BILL ANALYSIS �
------------------------------------------------------------
|SENATE RULES COMMITTEE | SB 978|
|Office of Senate Floor Analyses | |
|1020 N Street, Suite 524 | |
|(916) 651-1520 Fax: (916) | |
|327-4478 | |
------------------------------------------------------------
UNFINISHED BUSINESS
Bill No: SB 978
Author: Vargas (D), et al.
Amended: 8/20/12
Vote: 21
SENATE BANKING & FINANCIAL INST. COMMITTEE : 6-0, 4/11/12
AYES: Vargas, Blakeslee, Evans, Kehoe, Liu, Padilla
NO VOTE RECORDED: Walters
SENATE BUSINESS, PROF. & ECON. DEV. COMM. : 8-0, 4/23/12
AYES: Price, Emmerson, Corbett, Correa, Hernandez,
Strickland, Vargas, Wyland
NO VOTE RECORDED: Negrete McLeod
SENATE APPROPRIATIONS COMMITTEE : 7-0, 5/24/12
AYES: Kehoe, Walters, Alquist, Dutton, Lieu, Price,
Steinberg
SENATE FLOOR : 38-0, 5/31/12 (Consent)
AYES: Alquist, Anderson, Berryhill, Blakeslee, Calderon,
Cannella, Corbett, Correa, De Le�n, DeSaulnier, Dutton,
Emmerson, Evans, Fuller, Gaines, Hancock, Harman,
Hernandez, Huff, Kehoe, La Malfa, Leno, Lieu, Liu,
Lowenthal, Negrete McLeod, Padilla, Pavley, Price, Rubio,
Simitian, Steinberg, Vargas, Walters, Wolk, Wright,
Wyland, Yee
NO VOTE RECORDED: Runner, Strickland
ASSEMBLY FLOOR : 77-0, 8/22/12 - See last page for vote
SUBJECT : Securities transactions
CONTINUED
SB 978
Page
2
SOURCE : Author
DIGEST : 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.
Assembly Amendments (1) delete the requirement for an
issuer that is engaged in the business of purchasing,
selling, financing, or brokering real estate, and that
claims a specified exemption, for an offering which
involves the offer or sale of securities to any person who
is not an accredited investor in a transaction that is not
registered with the United States Securities and Exchange
Commission, to make reasonable efforts to ensure that the
investment is suitable for the investor, as specified, to
provide the basis upon which the issuer shall make that
determination, and to maintain the information used to make
the determination for four years; (2) add language which
specifies the information an issuer must provide regarding
the offering; and (3) make other technical revisions.
ANALYSIS : 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 prepared
for an informational hearing jointly held 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 here:
http://sbnk.senate.ca.gov/sites/sbnk.senate.ca.gov/files/fin
al%20agenda.pdf
In the interest of brevity, this analysis will provide 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
CONTINUED
SB 978
Page
3
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 which appear later in this analysis 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 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
CONTINUED
SB 978
Page
4
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.
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
CONTINUED
SB 978
Page
5
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 #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
(Commissioner).
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 Commissioner.
5. Requires the Commissioner to annually prepare a report,
CONTINUED
SB 978
Page
6
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 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/she finds that
the issuer materially violated the provisions of their
permit.
Background
In June 2011, investigative reporters Charles Piller and
Robert Lewis of the Sacramento Bee co-authored a two-part
series on "hard money" lending fraud in Nevada County.
That investigation stirred interest among the Senate
Banking and Financial Institutions Committee and Senate
Business, Professions, and Economic Development Committee.
On January 18, 2012, those committees held a joint
oversight hearing to investigate the following questions:
1. What is hard money lending?
2. How is it regulated, and by whom?
3. 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?
4. 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)?
5. Are changes to the laws under which hard money lenders
and brokers raise and lend money necessary or desirable?
The background paper developed for Joint Oversight hearing
CONTINUED
SB 978
Page
7
answered many of these questions, and contained eight sets
of findings and recommendations to help plug existing
loopholes and increase consumer protection. This bill
includes language to implement six of these
recommendations. Some of the recommendations that are not
included in this bill can be accomplished without amending
California law. Other recommendations were deleted from
this bill based on negotiations with interested parties.
FISCAL EFFECT : Appropriation: No Fiscal Com.: Yes
Local: Yes
SUPPORT : (Verified 8/22/12)
California Mortgage Association
Public Investors Arbitration Bar Association
ASSEMBLY FLOOR : 77-0, 8/22/12
AYES: Achadjian, Alejo, Allen, Ammiano, Atkins, Beall,
Bill Berryhill, Block, Blumenfield, Bonilla, Bradford,
Brownley, Buchanan, Butler, Charles Calderon, Campos,
Carter, Cedillo, Chesbro, Conway, Cook, Davis, Dickinson,
Eng, Feuer, Fletcher, Fong, Fuentes, Furutani, Beth
Gaines, Galgiani, Garrick, Gatto, Gordon, Gorell, Grove,
Hagman, Halderman, Hall, Hayashi, Hill, Huber, Hueso,
Huffman, Jeffries, Jones, Knight, Lara, Logue, Bonnie
Lowenthal, Ma, Mansoor, Mendoza, Miller, Mitchell,
Monning, Morrell, Nestande, Nielsen, Norby, Olsen, Pan,
Perea, V. Manuel P�rez, Portantino, Silva, Skinner,
Smyth, Solorio, Swanson, Torres, Valadao, Wagner,
Wieckowski, Williams, Yamada, John A. P�rez
NO VOTE RECORDED: Donnelly, Harkey, Roger Hern�ndez
JJA:k 8/22/12 Senate Floor Analyses
SUPPORT/OPPOSITION: SEE ABOVE
**** END ****
CONTINUED
SB 978
Page
8
CONTINUED