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Monthly Archives: February 2012

FINRA Issues Investor Alert On Account Statements

Investors whose portfolios have taken a hit recently might not be too keen to open their account statements. Bad move, according to the Financial Industry Regulatory Authority (FINRA). Instead, the self-regulator cautions investors to review their statements carefully and immediately contact the firm issuing their account statement about any unexplained fees, overcharges or unauthorized transactions.

“A single keystroke can make the difference between 100 and 1,000 shares,” says Gerri Walsh, FINRA’s Vice President for Investor Education.

On Feb. 23, FINRA issued a new Investor Alert titled It Pays to Understand Your Brokerage Account Statements and Trade Confirmations that details in plain language key elements of customer account statements, plus “red flags” that can help investors spot and avert problems.

The Securities and Exchange Commission (SEC) also is taking up the subject of unauthorized trading. On Feb. 27, it issued a risk alert outlining preventative measures to help brokerages improve their policing of authorized trades.

Fallout From Medical Capital Debacle Continues

The collapse of Medical Capital Holdings has led to numerous lawsuits and arbitration complaints by investors against the brokerages that failed to perform their due diligence before selling them private-placement investments in the troubled company. Now, for what is believed to be a first, an individual has been criminally charged with securities fraud for his role in selling Med Cap notes.

Nine counts of securities fraud were filed Feb. 23 by the Weld County District Attorney’s Office against John Brady Guyette. According to the Weld County complaint, the former Colorado stockbroker sold $1.3 million of Medical Capital investments to investors between August and December 2008. During that time, Medical Capital was showing signs trouble and had already missed several payments to investors in certain note offerings.

As reported Feb. 27 by Investment News, the focus of the complaint against Guyette concerns allegations that he sold Medical Capital notes to investors after the company failed to make payments to investors.

One of those investors is Lucille Linde, 92, who lost her life savings in Medical Capital investments. She began investing in Medical Capital and with Guyette in 2005. Three years later, in August 2008, she invested $300,000 in Medical Capital VI, says the Investment News article.

“Linde reported that prior to writing the checks on Aug. 15, 2008, [she] had been told by a fellow MedCap investor, Borge Villemsun, that MedCap had been late in making principal and interest payments to [him],” the complaint reads. “Linde reported confronting [Mr. Guyette] with this information. Linde reported that [Mr. Guyette] assured [her] that Villemsun had been paid and that the MedCap VI investment was guaranteed safe.

“Linde was not aware that when [she] wrote the checks on Aug. 15, 2008, MedCap II had failed to make principal and/or interest payments due to MedCap II investors. [Mr. Guyette] failed to disclose this information to Linde.”

The Securities and Exchange Commission (SEC) filed fraud charges against Tustin-based Medical Capital Holdings in 2009, freezing its assets and appointing a receiver to oversee its financial books. A number of independent broker/dealers subsequently came under fire from regulators for failing to disclose key information about Medical Capital to investors.

Securities America was the independent broker/dealer subsidiary of Ameriprise. It was one of the broker/dealers of Medical Capital Investments, selling some $700 million of the private placements. In August 2011, the B-D was acquired by Ladenburg Thalmann Financial Services Inc. for a reported $150 million in cash.

Tenant-in-Common Investors Are TICed Off

Complaints involving tenants-in-common (TIC) real estate investments are on the rise, as more disgruntled investors come forth with a laundry list of allegations – including inadequate pre-sale due diligence – against the broker/dealers and brokerage firms that recommended their investments.

TIC investments, or 1031 exchanges, are a form of real estate ownership in which two or more parties own fractional interests in a property. In the early 2000s, TICs entered into a new wave of popularity after a 2002 tax-code change allowed investors to defer capital gains on real estate transactions involving an exchange of properties.

Toward the end of 2008, however, the real estate market became mired in a full-blown crash, and TIC investments felt the effects. One of the biggest distributors of TICs, DBSI, Inc., filed for bankruptcy. Prior to becoming insolvent, investors in all 50 states had put approximately $1 billion into DBSI’s TIC investments.

Subsequent investigations into DBSI’s financials revealed that the company had begun to experience major liquidity issues beginning as early as 2004. By 2006, DBSI’s cash shortages had worsened considerably, prompting it to allegedly create fraudulent investment and tax structures as part of a $500 million fund to buy new properties and attract new investors.

DBSI would later fail to pay investors their dividends out of legitimate rents from the new properties; instead, it allegedly issued payments from profits made by marking up various properties and then selling them at inflated prices to unsuspecting investors. Many of these investors were introduced to DBSI by their broker/dealer.

Today, DBSI investors are filing arbitration claims against various broker/dealers for misrepresenting DBSI and failing to perform their required due diligence before recommending the investment to them.

Brokerage firms are obligated to perform certain duties for their clients. This includes researching a company whose investments they are marketing and selling and thoroughly investigating that company’s fiscal stability. Brokers also are required to inform their clients about an investment’s specific risks and other features, as well as ensure that the product they recommend is indeed suitable for the client’s investing objectives and risk tolerance.

In the case of DBSI, that didn’t happen. Stu Newman had begun to suspect that all was not right with his DBSI investment back in 2007. According to a 2009 article by the Orange County Register, Newman initially became suspicious about DBSI because of its unusually brief and poorly composed quarterly reports. When he and another DBSI investor later shared notes, neither could determine exactly how DBSI paid its investors.

“I was convinced that the only way they kept this going is by selling (to new investors),” Newman said in the article.

Future lawsuits and investigations would come to the same conclusion.

“About the only difference between Douglas Swenson and Bernard Madoff is a decimal point,” Newman says.

DBSI: What Went Wrong?

DBSI Inc., once a heavy hitter in the world of tenant-in-common investments, continues to make headlines in the wake of its bankruptcy filing. In addition to an ongoing criminal probe, DBSI founder and CEO Doug Swenson may be looking at charges of tax evasion, money laundering, racketeering and securities fraud.

TICs in general experienced a number of financial woes following the downturn in the real estate market, but in the case of DBSI, the problem may have more to do with deception rather than economics.

At least that’s what many of the thousands of investors who put their money into DBSI believe. Now it appears some high-ranking officials, including Idaho’s Attorney General, the Internal Revenue Service and the FBI, may share their opinion.

The court-appointed examiner in DBSI’s bankruptcy case, James Zazzali, stated in a 264-page report that DBSI executives ran “an elaborate shell game,” one that included improper and fraudulent use of investor money to prop up the company, to spend on pet projects and to enrich themselves.

DBSI filed for Chapter 11 bankruptcy protection in November 2008. At the time, it held more than $2 billion in property nationwide and managed other assets worth more than $2.65 billion.

Many of DBSI’s 10,000-plus investors lost their life savings when DBSI filed for bankruptcy, while others took huge, life-changing financial hits. Bill Marvel invested $3.5 million into DBSI buildings. After the firm’s bankruptcy, Marvel lost three buildings to foreclosure, and expects to lose a fourth. Out of his initial $3.5 million investment, Marvel expects to hold onto only about $500,000, according to a Feb. 9 Idaho Statesman article.

Then there’s DBSI investors like Barb Korducki, who is still trying to pick up the pieces from her doomed investment foray in DBSI properties.

“I was told that DBSI had made profits for all of their investors, year over year, for over 20 years. Like most owners, I sold a rental (owned before marriage) and put all the proceeds into a building.  Three years after the bankruptcy, we are still plagued with attorney bills.  Though we have never missed a payment, our loan has been turned over to a special servicer, who continues to make unreasonable demands.  He has added thousands of dollars in attorney fees and hotel stays.  It is like a never ending nightmare,” she says.

TICs: A Complicated Investment That Often Bites Investors

Once a booming industry, tenant-in-commons (TICs) have become mangled in controversy – not to mention litigation as more investors come forth with allegations of misrepresentation and fraud.

TICs are complex investments to begin with, and their private-placement memorandums do little to make them less confusing. Too often, the information on a TIC is so mired in hard-to-understand jargon that investors unknowingly set themselves up for potential problems down the road.

A tenant in common, or 1031 exchange, enables investors to own a fraction of a single real estate property. In return, tenant in common investors receive a monthly income, plus the ability to defer capital gains on real estate transactions involving the exchange of properties. The TIC industry experienced a significant boost in popularity during the years of 2002 to 2007. Investors bought $13 billion worth of TICs between 2004 and 2008, according to OMNI Real Estate Services of Salt Lake City.

Then, in late 2008, things began to unravel for the TIC world with the burst of the real estate bubble. TIC investors quickly saw the value of their properties plummet, and two leading TIC players – DBSI and Sunwest Management – sought bankruptcy protection after several of their deals went south. Investors in those deals were left with plenty of questions and, for some, the loss of their life savings. Many investors have gone on to file complaints with the Financial Industry Regulatory Authority (FINRA).

As reported Feb. 19 by Investment News, investors have, in fact, filed arbitration claims with FINRA for $12.6 million in cases involving direct broker/dealer sales of TIC deals from DBSI. Since June 2010, arbitration panels have awarded investors $4.8 million in those cases.

LPL Financial LLC also has had to face the music regarding TIC deals gone bad. On Feb. 10, a FINRA arbitration panel awarded an elderly California couple $1.4 million in a case involving two LPL real estate deals.

Investor complaints over TICs focus on a number of issues, including allegations that they were misinformed from the start by their broker/dealer about their TIC investment. Many TIC investors had no previous investment experience before getting into a TIC. Moreover, several contend they repeatedly told their financial advisor that their appetite for risk was in the “conservative” range and that their investment objective was to “generate income.”

Those characteristics do not describe a TIC. Unfortunately a few unscrupulous brokers used their clients’ lack of investing sophistication for their own personal gain.

TIC Sales Land Former LPL Rep in Hot Water

An elderly couple has been awarded $1.4 million by an arbitration panel of the Financial Industry Regulatory Authority (FINRA) in a claim involving sales of two tenant-in-common exchanges (TICs). The TICs were sold by former LPL broker David Glenn. The investors, Heinrich and Araceli Hardt, have gone on to file a separate lawsuit against the sponsor of the two TICs, Direct Invest LLC.

The award contained several allegations by the Hardts, including federal securities fraud and elder abuse.

A TIC is an investment in real estate whereby two or more parties own a fractional interest in a particular property. In 2002, TICs discovered new-found popularity after a change in an Internal Revenue Service ruling gave investors the ability to defer capital gains on real estate transactions involving an exchange of properties.

Turmoil in the economy has caused financial issues for several TICs and their sponsors in recent years. One leading TIC sponsor, DBSI Inc., filed bankruptcy protection in 2008. Since then, a number of broker/dealers involved in DBSI deals have found themselves at the center of arbitration complaints filed by investors.

In the Hardts’ case, the broker behind the TICs left LPL in 2010; he is now affiliated with United Planners’ Financial Services of America, according to a Feb. 14 article by Investment News.

“When these deals were structured, they used tricks,” stated the attorney representing the Hardts in the Investment News article. “A euphemism known as a “yield enhancement” for the TICs relied on “borrowed money” and “returning investors’ money back to them.”

The two TICs in question apparently produced distributions for only a couple of years. By the end of 2009, the Hardts say they stopped receiving payments on both of their TIC investments.

According to the lawsuit, documents for the private-placement offerings by the sponsor, Direct Invest, “contain multiple false and misleading statements regarding the strength and experience of the manager and property manager, the stability of the cash flows, the potential for appreciation, the superiority of the location, the nature and strength of current projected conditions for the greater Boston office market, the strength of the leases and their corresponding projections, the building fundamentals, the use of proceeds, and the purchase price in relation to the replacement cost.”

Alternative Investment Known as Non-Traded BDC on Radar of Regulators

First it was non-traded real estate investment trusts (REITs) that financially burned investors over the past year. Now another alternative investment product is causing similar concerns: Non-traded business development companies (BDCs)

BDCs invest in various debt and equity of small to mid-size businesses with debt instruments ranging from the senior-secured level to junk status. Despite their obvious risks, BDCs are quickly becoming the investment du jour. Non-traded BDCs raised almost $1.5 billion in 2011, compared with $369 million in 2010, and just $94 million in 2009, according to a Feb. 9 article by Investment News.

The growing popularity of BDCs has sparked concern among securities regulators. Reportedly, the North American Securities Administrators Association plans to intensify its scrutiny of BDCs by drafting a statement of policy on the products in the very near future. Among other things, the statement would contain a review of policies and standards governing any offering documents for a new fund.

The Financial Industry Regulatory Authority (FINRA) also is apparently interested in non-traded BDCs. According to the Investment News article, FINRA may issue an investor alert on non-traded BDCs as early as next month. As in investor alerts previously issued on non-traded REITs, FINRA’s non-traded BDC alert would likely highlight concerns regarding customer suitability and the overall lack of liquidity in non-traded investments.

As in the case of non-traded REITs, many critics of non-traded BDCs fear that some brokers may put their due diligence to clients on the backburner in favor of the high 7% sales commissions that are attached to the products.

FINRA Targets David Lerner Over Non-Traded REITs

Sometimes it takes awhile to learn a lesson. Just ask David Lerner. With his firm, David Lerner Associates, already facing a disciplinary complaint by the Financial Industry Regulatory Authority (FINRA) for misleading investors and selling shares in illiquid real estate investment trusts (REITs) to unsophisticated and elderly customers, owner David Lerner apparently continued to improperly pitch the products.

FINRA is now taking aim at Lerner personally. In an amended filing, the regulator added new allegations to the complaint it previously filed in May 2011 against Lerner’s firm. As reported on Jan. 30 by Reuters, FINRA’s latest complaint focuses on statements Lerner allegedly made to investors following the regulator’s actions against his company this past summer.

In the amended complaint, FINRA states that Lerner sent letters to more than 50,000 customers in July 2011 to “counter negative press” regarding FINRA’s action. That action concerned sales of Lerner’s Apple REITs and, specifically, the fact that Lerner’s firm reportedly mislead investors with information that failed to show distributions of the REITs exceeded income and were financed by debt.

In the letter that Lerner later issued to customers, FINRA says he also discussed a possible opportunity for Apple REIT shareholders to participate in a sale or listing on a national exchange as a way to dispose of their shares at a reasonable price.

FINRA says Lerner further made misleading, exaggerated statements to investors during a seminar that his brokerage firm hosted, including statements suggesting that closed REITs were a potential “gold mine.”

The case against Lerner and his Apple REITs has put non-traded REITs in general on shaky ground with broker/dealers throughout the country.  In October 2011, FINRA issued an investor alert about non-traded REIT investments, calling attention to the inconsistent dividends, illiquidity and inaccurate valuations associated with the products.

Problems Can Be Hidden In TIC Investments

The financial meltdown of several high-profile companies behind tenant-in-common (TIC) offerings raises new questions about the way TIC investments are marketed and sold to investors.

One of the largest real estate companies to file Chapter 11 bankruptcy over TIC-related issues is DBSI, Inc. Some 10,000 investors were left holding the bag when DBSI filed for bankruptcy protection in November 2008.

Idaho-based DBSI was founded in 1979 and quickly became a major player in the tenant-in-common industry. A court-appointed trustee in DBSI’s bankruptcy case concluded in a 200-plus-page report that DBSI executives ran “an elaborate shell game” – one that included improper and fraudulent use of “investor money to prop up the company, to spend on pet projects and to enrich themselves.”

Not all TIC investments go the way of DBSI, of course, but they do come with certain risks that investors may be unaware of until it’s too late. TICs, which provide a fractional ownership in a commercial property, gained newfound popularity in March 2002 after a tax law change gave investors the ability to avoid capital gains taxes by investing proceeds from a property sale into a TIC.

Following the amended tax law, TIC investments began to be sold in droves by financial brokers. And therein the problems began.

In 2005, the Financial Industry Regulatory Authority (FINRA) issued the first of several notices reminding brokerage firms that it was inappropriate to recommend a TIC transaction if the recommendation was based solely upon information and representations made by the sponsoring company in the TIC’s offering document.

Instead, brokerage firms were required to conduct a “reasonable investigation” of their own in order to ensure that the offering documents did not contain false or misleading information. Moreover, members needed to have a clear understanding of the investment goals and current financial status of the investor before recommending a TIC exchange.

Unfortunately that didn’t happen in a number of instances. Many brokers never lived up to their due diligence duties when it came to making recommendations to clients about TIC investments. Instead, they took their profit in fees and commissions, while investors were left with huge – and unforeseen – losses.


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