Friday, October 17, 2008

Settlements stack up in QES case


More than a year and a half after millions of dollars vanished when a Montecito-based intermediary firm collapsed along with a Las Vegas company, settlements between victims and those allegedly responsible for a case of brazen fraud are starting to take form.
Approximately $60 million has poured in as insurance companies and investment firms pay off those involved in a series of class action suits, inching closer and closer to the $98 million allegedly pilfered from the pockets of unsuspecting customers.

But to fully understand the failure of Qualified Exchange Services (QES), a 1031 exchange company headquartered on Coast Village Road, the story has to be traced back to an unexpected topic: breast implants.
In the 1990s, Donald McGhan had the industry of silicone implants by the horns, having founded several major implant manufacturers in the Santa Barbara area.
“He was kind of known as the godfather of breast implants,” said Michael Denver, an attorney with Hollister & Brace, a local law firm representing the class action plaintiffs.
But when some questionable business practices drew the attention of the Securities and Exchange Commission, McGhan agreed to a settlement while admitting no wrong and skipped town.
Landing in Las Vegas, he launched a new business, MediCor Ltd., with plans to dive back into the world of breast implants. Despite visions of snapping up existing manufacturers and distributors around the world, McGhan was strapped for cash, Denver said.
That’s when he became aware of Southwest Exchange (SWX), an escrow intermediary based in Henderson, Nev., through an investment banker named Peter Demarigny, according to the class action complaint.
The firm held cash from real estate sales for up to 180 days until it was used to purchase other property in order to avoid capital gains taxes, known as a 1031 exchange after its related IRS tax code section.
Plaintiffs allege McGhan eyed the millions of dollars sitting in escrow accounts and saw a solution to his cash problem.
“So he and Demarigny wine and dine the folks over at SWX a couple of times, but get rebuffed,” Denver said. “It doesn’t take a genius to figure out that if you had sold a piece of real estate property and you’re putting money into a little piggybank, you don’t want that money going into MediCor breast implants.”
McGhan then decided to buy out the company, the complaint alleges, pulling together $3 million and paying off the owner. The next day, he allegedly swiped $52 million from the piggybank and bought Eurosilicone SAS, a breast implant manufacturer in France, on behalf of MediCor.
“They were using new 1031 exchange money that was coming in for old 1031 exchange obligations,” Denver said.
The alleged Ponzi scheme of sorts rolled along for months with only a few minor bumps in the road. But when the real estate market started tanking in 2006, incoming deposits didn’t match outgoing payments and everything fell apart.
Customers of QES, which had become affiliated with SWX along with two other intermediaries and had allegedly become another source of quick cash for McGhan, lost in the neighborhood of $12 million.
Local residents Jon and Marie Sorrell, the primary plaintiffs in the suit, lost $719,600 when funds they made from the sale of property in Lake Arrowhead that they planned to use to purchase land in Santa Ynez was allegedly looted.
Marsha Slotten, a resident of Henderson, Nev., dumped $2.8 million in cash from the sale of a retail strip center in Las Vegas into her SWX account. When she returned 22 days later with plans to purchase two properties in Texas already in escrow, the cash was gone.
Everything was gone. Slotten went to the SWX offices, only a mile from her home, and found a note on the door said everyone had left for a seminar.
“What seminar would everyone go to, even the receptionist?” she said. “It didn’t make any sense.”
People across the hall said SWX employees split a day earlier, taking boxes of personal items and posting the sign on the door.
“It was surreal,” Slotten said. “It was like I was in a movie. It can’t be true, it just can’t. This can’t happen. You can’t work your whole life and get ripped off, boom.”
A total of 133 plaintiffs spanning 16 states are named in the complaint against McGhan, his daughter Nikki Pomeroy, his son Jim, officers at SWX and MediCor, and Demarigny, among others.
Hollister & Brace also filed two additional actions — one a legal malpractice suit against the law firm of Snell & Wilmer, which plaintiffs allege had created a conflict of interest by representing both SWX and McGhan, in addition to helping McGhan cover up his alleged scheme.
The other suit names three insurance producers and four insurance companies who allegedly participated in insurance fraud by issuing inexpensive policies to McGhan’s exchange companies and agreeing to call them “fidelity bonds.”
Doing so would allow McGhan to pass them off as more expensive bonds to convince potential clients that their money would be safe, the suit alleges.
So far, most of the insurance groups have settled — for a total of $17 million — although one continues to fight the suit, Denver said. UBS, which employed Demarigny, is settling for $23 million, while Citigroup, which employed Demarigny prior to UBS, is fighting the claim, he added.
Another $20 million is being settled by other involved entities. Denver said the non-settling defendants remain potentially liable for the full amount of remaining damages.
A racketeering case against McGhan and others is still underway, he said.
“I don’t think he’s getting a walk,” Denver said. “Something has to happen. He can’t just walk away from this.”
But Slotten said even if she gets back the full amount she lost — something she considers unlikely, considering attorney fees and other factors — she’ll still be far behind.
“It will never make us whole,” she said. “But after being broke for two years, I’d be grateful to get anything back.”
She was forced to postpone her retirement and start working in commercial real estate again. Even if her $2.8 million is returned, she said she’ll struggle to find a deal or financing similar to the plan she had set up a year and a half ago to fund her retirement.
“You can’t buy as much, it’s going to cost you more and it won’t generate as much income,” she said.
Although she got burnt this time around, Slotten said she would use a 1031 exchange company again, despite the relatively unregulated nature of the industry. But she would make sure to do a thorough check to make sure everything was legitimate.
“I didn’t do my due diligence because I thought I knew them,” she said. “I’m in the business and it made me feel stupid for not doing my homework.”

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