Q & A : First Pension Allegations Spark Concern About ‘Direct Participation’ Programs : Investments: They aren’t illegal, but use caution. Scrutinize the prospectus and always get a second opinion.
The allegations by the Securities and Exchange Commission last week that First Pension Corp. in Irvine may have stolen or misappropriated as much as $124 million from its investors have heightened financial experts’ concerns about such “direct participation” programs.
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Q: What did First Pension Corp. allegedly do wrong?
A: Before it declared bankruptcy last month, First Pension functioned as a pension fund administrator, setting up IRAs, Keoghs and other types of retirement accounts. The SEC has alleged that First Pension persuaded many of the clients to invest in trust deeds offered through other companies that were operated by the same people who ran First Pension--an apparent conflict of interest.
The SEC also claimed that as much as $99 million of investors’ money was never invested in real estate at all and that millions more may simply have been stolen by management at First Pension.
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Q: What is a “direct participation” program?
A: In a typical direct-participation program, a brokerage firm sells investment products that are controlled by the same people who run the brokerage. In this case, the SEC claims, the same people who owned First Pension were selling interests in pools of trust deeds through a brokerage firm they also controlled, VestCorp Securities.
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Q: What’s wrong with such an arrangement?
A: Legally speaking, nothing. Yet First Pension misled its investors by failing to disclose its connection to VestCorp. In addition, and far more seriously, the SEC alleges that First Pension’s owners used VestCorp and other companies they owned to set up an elaborate pyramid scheme to bilk thousands of consumers out of their money.
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Q: If direct-participation arrangements aren’t illegal, how come so many financial experts are wary of them?
A: Advisers often make larger commissions or bonuses for selling investments their own company or an affiliate offers than they would by selling products offered by other financial institutions. This can encourage unscrupulous advisers to put unwitting clients into bad investments, or ones that don’t match their financial objectives, just so the adviser or broker can collect a fatter paycheck.
In addition, some experts warn that direct-participation programs make it easier to defraud unwitting investors. “You don’t always get the normal system of checks and balances when only a few people are running the whole show,” said Elaine Cacheris, regional director for the SEC in Los Angeles. “In this case, the fox was in charge of the henhouse, and the investors were the chickens.”
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Q: Have there been problems with direct-participation programs before?
A: Yes. Prudential Securities’ highly publicized problems with some of its oil and gas partnerships is a prime example of the troubles these programs can cause, Cacheris said.
And last December, a federal court-appointed officer agreed with the SEC that the defunct Brokers Investment Corp. in Woodland Hills had misused much of the estimated $109 million it raised for limited partnerships offered by a telecommunications firm with which it had close ties.
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Q: How can I reduce the chances of getting ripped off if I invest in a direct-participation program?
A: First, realize that most of these programs are legitimate and that any investment you make will carry risks. Have your financial planner or adviser justify all these risks and explain how it would meet your overall investment goals.
Scrutinize the offering’s prospectus, including the section on conflicts of interest.
Always get a second opinion from a planner or adviser at another firm before you invest.
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Q: How can I find out more about my broker or the people who run the company that he suggests I invest with?
A: If you’re dealing with investment brokers, you should call the state Department of Corporations to see if they and the firm they work for are licensed and whether they have been the subject of disciplinary action in the past.
If the investment you are considering involves real estate, you can get similar information by calling the state Department of Real Estate.
You can also get the names of individuals who own the company, as well as any company listed under the “conflicts of interest” section of the prospectus, by contacting the California secretary of state.
You can also discover the disciplinary history of any brokerage firm or sales representative by calling the National Assn. of Securities Dealers’ toll-free hot line at (800) 289-9999.
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Q: What are the chances that First Pension investors will get all their money back?
A: Chances of a full recovery are virtually nil. Up to $124 million of the $350 million in assets of First Pension clients may have been lost. It will probably take several months and possibly even years to determine where the money went and then try to get what’s left of it back.
