BILL ANALYSIS Ó SB 978 Page 1 Date of Hearing: August 8, 2012 ASSEMBLY COMMITTEE ON APPROPRIATIONS Felipe Fuentes, Chair SB 978 (Vargas) - As Amended: June 18, 2012 Policy Committee: Banking and Finance Vote: 11-0 Urgency: No State Mandated Local Program: Yes Reimbursable: No SUMMARY This bill enacts several changes to the Real Estate Law and Corporations Code, by increasing real estate investor protections, and requiring the Department of Corporations (DOC) to focus greater regulatory scrutiny on, and provide greater transparency regarding, the activities of those who solicit investors in connection with real estate investments. Specifically, this bill: 1)Requires that loans for which investors are sought cannot exceed loan-to-value (LTV) ratios specified in the statute. These LTVs vary from 35% to 80%, depending on the type of property and its intended use (i.e., developed single-family residence, developed commercial, construction, undeveloped, etc.). 2)Interests in loans could not be sold, unless the real estate broker soliciting the investor ensures that the investor meets at least one of the following two requirements: a) The investment does not exceed 10% of the investor's net worth, as defined. b) The investment does not exceed 10% of the investor's adjusted gross income for federal income tax purposes, as specified. 3)Requires every real estate broker and any issuers, as specified, that solicit investors for privately-funded loans to make reasonable effort to ensure the purchaser understands the investment and it is suitable for the investor. 4)Requires the DOC Commissioner to annually prepare a report, as SB 978 Page 2 specified, for publication on the DOC's Internet Web site, summarizing data collected from persons to which it issues securities permits. 5)Authorizes the DOC Commissioner to examine those persons to which it issues permits, review compliance with the conditions of the permits and other applicable state law, and disqualify an offering if the Commissioner finds that the issuer materially violated the provisions of their permit. FISCAL EFFECT The Department of Corporations anticipates the need for two PYs to conduct regulatory examinations at a cost of approximately $250,000 (special fund). SB 978 Page 3 COMMENTS 1)Purpose . According to the author, SB 978 would implement a series of recommendations stemming from a joint informational hearing held by Senate Banking and Financial Institutions Committee and Senate Business, Professions and Economic Development Committee on hard money lending on January 18, 2012. The author argues SB 978 would increase the reporting requirements on those who seek to raise money from investors pursuant to Corporations Codes securities law exemptions. The author concludes that SB 978 would increase the protections available to people who invest their savings with entities soliciting funds for real estate investments. 2)Background . The provisions of this bill are designed to address issues related to what is commonly referred to as "hard money lending," which is the lending of money by private individuals and small pension plans to other private individuals and/or businesses. Interest rates are higher as the risk taken by the lender is usually higher and the loan is more likely to be secured by the asset than the creditworthiness of the borrower. Most hard money lenders lend solely based upon the deal or property at hand. As with all lending, hard money lending has two parts, raising money from investors and lending that money out. The funds usually come from private individuals, not a lending institution. Generally speaking, a license or permit is not required to solicit investors to invest in real estate securities. Investor solicitation may be conducted by licensed real estate brokers, or it may be conducted pursuant to state and federal securities laws. Hard money lending is common in real estate and construction characterized by short-term, high-interest loans and relaxed underwriting standards. Hard money lending is typically used by investors intending to buy a blighted property and rehabilitate it to increase its market value. Most hard money lending happens in lower-middle class neighborhoods where property values are relatively stable and blighted properties are available to purchase at significant discounts. Because of the nature of the transactions and the risks, hard money lending is done at high interest rates. 3)Previous legislation . SB 978 Page 4 a) SB 53 (Calderon and Vargas), Chapter 717, Statutes of 2011 enacted several changes to California's Real Estate Law, including a requirement that hard money lenders inform their investors about which provision or provisions of the Real Estate Law or the Corporate Securities Law govern their transactions. b) AB 2288 ((Blakeslee) of 2010) would have implemented specific criteria for issuers involved in hard money lending. This bill failed passage in Assembly Banking and Finance Committee. Analysis Prepared by : Roger Dunstan / APPR. / (916) 319-2081