A Modern Day Saint George

 

The real estate limited
partnership industry is awash in disappointing results, unfulfilled promises, foreclosed properties, bankrupt general partners and hints of worse scandals to come. To Robert Mills, the most startling aspect of this sordid story is not that so many deals are going bad but that so few limited partners are suing to recover their investments. He contends that financial advisors are partially to blame.

Mill, a San Rafael, California-based attorney who specializes in class action cases involving limited partnership securities, charges that some planners are too worried about being named as defendants to suggest their clients take legal action. Others mistakenly imagine that no money can be recovered from an insolvent partnership.

Mills is probably best known to the financial services industry as the founder of Private Securities Network, a broker-dealer, and as the former president of National Partnership Marketplace, a secondary market maker for partnership units. Earlier this year, Mills decided that he could not, in good conscience, continue to make a market for shares in programs that sometimes appeared destined for disaster. In addition, he discovered that many limited partners are unaware of the considerable rights they have under securities laws. So Mills has saddled his white horse, donned his armor and is galloping at full tilt toward the dragons of disrepute.

He has been instrumental in filing several lawsuits charging partnership fraud, misrepresentation and failure to disclose material facts. He also is evaluating the merits of other potential cases. In general, he does not sue either planners or broker-dealers, for two reasons. The first is pragmatic: Planners and broker-dealers usually have rather shallow pockets and little or no liability insurance. Second, the average lawsuit is better served, Mills believes, when the attorney has planners and broker-dealers on his side. The reason is simple: They have information that can help the suit. "As an attorney," he explains, "you want the planners and broker-dealers volunteering information rather than hiding it and leaving you to pry it out of them."

Few planners realize that many attorneys who specialize in limited partnership securities matters believe planners are not appropriate targets to sue. However, lawyers unfamiliar with securities cases often take a pepper-'em-with-buckshot approach. They collect the names of everybody connected to the partnership, form the planners who sold it to the receptionist in the sponsor's investor relations department, and name them all as defendants, right alongside the general partner. If a disgruntled investor obtains legal advice from an attorney who is not versed in the realities of securities law, a planner may well find himself caught up in the suit.

For this reason alone, Mills urges planners to take positive, assertive action before clients start looking through the Yellow Pages for a lawyer. He says a planner should send his clients to an attorney who will recommend suing the parties directly responsible for the investment's failure, not the planner himself.

Investors often assume it is too late to sue the principals of the deal once the failure becomes evident. Even if wrongdoing by the general partner caused the deal to fail, once the partnership's assets have been foreclosed and the general partner has filed for bankruptcy, what is left to recover?

"That thinking could not be more worn," Mills says emphatically. Often an insolvent partnership still has a pool of money sitting there for the taking. The money comes from the liability insurance carried by the law firm that prepared a misleading offering memorandum, the consulting firm that wrote a glowing market feasibility study, the real estate brokerage that oversold the partnership, or the accounting firms that signed off on the partnership's too-optimistic assumptions or failed to disclose irregularities during annual audits. "These professionals are separate, independent targets," Mills points out. "They all have malpractice insurance.

Mills served as a consultant in a lawsuit brought by investors in Belmont Square, a $3.7 million program organized in 1981 to acquire a small office complex in Portland, Oregon. By the time the suit came to trial in 1987, the real estate had been foreclosed, and the general partner not only had filed for bankruptcy but also was in jail for securities fraud. Nevertheless, investors have recovered $2.3 million from the real estate brokerage firm's malpractice insurance policy, and Mills expects them to receive at least another $1.4 million from the accounting firm's malpractice insurance carrier when a suit now under way is settled.

The general partner also may have purchased malpractice insurance to which the limited partners can look for relief. Such is the case, Mills reveals, with Consolidated Capital Equities Corp., which purchased a $5.14 million malpractice policy using partnership funds. Although both ConCap and Southmark, which acquired ConCap in 1988, are in bankruptcy, the prepaid insurance policy remains in effect.

Some planners also harbor the misconception that a plaintiff cannot win a lawsuit against a general partner or his fiduciaries without clear and compelling evidence of blatant fraud. Actually, federal and state securities laws provide what Mills calls "very potent remedies." If there was a misleading representation or if something material was absent from the offering circular, an investor "does not have to prove causation or reliance or fraud. [He] can go to court on strict liability and recover [the] investment, plus damages and attorney's fees," he explains.

Only an attorney can decide whether the shortcomings of a particular investment are sufficient to warrant legal action, so every planner should establish a relationship with a competent securities litigator to whom clients can be referred. "Find somebody who specializes in this very esoteric arena," says Mills, "not the lawyer across the hall or the guy you play golf with who handles business contracts."

Before referring clients, a planner should confirm that the attorney believes in selectively naming defendants, as opposed to using a scatter-gun approach that might include the planner as defendant. Obviously, no ethical attorney will guarantee not to sue a planner if the adviser deliberately undertook to defraud a client, but many can assure the planner will not be a target if he acted in good faith with the client's best interests at heart. After locating a competent attorney, a planner should share his concerns about partnership irregularities with clients invested in the program and suggest they talk with the lawyer. (Attorneys generally do not charge for this initial consultation.) Conversations between the client and the attorney are privileged, but the planner can stay involved. "I see nothing wrong with the planner following up with the client," says Mills, "asking if there are grounds for a suit and, if so, obtaining permission to call the attorney and offer help or additional information."

If the facts merit a lawsuit, the attorney may suggest any of three possible ways to proceed. The first is what Mills calls the "credible bluff." The client threatens to sue as a sole plaintiff to recover his own investment, to entice the general partner into giving the investor back his money. "It happens all the time," says Mills. The general partner may be motivated by two realities. First, the amount the client has invested usually is smaller than what the general partner's counsel would charge for responding to a lawsuit. Also, general partners know that most class actions are instigated by a mere handful of litigious investors who manage to persuade the more passive majority to join them. If a potential troublemaker can be weeded out early, the general partner improves his odds of avoiding a class action suit.

The client's second option may be a group lawsuit involving some, but not all, of the limited partners. All investors are sent a letter inviting them to join the suit by contributing a sum - usually 3% to 5% of their original capital contribution - to a fund that will be used for legal fees and expenses. Those who send a check become parties to the suit, and those who fail to respond are excluded. The advantage of this approach, Mills notes, is that if the defendants have a small malpractice insurance policy or only a limited pool of funds, the plaintiffs are more likely to recover their investment. The technique also is popular with lawyers, who get paid up front from the war chest that was collected. The disadvantage, Mills cautions, is that such cases rarely are settled until the statutes of limitations have run their course. The defendants usually stall until it is too late for other investors to file new suits before settling with the original group of plaintiffs.

The third remedy is a full-blown class action suit filed on behalf of all the limited partners. The process is time-consuming, but a class action sometimes is the only way to interest a lawyer in the case if there is no money up front to pay his fees. "An attorney may be willing to take a class action on a contingency basis, which he probably would not be willing to do for just a few investors," says Mills.

The client and the attorney must determine whether there are grounds for a suit and decide which kind of suit to file. The planner's role, basically, is to make the introductions, but his rewards can be considerable. For one thing, he reduces his own liability by demonstrating to clients that he genuinely cares about their well-being. "Studies show that people don't sue those who go to bat for them," says Mills. Also, a client may be sufficiently impressed by the planner's concern to remain a client and, perhaps, to recommend the planner to friends.

Finally - and most importantly - helping a client recover his losses "is the right thing to do," Mills says simply. "It is sad that many financial planners have literally become co-conspirators with general partners they detest because they [are afraid] to tell their clients how bad some of their investments actually are."

Besides serving the cause of justice, says Mills, recommending legal action against an irresponsible or unethical sponsor or fiduciary probably will allow the planner to stand a little taller during the day and to sleep a little better at night.