Source : Business Times - 19 Feb 2009
They say Orange County lender misled them into a risky scheme
Was it the real estate downturn, or were people misled into a risky investment scheme? That’s the question at the centre of a lawsuit filed on Tuesday that accuses Orange County real estate lender Dan J Harkey of bilking dozens of investors out of more than US$15 million
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In an added twist, the investors claim that their money helped fund the election of Mr Dan Harkey’s wife, California state Assemblywoman Diane L Harkey, R-Dana Point.
The lawsuit accuses Mr Dan Harkey of using slick marketing techniques - including mass mailings and DVDs of sales meetings - to attract investors in short-term, high-interest loans to real estate developers. It contends that Harkey exaggerated the value of the properties used as collateral by borrowers, making the individual investments appear much safer than they were.
Dan Harkey denied wrongdoing, saying any losses were related directly to the downturn in the real estate and financial markets.
Assemblywoman Harkey declined to be interviewed. A spokesman disputed the lawsuit’s claim that she used investor money to bankroll her campaign.
‘She had a 30-year career in business and banking in which she acquired substantial financial resources of her own,’ said Dave Gilliard, the assemblywoman’s political consultant. ‘She used her personal resources to help fund her political campaigns.’ Campaign finance records show that Ms Diane Harkey contributed US$1.1 million of her own money to two recent campaigns - an unsuccessful bid for the state Senate in 2006 and last year’s winning run for the Assembly.
Mr Gilliard added that Ms Diane Harkey had no ownership interest in her husband’s company, Point Center Financial Inc of Aliso Viejo.
The allegations centre on a little-known and lightly regulated segment of the real estate industry known as ‘hard-money’ lenders.
These lenders often provide financing for high-risk projects that banks won’t touch, such as speculative housing developments.
Wealthy individuals looking for outsized returns often provide the investment capital. The lawsuit alleges that many investors were retired people who entrusted Mr Dan Harkey and Point Center with their life savings.
The lawsuit, filed in Orange County Superior Court in Santa Ana, claims that Point Center made millions of dollars by charging broker fees upfront to borrowers, allowing the company to profit regardless of whether the loans were repaid.
When the borrowers defaulted, the lawsuit alleges, the investors were often left with foreclosed properties worth a fraction of the money they had invested.
The suit cites a US$19.3 million loan in 2006 to Burnett Development Corp, which planned to build 451 homes surrounding a golf course at the Palm Springs Country Club. The loan was made near the peak of the real estate boom, but conditions soon changed. Burnett Development defaulted on the loan in 2007 and Point Center foreclosed, according to court records. Burnett officials could not be reached.
The now-closed country club has fallen into such disrepair that the city of Palm Springs filed a lawsuit last year - naming individual Point Center investors as defendants - seeking immediate repairs to a property filled with weeds, polluted ponds and graffiti.
‘I was shocked. I thought this was being properly handled by Point Center Financial,’ said Terry Holdt, an investor and one of the plaintiffs in Tuesday’s lawsuit. ‘I knew the intention was to develop the property. I didn’t realize it hadn’t gone very far.’ Mr Dan Harkey declined to address specific cases cited in the suit, but said the plaintiffs represented a small group of unhappy investors. He said investors would make money once the market rebounded.
‘We will manage and chart our way through this,’ said Mr Dan Harkey, 62.
‘I can’t control it if there’s a very tiny renegade group that tries to create all these illusions. We’re probably the best-suited company in California to manage the portfolio back to health.’ The lawsuit also cited Point Center’s US$10 million loan in 2005 to a company that planned to build luxury oceanfront homes in Carpenteria.
In a summary of the project distributed to prospective investors, Point Center said the property owner had ’spent the past seven years securing California Coastal Commission approval’ and needed only final approval from the city of Carpenteria.
The developers, brothers Paul and Richard Ehline, personally guaranteed the loan, according to the Point Center summary. The summary advertised an ‘estimated minimum’ return of 23.5 per cent.
It sounded like a good opportunity to Carlsbad Realtor Jim Haiduck, who said he invested US$200,000 in the project based on assurances by Mr Dan Harkey’s staff that nearly all approvals had been secured.
But the Coastal Commission had not approved the project, the lawsuit alleges. In 2007, Ehline Development Corp defaulted on the loan, Point Center foreclosed and the Ehlines filed for bankruptcy protection.
The brothers listed US$120 million in bad debt in their bankruptcy filings, including US$43.6 million of debt on four separate Point Center loans.
‘This was just a clear case of misrepresentation,’ Mr Haiduck said.
‘We just don’t know where the money went. Now it’s in foreclosure.’ Richard Ehline, in an interview with the Los Angeles Times, said the project stalled when city planning officials said they would prefer a luxury hotel instead of a purely residential development. He said the US$10 million went to acquire the land and for pre-construction expenses.
Mr Ehline said the company spent all its money, was unable to acquire additional financing and was forced to give up the project.
‘We were getting ready to submit the formal application into the city for approval. That’s about the point in time that real estate started to take a downhill turn,’ he said.
The lawsuit, filed by Irvine attorney David C Grant, seeks to have investors reimbursed for their losses. Mr Grant said he hoped a third party could be appointed to manage the properties that investors now own through foreclosure.
Investors say they also filed complaints with the Securities and Exchange Commission, the California Department of Real Estate and the FBI. Officials with those agencies declined to comment.
The lawsuit also alleges that Mr Dan Harkey operated a ‘classic Ponzi scheme’, by renewing short-term loans and using new investors’ money to pay off investors who chose not to renew. One example cited by the plaintiffs was a loan for construction of a proposed shopping centre in Riverside County called Murietta Commons.
Point Center funded the original US$3.9 million loan in 2005 and then allowed the developer to renew the loan in 2007 for US$6.8 million without improving the property, using new investors’ money to repay investors who chose not to renew, the lawsuit alleges.
Investors in both loans were victimised by inflated appraisals, the lawsuit contends.
The proposed shopping centre was part of a flood-control channel and no tenant could be found, according to the lawsuit. The Murietta project was never built and the property went into foreclosure, the suit says.
Mr Dan Harkey called the Ponzi scheme allegation ‘nonsense’, noting that no agency had filed any allegations against him. Point Center has no record of discipline with the state Department of Real Estate, records show.
Mr Dan Harkey said he had been involved in real estate financing for more than 30 years. The Harkeys own a multimillion-dollar home in a gated Dana Point neighbourhood. Their car collection includes a Bentley, a Porsche and two Mercedes Benzes, according to Department of Motor Vehicles records.
The lead plaintiff in the lawsuit is retired Orange County attorney Lloyd Charton, who said he was owed more than US$1 million, some of which went to the Murietta refinancing.
‘He scammed us,’ Mr Charton said. ‘The representations that Dan Harkey made about the safety of the loans were untrue. He was bringing in new money to pay off investors on the same loan, and that’s a Ponzi scheme.’ Mr Charton lives two houses away from Mr Dan Harkey, and said his neighbour made the investments seem foolproof.
In a video-recorded sales pitch to potential customers - DVDs of the meeting were distributed to potential investors - Mr Dan Harkey vowed that investors’ money would be safe because the borrowers’ collateral far exceeded the loan amounts.
‘A default doesn’t mean you lose money. It merely means there’s a set of problems to solve,’ Mr Dan Harkey said in the video.
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