Friday, August 14, 2015
Was Irvine House- Flipping Business a Ponzi scheme?
A co-owner of a real estate firm based in Irvine and Long Beach set up a Ponzi scheme to pay off old investors while continuing to recruit new ones for a plan to flip distressed apartment buildings during the Great Recession’s housing collapse, a federal prosecutor told jurors.
However, Michael J. Stewart’s attorney told jurors his client was innocent and he thought his plan was a financially prudent one because homeowners who lost their property in foreclosure would have to turn to renting apartments Tuesday. Defense attorney Kenneth Miller also placed the blame for the company’s failure on co-defendant John Packard.
Packard, who pleaded guilty in November and “is hoping for a lesser sentence,” will testify against his former co-owner of Pacific Property Assets, according to Assistant U.S. Attorney Brett Sagel. Packard is awaiting sentencing.
Ultimately, Stewart and Packard declared bankruptcy in June 2009. The company’s 647 investors lost $91.6 million and the executives owed about $96 million in outstanding principal to banks, according to prosecutors.
In early 2009, during the downturn of the economy, “everybody’s extremely concerned… But defendant Michael Stewart is telling everybody, every potential investor … he has an opportunity for you to make money because his business is thriving,” Sagel said.
Stewart failed to tell his investors his company was failing, Sagel said.
The plan he sold to new investors was to snatch up apartment buildings at “rock bottom prices” and refurbish them to fill the void in housing when evicted homeowners look for a place to live, Sagel said.
“This investment was so great he called this the Opportunity Fund,” Sagel said.
Investors were told they could reap 15 to 30 percent interest a month, Sagel alleged.
“He was offering something too good to be true because it was,” Sagel said.
What he was telling investors was that the economic collapse “gravely affected PPA,” Sagel said.
Stewart’s and Packard’s business plan worked when they founded their company in 1999, Sagel said. They would borrow money from banks and individual investors while acquiring apartment buildings and renting out units and selling or refinancing the properties.
However, the rental income was never enough to even pay the bills, but as long as property values continued to thrive, the model worked as they sold off and refinanced the buildings, Sagel said.
Packard’s job was to acquire property, deal with the banks, get loans and manage the apartments. Stewart, an attorney and real estate broker, was in charge of recruiting investors.
When the housing industry began its collapse in 2006, the company found it tougher sledding to make a profit. By the end of 2007, the company had gotten its last refinancing deal, and the income from sales and loans had dried up, Sagel said.
That left one source of income left — new investors, Sagel said. The decision was made to “step on the gas with investors,” Sagel said.
At one point they put $2 million in the bank and then almost immediately pulled it back out so they could show investors a balance sheet with the money in the account, Sagel alleged.
Stewart also continued to draw a substantial salary while pulling his investments out of his struggling company even while he was giving investors a rosy account of its future, Sagel alleged.
The money from new investors to the Opportunity Fund was supposed to be spent on acquiring apartment buildings, but it instead went to pay off old debts, amounting to a Ponzi scheme, Sagel alleged.
Miller said his client could not have anticipated that the collapse of the housing industry would spread to apartments as well.
“What the government is doing is unfairly looking at this case with 20/20 hindsight,” Miller said. “Back when it was happening it wasn’t all that clear.”
By 2009, the housing industry slump appeared to be bottoming out, Miller said.
Stewart and Packard’s company had a solid track record and had earned praise for its business model before the economy cratered, Miller said.
Packard was the “hammer” who had “always come through” but had failed to win the financing to make the Opportunity Fund work, Miller said.
“Investors thought it was a good idea,” Miller said.
And they were warned in memos of the high risks, Miller said.
But up until April 2009, PPA had never failed to make a payment on a loan or to an investor, Miller said.
Stewart himself lost $1 million in his company’s collapse, Miller said.
Packard “was great at his job and Mike Stewart trusted him to do his job,” Miller said.
The two had $110 million in equity in 2006 and could have walked away with $40 million apiece after taxes if they had retired then, Miller said.
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