Affiliate Transactions as a Ponzi Scheme

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Actions by the Securities and Exchange Commission against real estate companies will catch my attention. A recent complaint against Robert Morgan and his affiliated real estate funds did just that.

The SEC complaint is just charges, so we don’t know if the statements are true or what Morgan’s response will be. I’m just using it as a learning tool.

The main charge against Morgan is a criminal complaint for mortgage fraud. In a Department of Justice press release:

The defendants provided false information to financial institutions and government sponsored enterprises overstating the incomes of properties owned by Morgan Management or certain principals of Morgan Management. The false information induced financial institutions to issue loans: (1) for greater values than the financial institutions would have authorized had they been provided with truthful information; and (2) that the financial institutions would not have issued at the time of issuance had they been provided with truthful information.

The SEC grabbed a piece of the action when it was discovered that Morgan has raised four private funds from investors to finance Morgan properties. The funds, managed by Morgan, made what look like mezzanine loans to the properties owned by Morgan.

See if you if you can spot the conflict? Yes it’s obvious.

According to the complaint, Morgan did not treat these as third-party loans in terms of documentation or valuation of the underlying assets. Morgan also used funds to pay off loans that were maturing and owed to other funds.

Lots of conflicts for sure. According to the complaint, the offering materials stated that the loans from the funds would be going to affiliates managed by the funds’ manager. According to the complaint, one fund’s loan to a Morgan affiliate was often used to fund the repayment of another fund’s loan. The SEC labels these pay-off as “Ponzi scheme-like payments.”

The SEC brought its charges for violating the anti-fraud provisions of the Securities Act and Exchange Act.

Numerous affiliate transactions like those in the Morgan empire are full of conflicts and issues. It can be done, with lots of controls and documentation in place. The SEC complaint makes it sound like those were not in place.

Sources:

Author: Doug Cornelius

You can find out more about Doug on the About Doug page

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