Southwest Exchange: “Uh, Uhm. . . uh. . .” $100,000,000 Reasons to Perform Due Diligence on Your 1031 Exchange Company

In one of the biggest 1031 swindles in Real Estate history, Southwest Exchange of Las Vegas, Nevada was charged with pilfering $100,000,000 of investors money. According to the Las Vegas Business Press, the principles of Southwest Exchange, CEO Donald McGhan and Shirley McGhan (his wife) face a massive civil lawsuit. According to LVBP in their May 18, 2007 edition:
“The couple is accused of one of the largest, most brazen frauds ever alleged against a Las Vegas financial institution. Along with daughter Nikki Pomeroy, son Jim, longtime investment broker Peter DeMarigney, plus a number of insurance companies, brokerage firms, a local bank and related business associates, the couple are named as defendants in a consolidated civil case. The suit alleges more than two-dozen acts of malfeasance affecting victims in Missouri, California, Idaho, Arizona, Nevada and elsewhere”

In addition, the FBI is investigating. “So too are state agencies that failed to detect the chicanery until more than 130 victims had lost more than $100 million. Those victims are all landowners who placed the proceeds from real estate sales into escrow accounts at the now-infamous Southwest Exchange in Henderson, which abruptly shut its doors in January. Instead of avoiding an IRS tax bill by parking their money in a supposedly safe, bonded institution for 180 days, these victims lost between $25,000 and $22 million each, some of which they will never recover.”

In a phone call dubbed “The Answering Machine Call” made regionally famous by Las Vegas’s Channel 8 CBS affiliate “Eye Witness News” , Donald McGhan attempts to lie to one of his clients who is desperate for answers:

“Uh, the wire for your transaction today was all set up, but uh, it didn’t end up going because of some screw up,. . . uh, with,. . . uhm, the coordination between the, uh, electronic wire transfer, uh, instructions over to, uh. . . , our bank and, uh we’re all set up to do that Monday morning. . . ”

The stumbling excuse filled excerpt continues: “So we recognize that you. . . you, uh, want, you know. . . feel. . . feel, uh, violated and want to do something, uhm, but if, if we get, if we get, uhm, uhm, people involved, uh, it is going to screw up going Monday morning. So let’s not–let’s just be patient for it.”

So it’s up to you to perform your own investigation and due diligence into any independent 1031 Exchange company. Do not allow these painful mistakes made by well meaning people, become your own personal nightmare !

 

   
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13 thoughts on “Southwest Exchange: “Uh, Uhm. . . uh. . .” $100,000,000 Reasons to Perform Due Diligence on Your 1031 Exchange Company

  1. Dean: I am an attorney who has been representing investors since 1994. In just the last six months, I have been contacted by an increasing number of investors who are being told that the income they were promised from a TIC deal is going to stop. The two companies you refer to are just the tip of the iceberg.

    There seems to be a misconception that this industry (and these offerings) are unregulated. Most of these transactions were sold as securities and many were sold through NASD brokerage firms. When these transactions collapse so quickly (the ones we are seeing were put together within the last 2 or 3 years) you know that the brokerage firms were asleep at the switch. There are supposed to be reserves, audits and a lot of due diligence by the brokerage firm.

    When I look at these transactions, I see that a lot of what should have been done before the investor’s money was taken just wasn’t done. We are advising our clients who bought into these exchanges through an NASD firm to seek compensation from that firm, and let the brokerage firm sort it out with the real estate company.

  2. Tim,

    Thank you so much for the information rich comment. I believe that what Pat Kitano author of “1031 Companies not Regulated” (transparentre.com) blog and I were referring to was the lack of a industry monitoring mechanism. Either a government monitoring system or something private with some teeth.

    It seems to me that if we are counting upon the firms to “police” themselves then it’s akin to handing the keys to the bar to an alcoholic. If I am completely off base please correct my thoughts on this matter.

    I would appreciate if you would consider adding information for a upcoming piece I am producing. It is a basic “Top 10 Questions to Ask your 1031 Exchange Company” for consumer due diligence.

    Thank you again your thoughts and expertise are greatly appreciated by me and my readers!

  3. Dean

    With the recent spate of QI failures there is no doubt that real property investors have become quite concerned about how to choose a QI. I have been in the Qualified Intermediary business for nearly 30 years and I can confirm that there are some very real indicators of the security of any QI.

    First: Look for completely segregated accounts. I am also an attorney and my law firm is required to segregate all trust funds held for a client. While QI funds are not trust funds in the true sense of the word, there is no reason they should be treated any less strictly. Funds are co-mingled by QI for their benefit and not the customer. More on this below

    Second: Don’t be confused by Fidelity Bonds or Insurance. What a customer needs to require is some sort of joint signatory control over the segregated account. Insurance or bonds may (or may not) provide some source of recovery if funds are lost, but an exchanger needs the funds to be there when they are to complete their exchange and the ONLY way to assure that is to have some control over the funds during t he exchange period. Size and financial strength of a QI may seem like all that is needed but without this security, there is no assurance your funds will be there when you need them

    Third: Insist that you receive ALL interest earned on your funds. The reason QIs co-mingle funds and the reason QIs lose funds is that they usually receive some or all of the interest earned on those funds. Hence there is an incentive for the QI to take risks with the funds to increase their (not the customer’s) return. Not only does this arrangement hide the true cost of the exchange, it is essentially stealing the return the exchanger is entitled to receive. Less than 4% of the QI nationally pay all the interest earned to the exchanger. Look for these companies Compare the actual cost (including lost interest) when comparing fees the QI will be paid. Often the “cheapest” QI may keep the most interest and become the most expensive option. TJ Starker received “interest” and there has never been any reason all exchangers should not receive this interest.

    Fourth: Often smaller companies (who do provide the necessary security) can provide greater flexibility and assistance in your exchange. Larger companies can only offer “cookie cutter” services and I can assure you every exchange is unique and will present issues that should be discussed and reviewed. When you want personalized professional service, you will find it in the very experienced smaller QI companies.

    Fifth: Look for experience and a long term track record. Ask other professionals about which QI they would use. Attorneys CPAs and experienced commercial real estate brokers will often have experience with a variety of QI and may provide some insight into who is best in your area. Remember that the QI need no be local as long as they meet your standards.

    These concepts are not rocket science, but it is amazing how often exchangers don’t do even the most basic “homework” before picking the QI who will hold their exchange funds.

  4. Tim,

    Thank you! I am going to write a consumer help article sometime next week after the holiday rush is over. I appreciate your contribution. I will be in contact next week. Again thank you for your time and readership.

  5. Rob,

    Thank you so much for your tips and suggestions. As I have stated in the past, I am not an attorney nor a QI. I appreciate presenting this information for everyone concerned. Later next week, I will be presenting an article of consumer tips during the due diligence process in choosing a exchange company. I will add some of your tips to the list. Thank you again!

  6. Interesting that an attorney would think investors’ names should be on account with duel signatures. Must not know about “Constructive Receipt” by which is a requirement of the IRS. There is a concern for exchanges to fail.
    Pass history shows that Attornies have acted as QIs and some have left with the cash equity. All QIs are in the business only because the companies make money by holding money. The investor has to wake up not worry about the small competive fees and little interest that is held back which is always taxable and make sure they choose a QI based on the fiancially strong backing, the parent company,and are they owned by a Title Escrow Company, and has that company been around for decades?
    Someday the small independant companies that can’t offer the security, will go away

  7. Alexandra,

    Thank you for weighing in on this subject. I agree with you on some of your points. The only point I do not agree with is the idea that “Someday the small independent companies that can’t offer the security, will go away.” In my opinion the only way that these companies will go away is when there is local, state, and federal laws and regulations enacted to regulate this “Dodge City” industry once and for all.

    Any lawyers out there that would like to take Alexandra on regarding her opinions? Rob, Tim, anyone ?

    Dean

  8. I am one of the many that lost money to the McGhan thieves. Not a big amount by the standards of those who lost several million, but the $180,000 I lost was most of my retirement. The lawyers will get most of any that I get back, so my retirement is gone, and at 60 I can look forward to working the rest of my life. I do so hope I can spend some of it visiting the McGhan scum in jail.

    I am writing to comment on the mention of people needing to do some homework before giving money to a 1031 QI. I actually did quite a bit of homework (not enough obviously). The reason I went with Arrow 1031/Southwest exchange and not with the other 8 I checked out was primarily because Southwest was the ONLY one that was registered with the state of Nevada, and Nevada was the only state requiring registration (I am from Texas).

    The one thing that frosts me so deeply about this whole thing is that Nevada did nothing to prevent it, and the IRS set up the whole program without requiring any over site or taking any responsibility for the loss.

    It is a sad truth, but the money is gone, and the McGhan scum will continue to live a life of luxury on the money they stole.

  9. I’m not an attorney, but I’ve read a lot about 1031 exchanges. Alexandra is correct about the “constructive receipt of funds” issue. The IRS rules prohibit the taxpayer from having control of the funds, actual or constructive, during the exchange period. Starker may have received interest, but remember that Starker was a pioneer in the process. After Starker’s case and until the IRS published rules for deferred 1031 exchanges (as I recall around 1990, give or take a year), most attorneys and CPA’s recommended to their clients that they avoid receiving interest because of the constructive receipt of funds issue. This position changed with the publication of the rules which included clarification that the taxpayer could receive interest on funds held by a Qualified Intermediary. I think that Rob also makes a good point that people should consider both the QI’s fee and interest policy when calculating the true cost of the QI’s services.

    Congress’s position on 1031’s in general is that because of “like-kind” substitution, the nature of the investment does not change, only the security for that investment. Therefore, a taxable event has not occurred. That being said, it would really simplify things if Congress and the IRS would relax the “receipt of funds” prohibition like they do in some other section of the Internal Revenue Code. Until that happens (which might be never), look for company ownership and financial strength in picking a QI as has been suggested by others above.

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  12. I was one of the 130 victims of the money stolen by McGahn and his co-horts. I hate to say it but no amount of investigation into a 1031 Exchange company will keep your money safe. Southwest Exchange had a stellar record. They had been in business for many years. What was hidden from the public was that the original owner had sold Southwest Exchange to McGahn and retained a small ownership (5% if I remember correctly). She smelled something fishy going on but McGahn offered to buy her out when she wanted to dig deeper so she took more money and left all of her former customers to twist in the wind as McGahn continued his ponzi scheme. (This according to court documents filed by the lawyers who filed the civil lawsuit).

    No amount of investigation could have prevented the loss we experienced. Frankly, the Federal Government needs to step in and provide oversight and regulate Exchanges. Further, as far as I know, McGahn has never been charged with a crime. My guess is this is because there are no laws that made taking money from your 1031 Exchange company and investing them else where is illegal. (He was among other tings pouring the money into a silcon breast implant business thinking the FDA was about to approve their use again. The didn’t and that business went bankrupt too).

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