Category Archives: Tenant-in-common TICs

An investor arbitration award involving tenant-in-common exchanges (TICs) may have been the final blow for broker/dealer Pacific West Securities. On March 6, a three-person arbitration panel of the Financial Industry Regulatory Authority (FINRA) awarded $2.1 million to a former client of a broker – William Swayne II – affiliated with the firm.

Pacific West announced in December that it planned to close its doors this month and that it had begun a recruiting effort to move the company’s brokers to Multi-Financial Securities Corp. According to the Broker Check Web site, however, Pacific West has yet to file the necessary paperwork to close or withdraw from the securities industry.

As reported March 13 by Investment News, the recent FINRA award against Pacific West Securities involves claimants Joseph and Marilyn Lightfoot, who allege that their TIC investments were not suitable for them “given their age, financial condition, cash flow needs, risk tolerance, over concentration in real estate and for other reasons.”

Included in the award was $200,000 in legal fees and interest.

The lack of suitability of the TICs was highlighted in the arbitration panel’s decision.

 “Among other evidence of a violation of a standard of care under the Securities Act of Washington was the disavowal by [Pacific West and its broker, William Swayne II] of any obligation to conduct a suitability analysis for the sale of TICs in the circumstances of a Section 1031 – like-kind-assets exchange for tax deferral purposes,” according to the award. The arbitrators “determined that the sale of these securities to [the Lightfoots] violated the duty of reasonable care.”

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 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.

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.

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.”

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.

The allure has rapidly faded for once-hot real estate investments known as TICs, or tenant-in-common exchanges. Between 2004 and 2008, investors bought $13 billion worth of TICs, according to OMNI Real Estate Services. But TICs, also called 1031 exchanges, are complex, high-fee deals and, as in many deals orchestrated by Wall Street, the products have increasingly left countless investors high and dry.

Case in point: Mary Boston, 70, of Dunlap, Tennessee. In 2007, Boston and her husband sold their local theater for $1.2 million, net of debt, according to an Oct. 29 article by the Wall Street Journal. Their tax preparer suggested a financial adviser might be able to help them arrange a 1031 exchange.

After paying the advisor, who was from ING Financial Partners, a 7% commission fee, the couple ended up putting $1.2 million – their entire liquid net worth – into two TICs. In return, they received a stake in two apartment complexes, the Sequoia at Stonebriar in Texas and The Retreat at Stonecrest in Georgia. The offering documents projected an annual yield of 6.5%.

But the Bostons had zero prior investing experience; Mrs. Boston says she told the advisor that she and her husband had a “conservative and moderate” risk tolerance, and that income was their primary investment objective.

After the deals closed, the Bostons had to come up with more money when one of the properties became involved in various lawsuits. Between the capital added and legal fees, the couple has sunk roughly $70,000 more into the property, the Wall Street Journal said.

Meanwhile, the monthly income on the Boston’s investment has plummeted from about $5,000 to $300 – and is projected by the property manager to dry up altogether this month.

The bottom line: TICs are considered a private placement, which is a highly complex and risky investment. The products, in fact, are listed as one of the top 2011 Investor Traps by the North American Securities Administrators Association.

Sales of tenant-in-common exchanges (TICs) have come back to haunt a number of broker/dealers, as they face a lawsuit brought by the trustee of one of the biggest creators and distributors of TICs – DBSI Inc.

DBSI, which defaulted on its payments to investors in 2008, has filed for Chapter 11 bankruptcy protection. Now, James Zazzali, the trustee in charge of the bankruptcy, is taking legal action against nearly 100 broker/dealers that sold the doomed product. The lawsuit, which was filed in November, alleges that the TIC from DBSI was actually a $600 million Ponzi scheme.

As reported Dec. 8 by Investment News, the five biggest earners of commissions for selling DBSI include: Berthel Fisher & Co. Financial Services Inc.; QA3 Financial Corp.; DeWaay Financial Network LLC; The Private Consulting Group, which shut down last year; and Questar Capital Corp.

Many of the firms listed in the DBSI lawsuit already are waging similar legal battles over failed private-placement deals. Among those on the DBSI list: Brecek & Young Advisors Inc., which merged into Securities America Corp. in 2009; KMS Financial Services; J.P. Turner Co. LLC; and Alternative Wealth Strategies Inc.

Unlike other private-placement investments that have hit hard times recently, DBSI has not been charged with fraud by the Securities and Exchange Commission (SEC). In July 2009, two high-profile private placements, Medical Capital Holdings Inc. and Provident Royalties LLC, were sued by the SEC for fraud. In the case of Provident Royalties, more than 40 broker/dealers that sold the product have been sued by Provident’s receiver.

A TIC is a real estate investment in which two or more parties own a fractional interest in a select property. The investments became popular in 2002 after the Internal Revenue Service ruled that investors could defer capital gains on real estate transactions involving the exchange of properties.