Nearly 100 small to midsize independent broker-dealers find themselves in trouble over sales of tenant-in-common exchanges, a form of real estate ownership in which two or more parties hold fractional interests in a property.
TICs gained popularity after a favorable Internal Revenue Service ruling in 2002 that allowed investors to defer capital gains on commercial real estate transactions involving the exchanging of properties.
Independent broker-dealers were big sellers of TICs from DBSI Inc., one of the country's biggest creators and distributors of the product until it defaulted on its payments to investors and filed for bankruptcy protection under Chapter 11 in November 2008.
The trustee for the DBSI bankruptcy, James Zazzali, now is zeroing in on the 90-plus independent broker-dealers that sold the failed product. In a lawsuit filed last month, the trustee is seeking to claw back about $49 million from 96 broker-dealers.
$600M PONZI SCHEME
The suit filed by Mr. Zazzali, a retired chief justice of the Supreme Court of New Jersey, alleged that the TIC deals from DBSI were actually a $600 million Ponzi scheme.
“At some point in or after 2004, the DBSI enterprise took on the characteristics of a Ponzi scheme, in which the guaranteed returns of the old investors could only be satisfied by the flow of funds from the new investors,” the complaint alleged.
According to the lawsuit, the five biggest earners of commissions for selling DBSI, in order, were Berthel Fisher & Company Financial Services Inc., QA3 Financial Corp., DeWaay Financial Network LLC, The Private Consulting Group — which closed last year — and Questar Capital Corp.
The lawsuit mystified some executives at broker-dealers that sold the product.
“The commissions on DBSI sales were generated on transactions which occurred before DBSI's financial problems became known,” Melissa Tarentino, general counsel for Investors Capital Corp., another firm named in the suit, wrote in an e-mail. “In that regard, a wholesale reclamation of commissions for all DBSI transactions, irrespective of point of sale suitability, seems largely inappropriate.”
Many firms named in the suit already face far-ranging legal problems from the fallout from other private-investment deals that tanked. Twenty-two are out of business, while one, Brecek & Young Advisors Inc., merged into Securities America Corp. last year.
Observers were quick to note that the trustee, Mr. Zazzali, has filed hundreds of lawsuits in the DBSI bankruptcy proceeding, including complaints against the local power and water companies. In another oddity, the lawsuit lists the broker-dealers in alphabetical order but stops listing firms at the letter T.
Mr. Zazzali said he could not comment on the litigation.
Nevertheless, the trustee's lawsuit against the broker-dealers, which was filed Nov. 4 in U.S. Bankruptcy Court in Delaware, seeks to recover “all fraudulent and preferential transfers of properties” in the matter — in this case, the commissions generated by the broker-dealers.
Unlike issuers of other private investments that imploded before and after the broad market collapse, DBSI has not been charged with fraud by the Securities and Exchange Commission. Two other notable issuers of private placements, Medical Capital Holdings Inc. and Provident Royalties LLC, were hit with fraud charges by the regulator in July 2009. The receiver for Provident Royalties sued more than 40 broker-dealers this summer seeking a claw-back in principal and commissions from firms that sold the product.
Idaho and its Department of Finance sued DBSI and its president, Douglas Swenson, in 2009. According to the lawsuit, Mr. Swenson did business through numerous companies that contained DBSI in the name.
“These DBSI companies are mere alter egos for Mr. Swenson,” the lawsuit alleged. “These DBSI companies were used to make fraudulent and unlawful offers or sales of securities as described in this complaint, and were formed for the purpose of shielding Swenson from accountability and for perpetrating fraud on the investors. These companies have such a unity of interest with Swenson that the separate personalities of the companies and Swenson no longer exist.”
Mr. Swenson could not be reached for comment.
The DBSI bankruptcy trustee's lawsuit against the broker-dealers “is probably a surprise to a lot of people,” said Berthel Fisher chief executive Tom Berthel, whose reaction was typical of executives whose firms were named in the suit. Executives also noted that DBSI had a track record going back decades and never had serious problems before 2008.
According to court documents, DBSI facilitated the exchange of commercial properties, managed the buildings and mailed monthly dividend checks to investors.
“QA3 acted with the utmost integrity” and will defend itself vigorously in the matter, said Greg Bolton, the firm's counsel.
Laurie Bauer, a Questar spokeswoman, said the firm, a subsidiary of Allianz Life Insurance Company of North America, was aware of the litigation and had been anticipating it for some time. Questar had not yet been served with the lawsuit, she noted, but was evaluating its liability.
Matthew Stahr, president of DeWaay Financial Network, declined to comment.
Other firms named in the suit tried to put the DBSI bankruptcy in the broader context of the economy.
“It's really unfortunate any time a business goes bankrupt,” said George Repple, chief executive of G.A. Repple & Co., adding that the firm did its “full due diligence” on DBSI. The latter firm's bankruptcy “happened at the same time as the economic collapse on Wall Street,” he said. “When you take liquidity out of the market, it has an impact on business.”
E-mail Bruce Kelly at firstname.lastname@example.org.