Nearly 100 small to midsize independent broker-dealers find themselves in hot water from sales of a real estate investment known as a tenant-in-common exchange.
Dubbed a TIC, the vehicle is a form of real estate ownership in which two or more parties have a fractional interest in the property. TICs gained in popularity after a favorable Internal Revenue Service ruling in 2002 that allowed investors to defer capital gains on real estate transactions involving the exchanging of properties.
But one of the decade's biggest creators and distributors of TICs, DBSI Inc., defaulted on its payments to investors in 2008. The firm filed for bankruptcy protection under Chapter 11 in November of that year.
Now, the trustee for the DBSI bankruptcy, James Zazzali, is zeroing in on the 90-plus independent broker-dealers that sold the failed product. In a lawsuit from last month, the trustee is seeking to claw back about $49 million from 96 broker-dealers.
(See the full list of B-Ds and the alleged commissions earned off of sales of DBSI TICs here.)
The suit filed by Mr. Zazzali, a former Chief Justice of the Supreme Court of New Jersey, claims that the TIC from DBSI was actually a $600 million Ponzi scheme.
“At some point in or after 2004, the DBSI enterprise took on the characteristics of 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 alleges.
According to the lawsuit, the five biggest earners of commissions for selling DBSI, in order, are: Berthel Fisher & Co. Financial Services Inc.; QA3 Financial Corp.; DeWaay Financial Network LLC; The Private Consulting Group, which closed last year; and Questar Capital Corp.
Indeed, many firms named in the suit already face far-ranging legal problems from the fallout of 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. (To see which firms sold the TICs from DBSI,
click here.)
Observers were quick to note that the trustee, Mr. Zazzali, has recently fired off hundreds of lawsuits in the DBSI bankruptcy proceeding, including complaints against the local power and water companies. In another oddity, the lawsuit against the broker-dealers, which is in alphabetical order, 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 federal bankruptcy court in Delaware, seeks to recover from the B-Ds “all fraudulent and preferential transfers of properties” in the matter, in this case the commissions generated by the broker-dealers.
Unlike 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 series 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 broker-dealers that sold the product.
The lawsuit “is probably a surprise to a lot of people,” Tom Berthel, chief executive of Berthel Fisher, said in a reaction that 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.
“QA3 acted with the utmost integrity” and will vigorously defend itself in the matter, said Greg Bolton, the firm's counsel. Laurie Bauer, a Questar spokeswoman, said the firm 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.
