BILL ANALYSIS �
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|Hearing Date:April 23, 2012 |Bill No:SB |
| |978 |
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SENATE COMMITTEE ON BUSINESS, PROFESSIONS
AND ECONOMIC DEVELOPMENT
Senator Curren D. Price, Jr., Chair
Bill No: SB 978Author: Vargas
As Amended:April 19, 2012 Fiscal: Yes
SUBJECT: Securities transactions: exemption from qualification
requirements.
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.
Existing law:
Business and Professions Code:
1) Exempts from the qualification requirements, subject to complying
with specified requirements, a transaction that involves the sale
of a series of notes secured directly by an interest in real
property or the sale of undivided interests in a note secured
directly by real property equivalent to a series transaction,
having no more than 10 investors.
2) Requires a real estate broker to indicate in the real estate
broker's transaction file the provisions of law pertaining to
qualification or exemption from qualification under which a
transaction is being conducted.
3) Requires a real estate broker to file certain information with the
commissioner relative to conducting these transactions that are
exempt from qualification.
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4) Requires a real estate broker to submit a copy of the information
in the real estate broker's transaction file relative to
qualification or exemption from qualification for a transaction to
any investor from whom the real estate broker obtains funds in
connection with the transaction.
5) Requires a real estate broker negotiating (1) a loan, as specified,
secured by a lien on real property or a business opportunity, or
(2) the sale of a real property sales contract or promissory note
secured directly or collaterally by a lien on real property, to
provide a disclosure statement, containing specified information
regarding the proposed transaction, to a prospective lender or a
prospective purchaser, respectively.
Corporations Code:
1)Provides for the regulation of securities pursuant to the Corporate
Securities Law of 1968.
2)Requires an issuer of securities to qualify with the Commissioner of
Corporations (Commissioner) of the offer and sale of securities
unless the transaction is subject to one of several exemptions from
the qualification requirements.
3)A willful violation of the above provisions is a crime.
4)Exempts from the qualification requirements the offer or sale of any
security made to no more than 35 people, as specified, and allows
the Commissioner to require the issuer to file a notice of
transactions.
5)Provides that the exemption remain available to an issuer who fails
to file the notice or files the notice after the time specified by
the Commissioner.
6)Requires an issuer relying on that exemption to file a notice within
15 business days following discovery of the failure to timely file
the notice, or after demand of the commissioner, whichever is
earlier.
7)Exempts from those qualification requirements an offer or sale of
any evidence of indebtedness or guarantee thereof, in a transaction
not involving a public offering, and does not require an issuer to
file a notice of transaction made in reliance upon that exemption.
This bill:
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Business and Professions Code (Real Estate Law) Changes:
1)Adds the following requirements to the portion of the Real Estate
Law (Article 5), 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.). The bill would also impose additional, specified
requirements governing property valuations and loan
disbursements, when all or a portion of the loan is used for
construction or rehabilitation.
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: (i) the investment
does not exceed 10% of the investor's net worth, exclusive of
home, furnishings, and automobiles; or (ii) 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.
c) The investment in the security is suitable and appropriate for
each purchaser, given the purchaser's investment objective,
portfolio structure, and financial situation.
Corporations Code Changes:
1)Requires persons who engage in certain types of transactions that
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are exempt from securities qualification requirements to file a
notice of transactions with the Department of Corporations (DOC), on
a form acceptable to the Commissioner, as specified. Failure to
file the required notice, or failure to file the notice within the
time specified by the Commissioner, would subject the issuer to a
monetary penalty, equal to the fee that would have been imposed on
that issuer, if the transaction had been qualified. The two types
of transactions that would be covered by these new filing
requirements include:
a) Corporations Code � 25102(e), which exempts from qualification
requirements of any offer or sale of any evidence of
indebtedness, whether secured or unsecured, and any guarantee
thereof, in a transaction not involving any public offering; and
b) Adds the above filing requirements to Corporations Code �
25102(f), which exempts from qualification requirements any offer
or sale of any security in a transaction that meets all of the
following criteria: (i) sales of the security are not made to
more than 35 persons; (ii) all purchasers either have a
preexisting personal or business relationship with the offeror or
any of its partners, officers, directors, or controlling persons,
or, by reason of their business or financial experience or the
business or financial experience of their professional advisers,
could reasonably be assumed to have the capacity to protect their
own interests in connection with the transaction, as specified;
(iii) each purchaser represents that he or she is purchasing for
his or her own account, and not with a view to or for sale in
connection with any distribution of the security; and (iv) the
offer and sale of the security is not accomplished by the
publication of any advertisement.
1)Requires any issuer that claims securities qualification exemption
for the offer or sale of securities involving real property, or
involving any indebtedness secured in whole or in part by real
property, to provide additional information regarding the nature of
their proposed offering to DOC on a form prescribed by the
Commissioner. The form to be used by these issuers would have to be
developed by the DOC, and would have to include any information the
Commissioner believes to be reasonably related to the protection of
the public, as specified.
2)Requires any issuer that claims a securities qualification
exemption, and that is principally engaged in the business of
purchasing, selling, financing, or brokering real estate, to make
reasonable efforts to ensure all of the following, on the basis of
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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.
c) The investment in the security is suitable and appropriate for
each purchaser, given the purchaser's investment objective,
portfolio structure, and financial situation.
1)Requires the Commissioner to annually prepare a report, as
specified, for publication on the Department's Internet Website,
summarizing data collected from persons to which it issues
securities permits.
2)Authorizes the 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 Section
25113, if he or she finds that the issuer materially violated the
provisions of their permit.
FISCAL EFFECT: Unknown. This bill has been keyed "fiscal" by
Legislative Counsel
COMMENTS:
1. Purpose. SB 978 would implement a series of recommendations
stemming from a joint informational hearing held by the Senate
Banking and Financial Institutions Committee and Senate Business,
Professions and Economic Development Committees on Hard Money
Lending in January 2012. These changes would increase real estate
investor protections, and require 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.
2. Background
a) Joint Oversight Hearing of the Senate Committee on Business
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Professions and Economic Development and the Senate Committee on
Banking & Financial Institutions. At the Joint Oversight
Hearing, held on January 18, 2012, the Committees reviewed the
findings of investigative reporters Charles Piller and Robert
Lewis. In June 2011 they co-authored a Sacramento Bee two-part
series report on "Hard Money" Lending Fraud in Nevada County."
That investigation stirred interest among the two Committees and
asked the following questions:
i. What is hard money lending?
ii. How is it regulated, and by whom?
iii. Is the existing regulatory structure protective of
consumers who obtain hard money loans? Is it protective of
persons who invest money used to fund hard money loans?
iv. Does the existing regulatory structure allow members
of the regulated industry to engage in regulatory arbitrage
(i.e., to structure their business activities in ways that
allow them to pick and choose their regulator and the laws
under which they are regulated, to ensure the least possible
oversight)?
v. Are changes to the laws under which hard money
lenders and brokers raise and lend money necessary or
desirable?
California's codes do not define "hard money" lending. The
phrase typically refers to the act of lending money to an
individual or a business, without the involvement of a
traditional financial institution. Commonly, borrowers who seek
out hard money loans cannot obtain financing through other means.
For these borrowers, money is hard to come by - thus "hard
money" lending. Hard money lending is also known as private
money lending, because the funds are typically provided by
private investors, rather than institutional investors.
Hard money lenders typically lend to borrowers unable to obtain
credit elsewhere, or to borrowers who need money more quickly
than traditional lenders can fund a loan. Because most borrowers
who obtain hard money loans have nowhere else to go for the
money, the terms of hard money loans tend to be less favorable to
borrowers than more traditional loans. Interest rates and points
tend to be higher, and loan lengths tend to be shorter than those
offered by more traditional lenders.
It is significant to note, however, that hard money lending is
not a synonym for subprime lending. To be sure, some hard money
loans are made to people with tarnished credit, whose low credit
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scores render them ineligible for more traditional forms of
credit. However, significantly more hard money loans are made to
people who have significant equity in their property, but who
lack a significant, steady source of income, lack the ability to
document their sources of income, or who, for other reasons, have
circumstances that render them ineligible for loans underwritten
using the one-size-fits-all underwriting standards applied by
traditional financial institutions. As regulators have tightened
down on traditional lenders' underwriting standards, hard money
lending has become a source of "credit of last resort" for more
and more groups of people.
a) Description of Existing Law. A detailed review of all of the
relevant laws governing the solicitation of investor funds for
real estate investments, and the making of so-called "hard money"
loans, is included in the background paper which was prepared for
the informational hearing held jointly by the Senate Banking and
Financial Institutions Committee and the Senate Business,
Professions and Economic Development Committee in January, 2012.
The full text of that background paper can be found at:
http://sbnk.senate.ca.gov/sites/sbnk.senate.ca.gov/files/final%20a
genda.pdf
In the interest of brevity, the following is a summary
description of the statutory regime governing the activities of
hard money lenders and brokers. This summary explanation should
not be considered a comprehensive description of the laws which
regulate hard money activities, nor should it be given legal
interpretation. It is simply an attempt to condense an extremely
lengthy and complicated statutory scheme into a few simple
paragraphs, which provide a context into which the findings and
recommendations on which SB 978 are based can be considered.
"Hard money" lending is the lending of money by private
individuals and small pension plans to other private individuals
and/or businesses. Hard money lending has two halves - a
"raising money from investors" half, and a "lending that money
out" half. 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 (see discussion in the next paragraph), or it
may be conducted pursuant to state and federal securities laws.
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
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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. Many of the findings
and recommendations below are focused on this exempt activity,
with the goal of flushing into the open those people who are
hiding behind these exemptions to purposefully avoid regulatory
scrutiny and oversight.
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 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.
3.Related Legislation.
SB 53 (Calderon and Vargas, Chapter 717, Statutes of 2011): Enacted
several changes to California's Real Estate Law, to give the DRE
more enforcement tools with which to crack down against mortgage
fraud and other real estate violations, add safeguards to protect
consumers who seek out services from real estate licensees, and make
technical changes. Among its provisions, the bill included a
requirement that hard money lenders operating under Article 6 inform
their investors about which provision or provisions of the Real
Estate Law or the Corporate Securities Law govern their
transactions. Prior to enactment of SB 53, that information was
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required to be documented in a licensee's files, but was not
required to be shared with investors.
NOTE: Double-referral to Banking & Financial Institutions Committee,
first. This bill was heard in Banking & Financial Institutions
Committee on April 11, 2012 and was approved by a vote of 6 to 0.
SUPPORT AND OPPOSITION:
Support:
None received as of April 17, 2012
Opposition:
None received as of April 17, 2012
Consultant:Michael Lynch