material to be consistent with the representations in the prospectus, we have not asked registrants to include in the prospectus all information that appears in the sales material. For example, when sales material contains general background information about the industry that is not specific to the registrant or the offering, we have not requested that registrants include that information in the prospectus.
Other Areas of Specific Staff Comment on Sales Material
Registrants often use sales material to highlight the quantity and consistency of distributions to investors. When a registrant’s sales material includes distribution information, we ask the registrant to disclose:
- the frequency with which, and the extent to which, it has funded distributions from sources other than cash flows from operations determined in accordance with US GAAP; and
- the primary sources of cash, other than cash flows from operations determined in accordance with US GAAP, that it has used to fund the distributions, such as offering proceeds or borrowings.
In addition, if earnings repeatedly have been insufficient to cover distributions, we ask registrants to disclose that fact in the sales material.
We ask newly formed registrants not to include an “annualized” distribution rate in sales material until they have paid distributions equal to that rate for at least two consecutive full quarterly periods. We also request that registrants state in their sales material that distribution payments are not guaranteed.
Presentation of Information about Registrant Affiliates
Many offerings subject to Guide 5 are conducted by registrants that have little or no operating history at the time the offering commences. As a result, sales material often includes information with respect to the operating history of a registrant’s affiliates, including its sponsor or external manager. We frequently advise registrants that prior performance and other historical information about a registrant’s affiliates – including prior performance of programs sponsored by the sponsor or managed by the manager – should be clearly differentiated from information about the registrant within the sales material.
We frequently ask registrants to present additional disclosure in sales material to provide a more complete description of an affiliate’s performance. For example, if a registrant’s sponsor manages a number of other programs, we ask the registrant not to present information about the most successful programs without also describing the sponsor’s less successful programs. We also ask registrants to balance their presentation of affiliates’ prior performance with disclosure of material adverse business developments experienced by those affiliates.
Pictures of Properties
When a registrant includes images or depictions of properties in its sales material, we often ask the registrant to confirm that it owns the properties. If a registrant does not own the properties, we frequently ask it to remove the images or depictions from its sales material. In the case of a mortgage REIT that has included a picture of a property in which it has a security interest, we often ask the registrant to clarify that it does not own the property and that the property is collateral for a loan.
We frequently comment on images of properties in the sales material of newly-formed registrants. If the sales material includes photographs of the sponsor’s properties, we ask the registrant to limit the number of photographs of sponsor-owned properties.7 We also ask the registrant to include prominent text with each picture explaining that the property is owned by the sponsor, not the registrant, and that investors will not acquire an interest in the pictured property. If the registrant’s sponsor does not own properties, or the properties it owns are not similar to the properties the registrant expects to purchase with the offering proceeds, we ask the registrant to remove the pictures of properties from the sales material.
Non-traded REITs often provide investors limited liquidity through stock redemption programs that may have significant restrictions, such as a cap on the total number of shares that can be redeemed in a year and limits on the amount and source of funds that the registrant is permitted to use for redemptions. In addition, non-traded REITs generally reserve discretion to amend, suspend or terminate their redemption programs.
Because redemption programs may be the only way for stockholders to liquidate their investments, registrants often highlight them in sales material. When sales material describes the benefits of a redemption program, we generally ask the registrant to also highlight the potential limitations and restrictions of the program. In addition, if a registrant historically has not satisfied all investor redemption requests, we often seek clear disclosure about registrant redemption history in sales material that discusses the redemption program.
Use of Non-GAAP Financial Measures
We frequently remind registrants that Regulation G, which relates to the use of non-GAAP performance and liquidity measures, applies to sales material. In our comments, we ask registrants to revise their sales material to comply with the requirements of Regulation G.
Use of Market Performance Data
Sales material often includes information about the historical performance of a market or asset class in which a registrant intends to invest. We ask registrants to refrain from presenting data that relates to markets or asset classes that are different from those targeted by the registrant, or to clarify the distinction between the data presented and the markets or assets targeted by the registrant. For example, in our comments, we ask registrants to avoid the use of historical traded-REIT stock performance data to illustrate the potential performance of a non-traded REIT. In addition, we frequently ask registrants to identify the source of any industry data used in their sales material.
Many non-traded REITs present performance data from the National Council of Real Estate Investment Fiduciaries (NCREIF) in their sales material. NCREIF data is derived from the performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes on behalf of tax-exempt institutional investors, the great majority being pension funds. While the NCREIF property portfolio may differ from the targeted portfolio of a non-traded REIT, in our comments we have not objected to the use of NCREIF data by non-traded REITs. We ask registrants to describe the material differences between the NCREIF portfolio and the non-traded REIT portfolio, such as the fact that the NCREIF data reflects the returns of a blended portfolio of institutional quality real estate and does not reflect the use of leverage or the impact of management and advisory fees.
Many non-traded REITs state in their sales material that investors will benefit from owning a security that is not traded because the value of that investment is not subject to volatility in the broader stock market. We ask registrants to balance these statements with information about other attributes of a non-traded security, including limited liquidity and the lack of price transparency.
Some non-traded REITs have proposed sales material that cites their static offering price as evidence that there is no volatility in the value of the security. Unless the offering price is based on a valuation of the security, we object to these statements and instruct these registrants to remove statements in the sales material that suggest a static offering price indicates a stable investment.
Non-traded REITs often disclose in their sales material that they intend to list their securities or liquidate their portfolio by an approximate date, providing stockholders the opportunity to monetize their investment. We frequently ask these registrants to clearly state in their discussion of the intended timeframe for a liquidity event that the actual date of the liquidity event may differ significantly and is at the discretion of management.
1 Securities Act Release No. 5692 (March 17, 1976). Guide 5, which was originally published as Guide 60, provides that it “is not a Commission rule nor is it published as bearing the Commission’s official approval; it contains comments and suggestions that the Division of Corporation Finance has developed in its processing of registration statements relating to real estate limited partnerships.”
2 Securities Act Release No. 33-6900 (June 25, 1991).
3 See generally Investor Bulletin: Real Estate Investment Trusts, which is available on our Investor.gov website at http://www.sec.gov/investor/alerts/reits.pdf.
4 Unless an exemption is available, a written offer deemed a “prospectus” as defined in Section 2(a)(10) must meet the disclosure requirements of Section 10 in accordance with Section 5(b)(1) of the Securities Act. After the effective date of a registration statement, however, any written offer that is accompanied or preceded by a final prospectus that meets the requirements of Securities Act Section 10(a) is excluded from the definition of “prospectus” under the Securities Act by clause (a) of Section 2(a)(10) and thus does not have to meet the disclosure requirements of Section 10.
5 Securities Act Rule 418 authorizes the staff to request the submission of sales material.
6 It is common practice for broker-dealers to file sales material prepared by registrants with FINRA for review and comment. FINRA’s review and comment process is not covered in this disclosure guidance.
7 The appropriate number of sponsor-owned property pictures in a piece of sales material will depend on the size and length of the sales material and the prominence and location of the pictures.