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Source of Title Blog

Someone Please Explain The Double Standard
by Robert Franco | 2008/12/08 |

As a title agent, I am required to keep client funds in a special Interest On Trust Account ("IOTA").  Funds in the IOTA account are kept segregated from our operating account.  The logic is simple - its not my money; it belongs to the clients.  Commingling client funds with company funds is expressly prohibited.  As a fiduciary, I owe the clients a duty to protect their money. 

Assume for the sake of argument that I get a hot stock tip, or Archie, at the local racetrack tells me that "Easy Money" in the fifth race is a "sure thing."  What do you assume would happen if I "borrowed" money from my IOTA account to make the investment, or place the para-mutual wager, and I lose it? (Would it even make a difference if I made money?)  I am guessing that I would not "pass go" and I would not collect $200 as I proceed straight to jail.

So, explain to me why a national underwriter, like LandAmerica, was allowed to put about $400 million of client money, held for 1031 exchange transactions, into commingled accounts that invested in auction-rate securities.  It sounds like LandAmerica was gambling with client funds.  When the securities became illiquid, the company collapsed and filed bankruptcy.  LandAmerica's agents could certainly never get away with commingling escrow funds - so why would LandAmerica do such a thing?

Source of Title Blog ::

Customers use 1031 Exchange services to avoid capital gains taxes when they sell property.  Section 1031 of the Tax Code provides that:

No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is to be held either for productive use in a trade or business or for investment.

There are some exceptions. But, basically, Section 1031 allows a taxpayer to sell property held for productive use in a business or for investment purposes and reinvest the proceeds in similar property and carry forward their basis in the new property, thereby delaying the capital gains tax.  To qualify, the proceeds must be held by a qualified intermediary, such as LandAmerica's 1031 Exchange Services, and the new property must be identified withing 45 days after the taxpayer sells the property relinquished in the exchange, and the new property must be purchased within 180 days.

According to a Wall Street Journal Online article, LandAmerica's Collapse Leaves Investors Looking for Cash, the company was investing its clients' money in auction-rate securities and when the securities became "illiquid" it notified its customers in a letter.

In the [bankruptcy] filing, the company said it had put much of the money it was holding for real-estate investors into commingled accounts that invested in auction-rate securities that have become illiquid. LandAmerica had guaranteed the money. The auction-rate securities market seized earlier this year. LandAmerica informed customers in a letter last week that it had "taken every reasonable step possible to avoid" the illiquidity problem.

Now, hundreds of LandAmerica's clients will not be able to complete their 1031 exchanges before the 180-day deadline and they will face severe tax consequences.  With LandAmerica in bankruptcy, it seems unlikely they will recover their losses from the company.  Worse yet, it appears that the company continued to accept 1031 exchange business months after the liquidity problems began.

For some good commentary on the debacle, see Thomas Smicklas's article, GMAC Restructuring Leaves SmartNotes Holders in the Lurch.

And speaking of shame, LandAmerica, the erstwhile gold-plated Title and Land Exchange company has completely screwed thousands of 1031 tax deferred property escrow account holders waiting to exchange property through their "top rated land exchange program" by selling the profitable portions of LandAmerica to Fidelity and throwing their 1031 tax deferred exchange investors who assumed escrow funds were held in trust for immediate release (so said the company) under the bus by declaring that portion of the company insolvent and throwing it into a Chapter 11 reorganization.

Clients were informed in a one page statement that the President of the company was "sorry" this happened, and referred the victims of this incredibly crafty screwing to a phone number, which repeated the letter in a Stalin-esque manner. If Congress ever wanted to investigate fraud and mismanagement of funds placed in trust, this would be it. Hundreds of millions of dollars placed in LandAmerica's 1031 tax deferred swindle are likely lost. To add insult to injury, any monies returned to the customers will receive a full tax treatment, blowing the 1031 intent.

According to the WSJ article, LandAmerica didn't disclose its poor investment strategies to its customers.  A few companies however, had insisted that its money be segregated in regular bank accounts.  Only about 50 of the 450 investors involved had segregated accounts.

This seems like quite a double-standard to me.  LandAmerica would never permit its title insurance agents to handle escrow funds with such careless disregard.  But, LandAmerica "guaranteed" the funds it played with, so I guess that's okay.  Remind me, what is the company's guarantee worth in bankruptcy?  It seems like LandAmerica adopted a "do as I say, not as I do" policy regarding client funds.

Someone should be going to jail... but who? 

Robert A. Franco
SOURCE OF TITLE




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Categories: Escrow/Funding, Ethics

1303 words | 4464 views | 7 comments | log in or register to post a comment


Not just in LandAm 1031

I think time will show that all the Major UWs had double standards for a number of elements of their operations.  I think we'll find that their "lender" divisions received much different underwriting guidance and where held to a far lower standard than their indpendent agents.  No one dared to kill deals for national lenders - they might get angry and move to the competiton. 

Much more pain for the UW ahead.

 
by Dave Wirsching | 2008/12/09 | log in or register to post a reply

DOUBLE STANDARD

Classic example of "I am bigger than the law" attitude. 

 
by Clanci Nelson | 2008/12/09 | log in or register to post a reply

Jail time

It seems that a lot of key officials at both public and private institutions were grossly ignorant of the perils of these auction-rate securities, but in some cases it seems they were misled by the Wall-Street types that were selling these securities.  It's very possible that these products were represented to the LandAmerica financila types to be as safe as cash.

It certainly is worth investigation, and I think that someone should be going to jail too, but I wouldn't assume that it should be a LandAmerica exec going to jail-- not yet at least.

 
by Slade Smith | 2008/12/09 | log in or register to post a reply

You are missing the point...

I'll forgive you Slade, since you aren't technically a title-guy.  The crime isn't making a bad investment... its using someone else's money for your own purposes.  It wouldn't matter if LandAmerica bought gold bricks and kept them under lock and key in a vault at their headquarters.  They were fiduciaries - holding someone else's money - they had no right to use that money for anything.

Of course, I'm guessing that there is some exception for these 1031 companies.  But, there should not be.  Just like I would go to jail for diverting escrow funds for my own personal investment, LandAmerica should be held to the same standards.

 
by Robert Franco | 2008/12/10 | log in or register to post a reply

Send them all up the river

Robert,

Unlike IOLTA (or IOTA) rules, I am unable to find any legal requirement for 1031 tax deferred exchange accounts to be held in specific kinds of investments (in my state). Without additional statutory requirements, I would think the investments would be subject only to the terms of contract between the exchangor and the intermediary and common law fiduciary duties (good faith, loyalty, lack of self-dealing etc.). Unless some type of fraud, collusion or misrepresentation was involved, I would be surprised if any of the execs see the inside of a municipal condominium.  

 However, on a purely visceral level I think these big businesses that mismanage client and consumer funds need to be shut down. I say handcuff the execs of these types of businesses to the reporters who "stole" the Empire State Building and send them all in the same paddy wagon to the pen.

 
by J. H. | 2008/12/10 | log in or register to post a reply

Yes... I agree...

There is apparently very little regulation of 1031 companies.  In my opinion, LandAmerica should be subject to the same standards that they require of their title agents.  My guess is that you are right - the terms of the contract allowed LandAmerica to make investments with their clients' money.  That would explain why so few actually required segregated accounts for their funds - they had attorneys representing them who actually read the contracts. 

It also appears that LandAmerica continued to accept new clients long after it was aware of its liquidity problem.  To me that indicates that there may have been some fraud. 

You are right that it is very unlikely that any LandAmerica executive will see the inside of a "municipal condominium."  (I love that term).  But, to me, that is only due to a technicality - they were able to get their clients to sign contracts that permitted them to escape their fiduciary duties.  Perhaps we need some new legislation in this area - 'cause if that ain't illegal, it should be.

 
by Robert Franco | 2008/12/11 | log in or register to post a reply

Illumination required - and appreciated.

Thank you for actually stating the obvious. Landam was a fiduciary and misused client funds - to what end it hardly matters as the strategy backfired. The guilty walk the streets of Richmond free men. Too often the 'what the heck, it's only money' attitude spawns the inevitable visit before a black robe, and yet it happens and happens again! We are victims of our own malformation - simply, 'these guys' acted like those whose small title company gets caught comingling monies simply because 'they' were in the title business! Shifting control of the industry to the Federal level is not the answer, and broadening the integration in the real estate industry has only created unemployment (if that is efficiency, what isn't). What could work is what has worked - in another sector, the banking industry (forgive me T.A.R.P.). Many times State Bank Examiners have uncovered misuse of funds in state chartered institutions. The mental handwork is not too elaborate. More eyes on the prize leaves less hands in the till. But, that is just one examiner's opinion.

 
by Joseph Grabiel | 2009/11/30 | log in or register to post a reply
Source of Title Blog

Robert A. FrancoThe focus of this blog will be on sharing my thoughts and concerns related to the small title agents and abstractors. The industry has changed dramatically over the past ten years and I believe that we are just seeing the beginning. As the evolution continues, what will become of the many small independent title professionals who have long been the cornerstone of the industry?

Robert A. Franco
SOURCE OF TITLE

 

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