Independent Appraisal

A sponsor has valued its non-traded program's units using a methodology based on the offering price since inception. In its most recent reporting period, it switches to valuing units based on an independent appraisal of the underlying properties, which produces a materially different per-unit figure. Must the sponsor disclose the change in methodology to investors, or is reporting the new number sufficient on its own?

1. A.No -- reporting the new number is sufficient; investors are not entitled to know how it was calculated.Wrong. Investors need to understand what a reported value represents; a silent change in methodology leaves them unable to interpret what a shift in the number actually means.
2. B.Yes, but only if the new figure happens to be lower than the prior figure.Wrong. The obligation to disclose a methodology change does not depend on whether the resulting number went up or down.
3. C.Yes -- the change in valuation methodology must itself be disclosed, separately from simply reporting the new figure.Correct. Investors need to know that the basis for the number changed, not just what the new number is, in order to interpret it correctly.
4. D.No, because valuation methodology is determined solely by the sponsor's board and is not a matter requiring investor-facing disclosure.Wrong. Who determines the methodology does not eliminate the need to disclose to investors that it changed.

Why: A per-unit value is only meaningful to an investor if she understands what it represents, and a change in how that number is calculated changes what it means, even if the number itself is reported clearly. Simply publishing a new figure without explaining that the underlying methodology changed leaves investors unable to tell whether a jump or drop in value reflects the program's actual performance or just a different way of counting. The change in methodology itself is something investors need to be told, separately from the resulting number.

A real estate program's independent appraisal assumes a regional rental growth rate that a selling firm's own market research suggests is substantially higher than what comparable properties in the same region have recently achieved. What should the firm do with this discrepancy?

1. A.Investigate and reconcile the discrepancy between the appraisal's assumptions and the firm's own market information, rather than accepting the appraisal's more favorable assumption without further inquiry.Correct. The firm must reconcile conflicting information rather than default to the more favorable figure.
2. B.Defer entirely to the independent appraiser's assumption, since an appraiser's professional judgment always supersedes a selling firm's own market research regardless of any apparent inconsistency.Wrong. Professional credentials do not automatically override contradicting information the firm itself possesses.
3. C.Disregard its own market research entirely and adjust it to match the appraisal, since the appraisal was prepared specifically for this program and is therefore controlling in every respect.Wrong. Being prepared for this specific program does not make an appraisal's assumptions automatically correct or controlling.
4. D.Ignore the discrepancy as immaterial, since assumptions about future rental growth are inherently speculative and therefore not a proper subject for due diligence scrutiny.Wrong. Forward-looking assumptions are exactly the kind of thing due diligence is meant to scrutinize.

Why: The firm should investigate and reconcile the discrepancy between the appraisal's assumptions and the firm's own market information, rather than accepting the appraisal's more favorable assumption without further inquiry.

Thornfield Realty Program's public offering price was set by the sponsor at the outset of the offering, before any properties were acquired, based on a targeted capital raise rather than any appraisal of underlying assets. Its later share repurchase plan instead prices repurchases using an independent appraisal of the portfolio's current value. An investor assumes the original offering price must have been based on the same appraisal methodology. Why is that assumption incorrect?

1. A.The assumption is correct; both prices are always required to derive from the same appraisal methodology under program rules.Wrong. There is no such requirement; the two prices are set on different bases in this program.
2. B.The original offering price is typically set by the sponsor to achieve a capital-raising target before the program owns any appraisable assets, while the repurchase price is tied to an actual appraisal of properties the program has since acquired -- the two prices come from entirely different bases.Correct. The offering price is target-driven and pre-asset; the repurchase price is appraisal-driven and post-acquisition.
3. C.The offering price is based on appraisal, but the repurchase price is not, reversing the roles described in the stem.Wrong. This reverses the actual bases described in the stem.
4. D.Neither price is based on any objective methodology; both are set arbitrarily by the sponsor with no required basis.Wrong. The repurchase price is tied to an independent appraisal, which is an objective basis, not an arbitrary sponsor decision.

Why: The original offering price is typically set by the sponsor to achieve a capital-raising target before the program owns any appraisable assets, while the repurchase price is tied to an actual appraisal of properties the program has since acquired -- the two prices come from entirely different bases.

A plan fiduciary who is also an officer of a DPP's sponsor directs the plan to purchase units in that same program. An independent appraisal confirms the units were purchased at a fair price, and considered purely as an investment, the program would have been a prudent choice for the plan. The fiduciary argues that since the price was fair and the investment prudent, there is no violation. Is he correct?

1. A.Yes -- fair pricing confirmed by an independent appraisal is sufficient to clear any concern about the transaction.Wrong. Fair pricing addresses whether the terms were economically sound; it does not clear the separate, categorical prohibition on transactions with a disqualified person.
2. B.No, but only because the appraisal was insufficiently independent, not because of the fiduciary's role with the sponsor.Wrong. The problem is not the appraisal's independence; it is the categorical prohibition on the plan transacting with a disqualified person, regardless of how the price was verified.
3. C.No -- the transaction is prohibited because it involves a disqualified person, regardless of how fair the price was or how prudent the investment would otherwise be.Correct. Fair pricing and investment merit do not cure a prohibited transaction with a disqualified person; that prohibition applies regardless of the terms.
4. D.Yes, provided the plan's other fiduciaries unanimously approved the transaction without the conflicted fiduciary's vote.Wrong. Approval by other fiduciaries does not exempt a transaction with a disqualified person from the categorical prohibition.

Why: Two things can both be true and the fiduciary is only tracking one of them. Fair pricing and underlying investment merit go to whether the transaction was economically sound; they do not answer the separate, categorical question of whether the plan engaged in a transaction with a disqualified person -- here, a fiduciary with his own interest in the sponsor. Certain transactions between a plan and a party in interest or disqualified person are prohibited outright, regardless of how fair the price was or how prudent the investment would otherwise have been. Fair pricing does not cure a prohibited-party problem; it answers a different question.