In August, 1967, securities agencies of Maryland, Virginia, the District of Columbia and the U.S. government issued an unusual joint warning that unregistered, and therefore uncontrolled, real estate partnership offerings were becoming "prevalent" in this region.
Nothing has changed in the 10 years since. Uncounted thousands of dollars have been lost by investors here every years. "It is a continuing problem of major proportions," said Paul Leonard, regional administrator of the U.S. Securities and Exchange Commission (SEC:.
Although the SEC and various state agencies receive dozens of phone calls and complaints from unhappy investors every day, it is with great selectivity that the government actually tries to put someone in prison for the multitude of sins that can be committed in selling real estate partnerships.
"The most important thing is to stop illegal practice," said Leonard. The illegal practice can e stopped much more quickly without the standards of proff of guilt necessary in a criminal prosecution - by going to court to seek a ruling that prohibits violation of the securities laws without punishing them.
The SEC can seek such actions on its own by filing a complaint alleging civil - not criminal - violations of securities laws. A federal prosecuter - the U.S. attorney - would take the case only if criminal charges were contemplated.
No criminal charges have ever been filed against General Financial Services (GFS), a Washington area holding company whose subsidiaries specialized in pension planning and organizing real estate partnerships.
An SEC compalint last summer against GFS alleged civil violations of the securities act.GFS and its officers, in signing consent judgements in response to the SEC complaint, neither admitted nor denied the allegations and agreed not to engage in certain practices.
No fines have been levied, no prison terms imposed.
If the conditions of a consent decree are sunsequently violated, and if that can be proved by the SEC or a prosecutor, consent decree signers are subject to charges of contemp of court.
The "consent route," as attorneys call it, frequently angers those who lose money in investments and feel that justice should extract a pound of a promoter's flesh. They would agree with Norman Polovoy, Maryland state securities commissioner, when he says, "To some extent the consent route is a cop-out."
But, Polovoy adds, "You have an order of priorities.You have to decide if it's more important to send this guy to jail and work up a criminal case, which means letting him continue to operate for another year . . . or to try and get him in, sign a consent and get the practice stopped . . ."
Criminal prosecutions do happen, even if the case are chosen carefully. The SEC regional office points to five major securities frauds it has referred to the U.S. attorneys for criminal action in recent years.
Nonetheless, if a prosecutor takes a case on referral from the SEA or a state securities office, there are some psychological problems with a jury he has to overcome , particularly if the victims are wealthy.
Said one prosecutor who specializes in fraud cases: "Let's say my victim is a doctor, and I've got him on the stand as a witness. The guy on the jury just got a bill for $300 for his annual physical. And the doctor testifies that some sharpies took him for $10,000. Is the juror horrified? He is not. Does he vote to convict? He does not. He wants to give them a medal."
Lewis Brothers, the Virginia securities commissioner, tells about the victim of an oil-and-gas leasing deal that was presented to him strictly as a tax shelter but turned out to be a real loser as well.
"We interviewed this victim," Brothers said, "and he told us, 'I hope you get 'em, but for God's sake don't get my money back. I've already taken the tax write-off.'"
There also is the embarrassed victim. "It bothers him that he was stupid enough to be taken in on this," a federal prosecutor said, "and he loses a little money. But he can afford the money and he's damned if he's going to come forward and admit in open court that he was stupid."
The fact that a rotten investment originally was sought as a tax shelter is not a legal defense, but juries consider it anyway and defense attorneys know that, prosecutors say. And finally, there is problem of proving beyond reasonable doubt that there was fraud, and a criminal prosecution would require.
"A lot of these schemes - particularly in real estate - don't start out as fraud," a prosecutor said. "They go along for a while, then something goes wrong and there's not enough money, so they'll dip into another account. But they say they intend to pay it back. Is that fraud? Can I prove it?" It's a fine line.
While these pragmatic concerns are being weighed by prosecutors and the SEC, there is a flood to stem.
"We are inundated with complaints," said the SEC's Leonard. Irregularities in real estate syndications "are a continuing problem of major proportions."
The SEC and the securities commissions of Virginia, Maryland and the District of Columbia took the unusual step in 1967 of issuing a joint release warning area investors of the problem. Interests in limited real estate partnerships were being sold, the release said, without being registered under the securities laws.
An "unregistered security." The very sound of the term is designed to put the uninitiated person directly to sleep just at the time when he should be paying attention.
A stock is a security. A bond is a security. So, the courts have ruled, are shares of most real estate partnerships. And a security, unless it qualified for some technical exemptions, must be registered.
That means, simply, that the SEC or a state agency has read what the promoters have to say about what they are selling and that the SEC has decided the information in the literature is adequate for the potential investor to make a reasonable business decision.
It does not mean that the SEC thinks that it is a good buy, or that the SEC conducted an independent investigation to verify all the claims in the statement. A registered security will contain these words, prominently displayed: "These securities have not been approved or disapproved by the Securities and Exchange Commission nor has the Commission passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense."
A good registration statement in a real estate venture is a ponderous document, but it usually will say in bold face on the cover page tht real estate purchased with little money down is a "high risk venture," or something similar to that.
The statemant will detail the cost of the project and the underlying financial structure. It will tell about the "track record" of the promoters, and how much profit they expect to make.
It will explain the investor's responsibilities ad liabilities. it will detail the proposed operation and administration of the venture and answer dozenz other questions.
If it is a limited real estate partnerships, it will contain a very important and apparently little understood fact: there is no market, no New york Stock Exchange, no place where an investor can sell his share if he becomes unhappy with the investment. He must find his own buyer, and if a building has lost all its tax advantages (which happens in time) and is running in the red, he is stuck.
Securities lawyers make a very good living drafting such documents and getting them approved. The act that the promoter goes to the expense of having such a document prepared and approved says something positive, according to securities officials.
"The ones who obey the law" and carefully file their statements and get them approcved, however, "are not the ones who trouble us," said polovoy. "The ones who trouble us are the ones who never ask."
And there are clusters of them out there. Usually, some time passes before the investor discovers he has been taken or that the slick brochure full of promises but devoid of warnings did not really tell him what he was risking.
By the time it may be too late, for the investment and for justice. The statute of limitations on failure to register runs out in one year. After that, you have to prove fraud to get a conviction.
Individuals do not have to depend on federal and state offices. Area courthouse are choked with civil suits filed by angry investors seeking relief from some promoter or another. Such a process is expensive, time consuming and frustrating.
"Putting more laws on the books is like putting your finger in a dike that's overflowing," said maryland's Polovoy. "As a first line of defense, people have to become more cynical and more suspicious about investments."