What are Illiquid Investments?
Illiquid investments are assets that are difficult to sell or convert into cash quickly without incurring significant losses. Illiquid investments can be concerning for a few reasons. They are ultimately associated with higher risk, as they may be subject to fluctuations in the market conditions or other factors that can impact their value. As a result of this, investors should carefully consider and weigh the benefits and risks prior to making any investment decisions.
Examples of Illiquid investments include:
Oil and Gas LPs: Oil and Gas LPs are illiquid investments because they are often structured as limited partnerships, which means that investors are unable to sell their shares without the approval of the general public. Oil and Gas LPs can also be highly dependent on the underlying assets, which can be subject to fluctuations in commodity prices and other market factors. This can make it difficult to accurately assess the value of an investment, further reducing liquidity.
Reg D Private Placements: Regulation D private placements are securities offerings that are exempt from registration with the Securities and Exchange Commission. (SEC) under certain conditions. These offerings are typically limited to accredited investors or entities that meet certain financial criteria. Reg D Private placements are often illiquid investments because they are not traded on the public exchanges, and there is typically no second market for these types of securities.
Non-Traded REITs: Non-traded REITs are real estate investment trusts that are not publicly traded on stock exchanges. Unlike publicly traded REITs, which can be bought and sold like stocks, non-traded REITs are sold through private placements and have limited liquidity options. Investors in non-traded REITs may have difficulty selling their shares quickly and may be subject to lock-up periods or redemption restrictions. The lack of an active secondary market can make non-traded REITs illiquid and potentially challenging to exit the investment before its maturity or a liquidity event, which can be several years or more.
Non-Traded BDCs: Business Development Companies (BDCs) are closed-end investment companies that primarily invest in small and mid-sized businesses. Non-traded BDCs, like non-traded REITs, are not traded on public exchanges. Investors in non-traded BDCs may face limited opportunities to sell their shares, and redemption plans may have specific limitations, making the investment illiquid.
Structured notes are complex investment products created by combining a debt component with derivative securities. They often have features tied to the performance of an underlying asset or index. Structured notes can have various terms and maturities, and the secondary market for them can be limited or non-existent. As a result, investors may find it challenging to sell structured notes before their maturity date, making them illiquid.
Hedge Funds: Hedge funds are investment funds that are typically only available to accredited investors. These funds are often less liquid than other types of investments, and they have restrictions on when investors may withdraw their funds.
Venture Capital: Venture capital investments involve investing in early-stage companies that are not yet profitable. These investments can be highly risky and may take years to generate a return. Additionally, venture capital investments are less liquid, and may not be a ready market for the shares.
1031 DSTs (Delaware Statutory Trust) – 1031 DST investment involves utilizing a provision in the tax code (Section 1031) to defer capital gains taxes on the sale of investment property by reinvesting the proceeds into a Delaware Statutory Trust (DST) that holds real estate assets. Investors exchange their relinquished property for a fractional ownership interest in the DST, allowing them to defer taxes until they eventually sell their interest in the trust. A 1031 DST investment is typically considered illiquid. Once an investor exchanges their relinquished property for a fractional ownership interest in the DST, it can be challenging to sell or liquidate that interest quickly. Unlike publicly traded assets, such as stocks or bonds, DST interests are not freely traded on an exchange, and finding a buyer for the investment can take time.
A TIC, or Tenant in Common investment also falls under the category of illiquid investments. When investors participate in a TIC arrangement, they own a fractional interest in a property along with other investors. Similar to 1031 DST investments, TIC investments lack liquidity because they are not easily traded on public exchanges. Selling a TIC interest often requires finding a buyer, which can take time and may result in selling at a discount. Therefore, investors should be aware that TIC investments are generally illiquid and may tie up their capital for an extended period.
These investments typically require a longer holding period and are associated with higher risk and higher potential returns. Due to their lack of liquidity, they are generally not suitable for investors who need access to their money in the short term.
Cautionary Signs of Illiquid Investments
Here are some cautionary signs to watch out for when considering an illiquid investment:
Lack of Transparency: If an investment is opaque or difficult to understand, it may be a red flag. Investors should be able to understand the risks and potential rewards associated with any investment they are considering.
High Fees: Some illiquid investments may come with high fees, which can eat into your returns. It’s important to carefully consider the fees prior to investing.
High Risk: Illiquid investments are often associated with higher risk the more liquid investments. Before investing in an illiquid asset, be sure to consult with a trusted family member or advisor to review the pros and cons of these investments.
Lack of Regulation: Some illiquid investments may be unregulated or subject to less oversight than other types of investments. This can increase the risk of fraud or other types of misconduct. By remaining vigilant and seeking out accurate information, investors can help protect themselves against the risks of illiquid investments
Suitability Checklist for Illiquid Investments
Your financial advisor should only recommend investments that are suitable for you. The financial advisor should conduct a suitability analysis on a holistic level. Liquidity needs, time horizon, risk tolerance, age, income, are just a few categories an advisor should take into account prior to recommending any investment. Once that is completed the brokerage firm must ensure that due diligence was completed at every level of each investment.
Can a Securities Fraud Attorney Help with Illiquid Investments?
A securities fraud attorney can help investors who have been the victim of fraud or other misconduct related to an illiquid investment. They can assist with investigating the investment, which would entail determining whether fraud or misconduct has occurred. They can also assist in guiding you through the legal options you have, and they can also represent you in a FINRA Arbitration investigation.
What is FINRA Arbitration and How Does it Work?
FINRA is responsible for overseeing the activities of brokerage firms, and for enforcing rules and regulations related to the trading of securities. Seeking restitution through FINRA arbitration can be a helpful process if you feel as though you’ve been defrauded. Once you’ve retained a securities fraud attorney, the process of filing a claim through FINRA could take place.
This claim should include a description of the fraud, the amount of money lost, and any supporting documentation. Once the claim is filed, FINRA will appoint an arbitrator to hear the case. The arbitrator is responsible for reviewing the evidence and making a decision about whether the investor is entitled to restitution.
If the arbitrator rules in favor of the investor, they will issue an award for damages, and this can be used to seek restitution from the person or company that defrauded the investor. There is also the possiblity of a settlement.
Free Consultation with a Securities Fraud Attorney
The White Law Group’s FINRA arbitration attorneys have handled over 700 FINRA arbitration claims involving unauthorized trading, unsuitable investments, fraud, negligence, churning/excessive trading, and improper use of margin. The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Seattle, Washington.
If you are concerned about your illiquid investments, we may be able to help you. For a free consultation with a securities attorney, please call the firm’s office at 888-637-5510.
For information on The White Law Group and its representation of investors in broker negligence claims, visit https://whitesecuritieslaw.com.
Last modified: March 21, 2024
