BILL ANALYSIS                                                                                                                                                                                                    Ó



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          SENATE THIRD READING
          SB 978 (Vargas and Price)
          As Amended  August 20, 2012
          Majority vote 

           SENATE VOTE  :38-0  
           
           BANKING & FINANCE   11-0        APPROPRIATIONS      17-0        
           
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          |Ayes:|Eng, Achadjian, Charles   |Ayes:|Gatto, Harkey,            |
          |     |Calderon, Fletcher,       |     |Blumenfield, Bradford,    |
          |     |Fuentes, Gatto, Harkey,   |     |Charles Calderon, Campos, |
          |     |Roger Hernández, Lara,    |     |Davis, Donnelly, Fuentes, |
          |     |Morrell, Torres           |     |Hall, Hill, Cedillo,      |
          |     |                          |     |Mitchell, Nielsen, Norby, |
          |     |                          |     |Solorio, Wagner           |
           ----------------------------------------------------------------- 

           SUMMARY  :   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)Adds the following requirements to the portion of the Real 
            Estate Law, which regulates real estate brokers who make or 
            broker loans funded by a single investor: 

             a)   The loans for which investors are sought could not exceed 
               specified loan-to-value (LTV) ratios specified in the 
               statute.  These LTVs would 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.).  This bill also imposes additional, 
               specified requirements governing property valuations and loan 
               disbursements, when all or a portion of the loan is used for 
               construction or rehabilitation; and, 

             b)   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:  the investment does not exceed 10% of the 







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               investor's net worth, exclusive of home, furnishings, and 
               automobiles; or the investment does not exceed 10% of the 
               investor's adjusted gross income for federal income tax 
               purposes for the last tax year or, in the alternative, as 
               estimated for the current year.

          2)Requires every real estate broker that solicits investors for 
            privately-funded loans to make reasonable effort to ensure all 
            of the following, on the basis of information he or she obtains 
            from the purchaser:

             a)   All persons to whom securities are sold can be reasonably 
               assumed to have the capacity to understand the fundamental 
               aspects of the investment, by reason of their educational, 
               business or financial experience;

             b)   All persons to whom securities are sold can bear the 
               economic risk of the investment; and,

             c)   The investment in the security is suitable and appropriate 
               for each purchaser, given the purchaser's investment 
               objective, portfolio structure, and financial situation.

          3)Forgives a real estate broker from complying with number 2 above 
            if a real estate broker does of all of the following:

             a)   Obtains from each person a completed questionnaire in a 
               form approved by the Commissioner of DOC. 

             b)   Uses the responses in the questionnaire as an aid. 

             c)   On an annual basis, obtains an updated investor 
               questionnaire.  

          4)Requires any issuer that claims a securities qualification 
            exemption for the offer or sale of securities involving real 
            property for an offering which involves the offer or sale of 
            securities to any person who is not an accredited investor  and 
            which involves the offer or sale of securities that are not 
            registered with the United States Securities and Exchange 
            Commission to provide additional information regarding the 
            nature of their proposed offering to DOC on a form prescribed by 
            the DOC Commissioner.

          5)Requires the DOC Commissioner to annually prepare a report, as 







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            specified, for publication on the DOC's Internet Web site, 
            summarizing data collected from persons to which it issues 
            securities permits.

          6)Authorizes the DOC Commissioner to examine those persons to 
            which it issues permits pursuant to Corporations Code Section 
            25113, review compliance with the conditions of the permits and 
            other applicable state law, and disqualify an offering permitted 
            pursuant to Corporations Code, Section 25113, if he or she finds 
            that the issuer materially violated the provisions of their 
            permit.

           EXISTING FEDERAL LAW  :  

           1)Establishes the Securities Act of 1933 and the Securities and 
            Exchange Act of 1934 administered by the Securities and Exchange 
            Commission.  
           
           2)Establishes the National Association of Security Dealers that 
            helps define the national behavior standards for member and 
            minimum standards for listed securities which is regulated by 
            the Securities and Exchange Commission.  
           
           3)Defines an "accredited investor" as any person who comes within 
            any of the following categories, or who the issuer reasonably 
            believes comes within any of the following categories, at the 
            time of the sale of the securities to that person:
           
              a)   Any bank or any savings and loan association or other 
               institution whether acting in its individual or fiduciary 
               capacity; any broker or dealer registered pursuant to section 
               15 of the Securities Exchange Act of 1934; any insurance 
               company, any investment company registered under the 
               Investment Company Act of 1940 or a business development 
               company, any Small Business Investment Company licensed by 
               the U.S. Small Business Administration, any plan established 
               and maintained by a state, its political subdivisions, or any 
               agency or instrumentality of a state or its political 
               subdivisions, for the benefit of its employees, if such plan 
               has total assets in excess of $5,000,000; any employee 
               benefit plan within the meaning of the Employee Retirement 
               Income Security Act of 1974 if the investment decision is 
               made by a plan fiduciary, as defined in section 3(21) of such 
               act, which is either a bank, savings and loan association, 
               insurance company, or registered investment adviser, or if 







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               the employee benefit plan has total assets in excess of 
               $5,000,000 or, if a self-directed plan, with investment 
               decisions made solely by persons that are accredited 
               investors;
              
              b)   Any private business development company;  

              c)   Any organization described in section 501(c)(3) of the 
               Internal Revenue Code, corporation, Massachusetts or similar 
               business trust, or partnership, not formed for the specific 
               purpose of acquiring the securities offered, with total 
               assets in excess of $5,000,000;
              
              d)   Any director, executive officer, or general partner of the 
               issuer of the securities being offered or sold, or any 
               director, executive officer, or general partner of a general 
               partner of that issuer;  

              e)    Any natural person whose individual net worth, or joint 
               net worth with that person's spouse, at the time of his 
               purchase exceeds $1,000,000;
              
              f)    Any natural person who had an individual income in excess 
               of $200,000 in each of the two most recent years or joint 
               income with that person's spouse in excess of $300,000 in 
               each of those years and has a reasonable expectation of 
               reaching the same income level in the current year;
              
              g)   Any trust, with total assets in excess of $5,000,000, not 
               formed for the specific purpose of acquiring the securities 
               offered, whose purchase is directed by a sophisticated 
               person; and,
              
              h)   Any entity in which all of the equity owners are 
               accredited investors. Ý17 Code of Federal Regulation (C.F.R.) 
               230.501] ÝRule 501, Regulation D]  

          EXISTING STATE LAW  :  
           
          1)Establishes the Corporate Securities Law of 1968 provides for 
            exemptions from qualification for certain securities 
            transactions. ÝCorporations Code, commencing with Section 25000]

          2)Provides that the Commissioner of the DOC to approve all 
            securities offered or sold in California. ÝCorporation Code, 







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            Section 25100]

          3)Prohibits any person to offer or sell in this state any security 
            in an issuer transaction whether or not by or through 
            underwriters, unless such sale has been qualified under Section 
            25111, 25112 or 25113 or unless such security or transaction is 
            exempted or not subject to qualification. The offer or sale of 
            such a security in a manner that varies or differs from, exceeds 
            the scope of, or fails to conform with either a material term or 
            material condition of qualification of the offering as set forth 
            in the permit or qualification order, or a material 
            representation as to the manner of offering which is set forth 
            in the application for qualification, shall be an unqualified 
            offer or sale.  ÝCorporations Code, Section 25110]

          4)Requires all purchasers to have either have a preexisting 
            personal or business relationship with the offeror or any of its 
            partners, officers, directors or controlling persons, or 
            managers (as appointed or elected by the members) if the offeror 
            is a limited liability company, or by reason of their business 
            or financial experience or the business or financial experience 
            of their professional advisers who are unaffiliated with and who 
            are not compensated by the issuer or any affiliate or selling 
            agent of the issuer, directly or indirectly, could be reasonably 
            assumed to have the capacity to protect their own interests in 
            connection with the transaction.
          ÝCorporations Code, Section 25102 (f)]

          5)Defines "issuer" as any person who issues or proposes to issue 
            any security, except when specified.  ÝCorporations Code, 
            Section 25010]

          6)Requires every issuer qualifying securities for sale in this 
            state to keep and maintain a complete set of books, records, and 
            accounts of such sales and the disposition of the proceeds 
            thereof, and shall thereafter, at such times as are required by 
            the commissioner, make and file in the office of the 
            commissioner a report, setting forth the securities sold by it 
            under such qualification, the proceeds derived therefrom and the 
            disposition thereof.  ÝCorporations Code, Section 25145]

          7)Requires California Real Estate Law, Finance Lenders Law, and 
            Residential Mortgage Lending Act licensees to comply with the 
            federal Secure and Fair Enforcement for Mortgage Licensing Act 
            of 2008 (the SAFE Act) by requiring those engaging in mortgage 







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            loan origination activities to obtain a license from DOC after 
            meeting specified requirements, or if a real estate licensee, 
            obtain a license endorsement from the Department of Real Estate 
            after meeting specified requirements. 

           FISCAL EFFECT  :   According to the Assembly Appropriations 
          Committee, DOC anticipates the need for two personnel years (PYs) 
          to conduct regulatory examinations at a cost of approximately 
          $250,000 (special fund).

           COMMENTS  :  According to the author, SB 978 would amend several 
          actions of law governing the ability of entities to solicit funds 
          from investors.  The contents of the bill 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 changes contained in SB 
          978 would increase the reporting requirements on those who seek to 
          raise money from investors pursuant to Corporations Codes 
          securities law exemptions.  SB 978 would also increase the 
          protections available to people who invest their savings with 
          entities soliciting funds for real estate investments.  

          What is hard money lending?

          While hard money lending is not defined in statute, most hard 
          money comes from private individuals with a great deal of money on 
          hand.   The money used for investment purposes comes from people, 
          not a typical lending institution.  

          Most hard money lenders lend solely based upon the deal or 
          property at hand. They only lend up to a certain percentage of the 
          fair market value of the property, that way in the event of 
          default, the hard money lender would profit if they had to 
          foreclose or sell.  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. 

          Typically hard money lenders will only loan you up to 70% ARV 
          (after repaired value). This means that a hard money lender can 







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          loan you up to 70% of what the home is worth in repaired 
          condition. So if a home is worth $45,000 in the condition it's in 
          and needs $20,000 in repair work and after it is repaired the 
          current fair market value is worth $100,000, then typically a hard 
          money lender can lend you up to $70,000, which would cover the 
          cost of the house and the repairs. Hard money lenders will often 
          loan the investor the funds necessary to both purchase the 
          property and to complete its rehabilitation. 

          A downside to hard money lending is high interest rates. Interest 
          rates vary from 12% - 20% annually and terms can last for 6 months 
          to a few years.  Many times these rates vary depending on a credit 
          score. Typically hard money lenders will charge anywhere from 2-10 
          points just to use their money. One point equals one percent of 
          the mortgage amount. So charging 1 point on a $100,000 loan would 
          be $1000. 

          Investors also use hard money when they need to purchase quickly.  
          Typical soft money or conventional loans take 30 days or more.  

          State securities laws generally authorize two types of activity:  
          (1) permitted or qualified activity, which requires the submission 
          of application documents to DOC, and the review and approval of 
          those documents, before money may be raised from investors; and 
          (2) exempt activity, which allows persons to raise money from 
          investors without a lengthy and costly securities filing 
          requirement, provided they adhere to the rules which apply to the 
          exemption under which they are operating.   

          The Real Estate Law also authorizes the solicitation of investors 
          in connection with hard money lending, and defines a class of 
          brokers called threshold brokers, who can generally be thought of 
          as those who make, broker, and/or service mortgage loans that are 
          funded by private individuals and small pension plans, and who are 
          authorized to solicit investors to fund these loans.  In deference 
          to the nature of their activities, threshold brokers are subject 
          to several layers of regulatory supervision and reporting to which 
          other real estate brokers are not.  The special rules that apply 
          to threshold brokers are found in Articles 5 and 6 of the Real 
          Estate Law.  Real estate brokers who make or broker 
          single-investor loans (i.e., loans where a single investor funds 
          the entire loan) must follow Article 5.  Real estate brokers who 
          make or broker multi-investor loans (i.e., loans with between two 
          and ten investors funding the loan) must follow Articles 5 and 6.  
          Both types of brokers (single-investor and multi-investor) are 







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          also subject to all of the other provisions of the Real Estate Law 
          that apply to non-threshold brokers.  

          Money raised from investors is typically lent out either pursuant 
          to the rules contained in the Real Estate Law or (less commonly) 
          pursuant to the California Finance Lenders Law.  
           

           Analysis Prepared by  :    Kathleen O'Malley / B. & F. / (916) 
          319-3081 


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