BILL ANALYSIS �
SB 978
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Date of Hearing: July 2, 2012
ASSEMBLY COMMITTEE ON BANKING AND FINANCE
Mike Eng, Chair
SB 978 (Vargas & Price) - As Amended: June 18, 2012
SENATE VOTE : 38-0
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.
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
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
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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)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.
4)Requires any issuer that claims a securities qualification
exemption, and that is engaged in the business of purchasing,
selling, financing, or brokering real estate 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 make reasonable
efforts to ensure all of the following:
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
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appropriate for each purchaser, given the purchaser's
investment objective, portfolio structure, and financial
situation.
5)Requires the DOC Commissioner to annually prepare a report, as
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
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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 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. �17 C.F.R. 230.501] �Rule 501,
Regulation D]
EXISTING STATE LAW
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1)Establishes the Corporate Securities Law of 1968 provides for
exemptions from qualification for certain securities
transactions. �Corporations Code, commencing with Section
25000]
2)Provides that the Commissioner of the DOC to approve all
securities offered or sold in California. �Corporation Code,
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.
�Corporations 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.
�Corporations Code, Section 25102 (f)]
5)Defines "issuer" as any person who issues or proposes to issue
any security, except when specified. �Corporations 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
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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 there from and
the disposition thereof. �Corporations 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
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 : Unknown.
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
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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
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
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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.
PREVIOUS LEGISLATION
SB 53 (Calderon and Vargas), Chapter 717, Statutes of 2011:
Enacted several changes to California's Real Estate Law, to give
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 required to be documented in a
licensee's files, but was not required to be shared with
investors.
AB 2288 ((Blakeslee) 2010 Legislative Year) Failed passage in
Assembly Banking and Finance Committee. Would have implemented
specific criteria for issuers involved in hard money lending.
REGISTERED SUPPORT / OPPOSITION :
Support
None on file.
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Opposition
1 individual
Analysis Prepared by : Kathleen O'Malley / B. & F. / (916)
319-3081