Alternative investments are back in the news. The Massachusetts Securities Division has announced an investigation of broker-dealers selling oil and gas and car dealership limited partnerships, and has issued subpoenas to sixty-three firms selling the private placements., The Financial Industry Regulatory Authority (FINRA) and Securities and Exchange Commission (SEC) have announced similar inquiries, which are still underway. In May 2020, the Massachusetts Securities Division filed formal charges against GPB Capital Holdings, LLC. GPB, a complex network of car dealerships, waste carting, and oil and gas limited partnerships, is alleged to have raised $1.5 billion based on false and misleading offering statements.
A federal class action in Texas, Kinnie Ma Individual Retirement Account v. Ascendant Capital LLC., alleges that seventy-five broker-dealers facilitated the sale of financially troubled and insufficiently vetted limited partnerships that invested in oil and gas and car dealerships. In addition to the class action, hundreds of individual FINRA arbitration claims have been filed, and it would appear that more are forthcoming.
These developments bring to mind earlier enforcement actions, in the wake of the financial crisis and Great Recession of 2008–2009, which challenged investor exposure to alternative investments and sought to impose concentration limits on such investments for retail investors.
GPB can rightfully be called a major event in the broker-dealer world due to the sheer number of broker-dealers involved. It may also, however, present an opportunity to test some novel legal theories, some of which will be discussed in this article. As explained in detail below, the Uniform Limited Offering Exemption (ULOE), approved by the North American Securities Administrators Association (NASAA) in 1983 and adopted, in varying formats, by eleven U.S. states, provides a presumption of suitability for portfolio allocations of up to 10 percent of alternative investments, such as nontraded real estate investment trusts (REITs) and limited partnerships. The ULOE has not been extensively tested by the courts or arbitration panels. While NASAA has more recently proposed a 10 percent concentration limit for nontraded REITs, that proposal has not been fully adopted.
THE GREAT RECESSION
The financial crisis of 2008 and the ensuing Great Recession brought unprecedented and unwelcome attention to nontraditional investments, such as nontraded REITS, tenant-in-common investments, oil and gas limited partnerships, and similar alternative investments. With the crash of the real estate markets, investors concentrated in securitized (and nonsecuritized) real estate investments found themselves strapped for cash, as numerous limited partnerships and Regulation D offerings failed or struggled, along with broad swaths of the overall economy. As Warren Buffet famously quipped, “It’s only when the tide goes out that you see who’s been swimming naked.”
Regulators, quick to pounce, prosecuted the issuers and sellers of nontraditional alternative investments. Federal and state regulators brought numerous enforcement actions against issuers of syndicated real estate and other alternatives, along with the broker-dealers who marketed and recommended them.
STATE CONCENTRATION LIMITS
In the wake of the 2008–2009 financial crisis, many states implemented concentration limits on alternative investments, which they defined as nontraded REITS, limited partnerships, and other alternatives to the traditional baskets of publicly traded stocks, bonds, and money market investments. Alternative investments include structured products, nontraded REITS, limited partnerships, Regulation D offerings, and the like. In order to manage risk and comply with state regulations, many independent broker-dealers have modified their written supervisory procedures to impose concentration guidelines of their own—typically, between 10 and 20 percent of an investor’s net worth, depending on such factors as overall net worth, trading experience, sophistication, and age. NASAA, an association of state blue sky securities regulators, proposed a rule in 2016 that would cap the exposure of nonaccredited investors at 10 percent of liquid net worth. According to NASAA, its proposal “would add a uniform concentration limit of ten percent (10%) of an individual’s liquid net worth, applicable to their aggregate investment in a REIT, its affiliates, and other nontraded REITs, as defined therein.”
While alternative investments are often disparaged, they have some distinct features that make them attractive. For one, alternative investments typically do not correlate with the stock market, which offers investors downside protection in a falling market. And while publicly traded REITs provide a measure of liquidity, they tend to rise and fall with the vagaries of the market. Alternative investments clearly offer investors diversification that standard equities do not, but how much is too much when it comes to concentration levels in alternative investments?
UNIFORM LIMITED OFFERING EXEMPTION
While the trend over the past ten years has clearly been in favor of imposing concentration limits, the converse question is worth considering. In other words, if a recommendation of over, say, 10 percent of an investor’s portfolio in alternative products is presumed unsuitable, is the converse true? Is an investment of 10 percent or less of the same customer’s net worth in an alternative investment presumed to be suitable? This question is posed in Securities Regulation by Professors Coffee, Sale, and Henderson. John Coffee and his co-authors discuss the Uniform Limited Offering exemption, adopted by NASAA in 1983 under the authority of §19 (d) of the 1933 Securities Act, which was intended to create an exemption from state registration and qualification for certain specified private offerings. While the ULOE references some of the terms and standards in SEC Regulation D, it also contains a suitability standard. According to Coffee and his colleagues, “Even more importantly, [the ULOE] includes a suitability standard for sales to non-accredited investors, which requires that the investment be suitable for the purchaser upon the basis of the facts, if any, disclosed by the purchaser as to other security holdings and as to his financial situation and needs.” The ULOE “then adds a presumption that if the investment does not exceed 10% of the investors’ net worth, it is presumed to be suitable.”
The text of the ULOE provides the following: “For the purpose of this condition only, it may be presumed that if the investment does not exceed 10% of the investors’ net worth, it is suitable.” The ULOE applies to any offer or sale of securities sold under Reg. D Rule 506 (§ 505 having been repealed subsequent to issuance of the ULOE), “including any offer or sale made exempt by application of Rule 508(a).” Thus, thirty-seven years ago, NASAA suggested that at least for some Regulation D issues, a recommendation of no more than 10 percent of an investor’s net worth would be presumed suitable. And while in 2016 NASAA proposed imposing a concentration limit of 10 percent on nontraded REITs, that proposal has yet to pass.
Eleven states have adopted the suitability presumption in the NASAA ULOE. For example, Alabama and Indiana provide a presumption of suitability if an alternative investment does not exceed a specified minority presumption of the investor’s net worth. For Alabama, suitability is presumed if alternatives do not exceed 20 percent of the investor’s net worth; in Indiana, the presumption applies for a recommendation of no more than 10 percent. Tennessee agrees that, for an alternative investment, “It may be presumed that if the investment does not exceed 10% of the sum of the purchasers’ net worth, the investment is suitable.” Louisiana provides that “it may be presumed that if the investment does not exceed 25% of the investor’s net worth, it is suitable.” These various state regulations survived the 2008–2009 financial crisis and the ensuing Great Recession, and, while they harken to an earlier era, they seem to bespeak a more balanced view of customers’ investment portfolios. Thus, at least in some states (by our count eleven), while an overconcentration in alternative securities might be deemed unsuitable, alternatives are presumed to be suitable in smaller doses.
This allocation approach is consistent with the philosophy that suitability must be viewed on balance as a whole and not in isolation. This viewpoint is also consistent with the teaching of the FINRA suitability rule, Rule 2111, which provides that suitability should include an assessment of the customers’ other securities holdings (quantitative suitability), net worth and income, along with other traditional factors such as customers’ risk tolerance and investment objectives.
Moreover, the presumed suitability of relatively modest concentrations is consistent with the teachings of new Regulation Best Interest (Reg. BI), which imposes a three-tiered approach to suitability. Under Reg. BI, a registered representative should consider three aspects of suitability. First, is the investment suitable for anyone? Second, is the investment suitable for this investor? Third, the registered representative must determine whether the recommended quantity is suitable for the customer in question.
This is not to suggest that the presumed suitability of smaller holdings, under 10 percent concentration levels, can be bootstrapped into a substitute for the suitability of a product that is not suitable for anyone or not suitable for this specific customer under any circumstances under Reg. BI. A product that was never suitable for any investor cannot be sanitized by a presumed statutory concentration level. Moreover, there probably are some products that, while objectively suitable, will likely be viewed as unsuitable for particular investors based on the product’s complexity. However, regulators, particularly those in jurisdictions that have been aggressive in securities enforcement, should be mindful of these concentration presumptions in their prosecutions. Moreover, firms that have complied with their state’s concentration guidelines might make the argument that an overall view of a balanced portfolio is more appropriate than the cherry-picking approach favored by some regulators and claimants’ lawyers. If alternative investments, generally, are viewed as a legitimate tool for diversifying a client’s portfolio, it would appear to be unfair to punish an advisor for a small portion of a portfolio that did not produce that same rate of return as equities in a rising market, for example.
THE ULOE AND PREEMPTION
Any discussion of state blue sky laws should also include a mention of federal preemption. Federal preemption of securities regulation is far from complete, and many blue sky laws, some of which antedated the Securities Act of 1933, exist side by side with their federal counterparts. Yet there are areas of both express and implied preemption. Under the Supremacy Clause of the Constitution, federal law displaces state law where (1) Congress expressly preempts state law; (2) Congress has established a comprehensive regulatory scheme in the area, effectively removing the entire field from the state realm; or (3) state law directly conflicts with federal law or interferes with the achievement of federal objectives.
The National Securities Markets Improvement Act of 1996 (NSMIA) precludes state regulation of enumerated federally regulated securities, including some Regulation D exempt offerings. NSMIA, while permitting state fraud claims, bars state regulation of covered securities, including both listed securities and some transactions exempt from registration.
The Securities Litigation Uniform Standards Act (SLUSA) preempts covered class actions based on state law that alleges a misrepresentation or omission of material fact in connection with the purchase or sale of a covered security, which generally means a listed security. The Supreme Court declined to extend the reach of SLUSA in Chadbourne & Parke LLP v. Troice. The plaintiffs in Troice did not purchase covered securities from the defendants. Rather, they purchased bogus certificates of deposit from fraudster Alan Stanford, which they alleged were going to be used in the future to purchase covered securities on their behalf. Thus, in that case, the victims did not allege that they themselves directly purchased covered securities. Rather, they alleged that they purchased CDs that would be used indirectly in the future to purchase securities. This, the Supreme Court held, was more in line with traditional garden-variety state court fraud, which was traditionally relegated to state court enforcement actions. The Court did not seek to “limit the scope of protection under state laws that seek to provide remedies for victims of garden variety fraud.” The Court reasoned that the intent of Congress was to “protect securities issuers, as well as investment advisors, accountants and brokers who help them sell financial products, from abusive class action cases.” The Court sought to strike a balance between providing relief for federally registered brokers and investment advisors, on the one hand, and allowing traditional state claims on the other, noting that the majority opinion “preserved the ability for investors to obtain relief under state laws when the fraud bears so remote a connection to the national securities market that no person actually believes he was taking an ownership position in that market.”
Regardless of whether the private placement actually complied with the substantive requirements of Regulation D or Rule 506, the securities sold to Plaintiffs are federal “covered securities” because they were sold pursuant to those rules. As a result, FLA. STAT. § 517.07 does not require registration of such securities. Furthermore, any attempt by Florida to require registration of such securities or securities transaction would be preempted by NSMIA. Congress expressed its intent in NSMIA that federal regulations alone should govern the registration of national securities offerings. Where a Form D was filed with the SEC for a transaction that purported to merit an exemption from federal registration pursuant to Regulation D, Florida law could not require duplicative registration or a transactional exemption from registration.
Thus, the Temple court dismissed state law claims on federal preemption grounds, suggesting that future state law claims alleging sale of unregistered securities might face significant headwinds. Other district courts have agreed, noting that “Defendants’ state law failure-to-register claim is preempted because [issuer] Pinnacle purported to sell its stock under the Rule 506 exemption.”
Subsequent decisions have distinguished Temple or questioned its reasoning. For example, the Sixth Circuit Court of Appeals has held that “offerings must actually qualify for a valid federal securities registration exemption in order to enjoy NSMIA preemption.” The Court of Appeals in Brown v. Earthboard Sports USA, Inc. reasoned that NSMIA did not expressly preempt state claims against imperfectly registered exempt securities and concluded that “NSMIA preempts state securities registration laws with respect only to those offerings that actually qualify as ‘covered securities’ according to the regulations that the SEC has promulgated.”
Would application of the ULOE be preempted by federal law? The answer to this question, as is often the case with securities law, depends on the surrounding facts and circumstances. For example, a respondent in a state court regulatory prosecution by local blue sky regulators would presumably be able to avail itself of that state’s version of the ULOE exemption. Thus a hypothetical Tennessee broker-dealer facing regulatory sanctions in a suitability prosecution by the Tennessee State Securities Division would be able to assert the presumption of suitability in that state’s version of the ULOE. On the other hand, the same broker-dealer might face a chillier reception when trying to assert a state statute as a defense to a federal enforcement action brought by the SEC in federal court or before an administrative law judge alleging a violation of federal law.
Closer questions are presented by a regulatory action brought by a self-regulatory organization, such as FINRA, for violation of an SRO rule, especially the suitability provisions of FINRA Rule 2111. FINRA rules approved by the SEC might be candidates for preemption. On the other hand, a private arbitration brought by an individual investor should be defensible by reference to the ULOE, especially if the statement of claim alleges violations of state law.
The Uniform Limited Offering Exemption, approved by the North American Securities Administrators Association in 1983 and adopted, in varying formats, by eleven U.S. states, provides a presumption of suitability for portfolio allocations of up to 10 percent of alternative investments, such as nontraded REITs and limited partnerships. Although the ULOE could be viewed, at least by some investor advocates, as a holdover from the deregulation ethos of the Reagan era, it remains on the books in several jurisdictions (and of the NASAA) and could be used as a defense to a claim of unsuitable recommendations in violation of state blue sky laws. While NASAA has proposed a 10 percent concentration limit for nontraded REITs, that proposal has not been fully adopted.
Whether an individual state’s ULOE rule is preempted by federal law is likely to depend on the nature of the proceeding and the plaintiff bringing the claim. An individual investor bringing a claim alleging a violation of state law, in FINRA or state court, is more susceptible to a defense based on the ULOE than, say, a federal regulatory agency bringing an enforcement action in federal court.
 Robert J. Usinger is a graduate of Brooklyn Law School and a claims professional specializing in financial institutions claims. Robert has also worked as a coverage attorney, with a focus on professional liability matters. Barry R. Temkin is a partner at Mound Cotton Wollan & Greengrass LLP and an adjunct professor at Fordham University School of Law, where he teaches broker-dealer regulation. The views expressed in this article are the authors alone and not those of Fordham or Mound Cotton. Arie Smith, an associate at Mound Cotton, contributed to the research and writing of this article.
 See Massachusetts Securities Division v. GPB Capital Holdings, LLC, May 2020, https://www.sec.state.ma.us/sct/current/sctgpb/2020-5-27-MSD-GPB-Complaint-E-2018-0100.pdf; Massachusetts Securities Division Newsletter, December 2018, http://www.sec.state.ma.us/sct/sctpdf/newsletters/Securities-newsletter-Dec-2018.pdf.
 See, e.g., Mass. Securities Division v. Securities America, https://www.sec.state.ma.us/sct/archived/sctfive/SecuritiesAmericaSignedConsentOrder.pdf (10% Concentration limit); In Re LPL Financial, https://securitiesarbitration.com/wp-content/uploads/lpl-financial-complaint.pdf.
 NOTICE OF REQUEST FOR PUBLIC COMMENT REGARDING A PROPOSED AMENDMENT TO THE NASAA STATEMENT OF POLICY REGARDING REAL ESTATE INVESTMENT TRUSTS, http://nasaa.cdn.s3.amazonaws.com/wp-content/uploads/2016/07/Notice-for-Public-Comment-REIT-Concentration-Limit-07272016.pdf.
 Section 19 (d) of the 1933 Act provides for cooperation, information sharing and an annual conference between the SEC and state securities regulators. 15 USC 77 (s); Uniform Limited Offering Exemption.
 See FINRA Rule 2111, https://www.finra.org/rules-guidance/rulebooks/finra-rules/2111; FINRA Notices to Members 03-07, 03-71, 05-26, 05-50, and 05-59; FINRA Regulatory Notices 09-31, 09-73, 10-09, 10-22, 10-51, and 12-03.
 Section 19 (d) of the 1933 Act assumes the presence of blue sky regulation, and provides for cooperation, information sharing, and an annual conference between the SEC and state securities regulators. 15 USC Section 77s.
 15 USC § 78 (bb)(f)(1). R.W. Grand Lodge of Free and Accepted Masons of PA v. Meridian Capital Partners, Inc., 634 Fed. Appx. 4, at *8-9 (2d Cir. 2015); see also, Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71 (2006).
 Temple v. Gorman, 201 F. Supp. 2d at 1244. Accord, Pinnacle Communications Int. v. American Fam. Mortg., 417 F. Supp. 2d 1073 (D. Minn. 2006) (“When an offering purports to be exempt under federal Regulation D, any allegation of improper registration is covered exclusively by federal law.”). But see Brown v. Earthboard Sports USA, Inc., 481 F. 3d 901, 910 (6th Cir. 2007) (only registered Regulation D securities preempt state law claims) and Ciuffitelli for Trustee of Ciuffitelli Revocable Trust v. Deloitte & Touche LLP, 2017 WL 2927481 (D. OR. 2017) (“The court concludes NSMIA preemption is limited to securities that actually qualify as covered securities under federal law.”)