DBSI Inc., an Idaho-based commercial real estate investment company, is facing questions from investors after becoming insolvent. DBSI based much of its business on Tenants in Common (TIC) investments. In 2003, the Internal Revenue Service (IRS) amended rules so that investors could avoid capital gains tax by investing proceeds from a property sale into TIC investments. TICs allow individuals to become fractional owners of a single property. Unlike other legitimate TIC investments, DBSI appears to have been involved in circumspect activities.
Between 2003 and 2008, investors poured approximately $1 billion into DBSI's TIC investments. However, regulatory questions have been raised concerning the nature of TIC investments. There has been debate as to whether TICs should be classified as real estate investments or securities products. DBSI sold both types of offerings concurrently, thereby creating a legal quandary for many investors now that the company is in bankruptcy.
For those TICs sold as securities products, intermediary broker-dealer firms who ultimately sold the product were required to conduct due diligence prior to selling the investment and conduct ongoing monitoring thereafter. At the very least, broker-dealers must perform due diligence on financial statements, perform background checks on key persons, and assess the value of any underlying real estate. There existed a myriad of issues that ultimately led DBSI to its current predicament, systemic issues that seem to have existed for some time.
It appears that DBSI began encountering liquidity issues as early as 2004. By 2005 this shortage created an earnest need for new investor funds in order to maintain current operations. Part of maintaining operations included paying off older investors. Unlike other TIC investment deals, DBSI guaranteed a 7% dividend to investors. In order to make these payments to investors amid chronic cash shortages, DBSI appears to have created two schemes. The two alleged scheme include:
Hidden Markups - DBSI would buy a commercial property at a given price and then sell it to new investors at a profit. The amount of the markup was not disclosed in many cases; a violation of securities law provided the properties were sold as a security. One disturbing characteristic of this practice was the amount of time between DBSI buying an investment property and selling it to investors; sometimes it was as short as one day.
"Accountable Reserves" - Beginning in 2005, every new DBSI project had an accountable reserves fund that set aside money for tenant improvements and repairs. In actuality, only 18% of the money in those funds went towards tenant improvements and repairs. The other 82% of the over $99 million available in accountable reserves went towards other DBSI funds.
Even with the abovementioned schemes DBSI was not able to maintain a financially viable enterprise. By 2007, the company was losing $3 million a month on its properties. That number increased to $8 million by 2008. Despite years of losing money, investors were only issued warnings on their investments six weeks prior to the company filing bankruptcy.
In the aftermath of DBSI's bankruptcy filing, state investigators began looking into the actions of the company. The bankruptcy court in Delaware appointed an examiner, Joshua Hochberg, to conduct a detailed analysis of the company aimed at determining its actions prior to becoming insolvent. He is charged with tracking more than $3 billion in DBSI transactions in an attempt to discover the location DBSI resources.
To date it has been discovered that company insiders bilked more than $75 million since 2000, over $35 million going to CEO Douglas Swenson. According to Hochberg, Swenson is the only member of DBSI's management who is refusing to answer questions. Following a threat to compel him to submit to questioning, Swenson presented a letter stating that he would exercise his Fifth Amendment right against self-incrimination if forced to answer questions about DBSI.
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