The Retiree Who Wants a Third of Her Money in One Illiquid Program
Ruth is 71 and retired. Her liquid assets are $500,000 in a brokerage account, $90,000 in CDs maturing next month, and $50,000 in a money market fund. Social Security and a small pension produce $31,000 a year, but she withdraws roughly $30,000 annually from savings to cover expenses. Her only other asset is a mortgage-free condo worth $410,000. She has never owned a limited partnership; her experience is limited to mutual funds and CDs. She wants to put $200,000 into a non-traded REIT limited partnership paying a 6.25% annual distribution because “the yield beats my CDs and I need the income.” She signs the subscription agreement during the meeting and asks you to send it in today.
1. What must you be able to establish before this subscription can be accepted, and which specific facts in Ruth's profile cut against acceptance?
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FINRA Rule 2310 requires reasonable grounds to believe, based on information from the customer, that she is in a financial position to realize to a significant extent the benefits of the program (including tax benefits), has a fair market net worth sufficient to sustain the risks of the program - including loss of the entire investment and lack of liquidity - and is otherwise suitable. Rule 2111 adds the reasonable-basis, customer-specific, and quantitative suitability obligations.
Against acceptance:
- Concentration. $200,000 is about 31% of $640,000 of liquid net worth. Many states and the NASAA non-traded REIT policy use a 10% of liquid net worth ceiling; check your state's rule. Even absent a hard cap, a third of liquid assets in one illiquid program is hard to defend.
- Liquidity need. She is drawing ~$30,000 a year from savings against $640,000 of liquid assets. Locking up $200,000 of that base in a program with no public market and limited redemption accelerates depletion.
- The yield is not a coupon. The 6.25% distribution may be funded partly from offering proceeds or borrowings; distributions that include return of capital reduce net asset value and are not comparable to a CD coupon.
- Experience. No alternative-investment experience; she cannot be said to be able to evaluate the risks and merits without significant education.
A supportable order, if any, is far smaller - on the order of the 10% figure - and only after documenting the discussion.
2. Ruth says, “Fine, make it $64,000, but I want the full 6.25% on it.” How do you handle that instruction and what do you tell her about the distribution?
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Accept the reduced order only after the suitability file supports it, and route it to a registered principal for review - an order this size in an illiquid DPP at her age and draw rate should be approved, not merely written. Document the conversation, the alternatives discussed, and the reason for the reduction.
On the distribution, explain plainly:
- The rate is a distribution rate, not a yield or a guarantee. It is set by the sponsor and can be changed or suspended.
- Distributions may be paid from cash flow, offering proceeds, borrowings, or asset sales. Portions funded from anything other than operating cash flow are a return of her own capital and reduce NAV, so a 6.25% distribution with a declining NAV is not income in the way a CD coupon is.
- The shares are illiquid; there is no public market, and any repurchase program is discretionary, capped, and often suspended.
- She should consider whether keeping a larger cash/CD reserve is the better answer to her income need.
Do not repeat or endorse any statement that the distribution is “like a bond coupon” or “safe.” If she still wants $200,000, escalate in writing to supervisory and compliance rather than executing the order.
3. If the full $200,000 order were nonetheless entered and confirmed, what supervisory and recordkeeping failures would you have created?
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Several, and they compound:
- Rule 2310 and Rule 2111 violation. No reasonable grounds existed on the documented facts, so the firm failed its suitability gate at the point of sale - the obligation attaches when the order is accepted, not when a complaint arrives.
- Principal review failure. New DPP accounts and DPP orders are typically subject to heightened principal review; the file would show no analysis of concentration, liquidity, or the source of the distribution.
- Books and records (Rule 4511 and firm policy). The account record would lack the financial-profile data, the investor questionnaire, and the rationale. That omission is itself the violation and also destroys the firm's ability to defend the sale.
- State blue-sky exposure. The units must be registered or exempt in her state of residence, and some states impose their own concentration limits on the offering.
- Disclosure failure. No documentation that she understood return of capital, illiquidity, or loss-of-principal risk.
The practical lesson: the suitability determination is a documented analytical step, not a signature on a subscription agreement.