BILL ANALYSIS �
SB 978
Page 1
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 Hern�ndez, Lara, | |Davis, Donnelly, Fuentes, |
| |Morrell, Torres | |Hall, Hill, Cedillo, |
| | | |Mitchell, Nielsen, Norby, |
| | | |Solorio, Wagner |
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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. �17 Code of Federal Regulation (C.F.R.)
230.501] �Rule 501, Regulation D]
EXISTING STATE LAW :
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,
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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. �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
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. �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
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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
FN: 0004992