Closer oversight of realty exchange firms begins

The once-obscure companies that facilitate tax-deferred real estate deals the so-called 1031 exchange companies face stiffened state regulation this week.

Investors who appear to have lost tens of millions of dollars in last winter's collapse of Las Vegas-based Southwest Exchange, meanwhile, likely will wait years before courts decide if they are able to recover any of their losses.

The new state regulations, which took effect Sunday, require background checks for exchange-company employees who handle money, require expanded bond and insurance liability coverage and give the state Financial Institutions Division the authority to audit exchange companies.

And the new law specifically requires the exchange companies to act as fiduciaries working in the best interest of their clients.

Exchange companies, also known as qualified intermediaries, handle funds for investors who have sold a property and look to make a tax-deferred exchange for another property.

If the intermediary holds the funds from the sale until a replacement property is purchased, the Internal Revenue Service doesn't consider the taxpayer to be in receipt of the money or responsible for paying taxes on any profit.

The amounts held by exchange companies grew rapidly during the real-estate boom early in this decade.

Lawsuits surrounding the collapse of Southwest Exchange claim the amounts were too tempting for Donald McGhan, the company's chairman.

Brad M. Johnston, an attorney with Hale Lane in Reno, says plaintiffs in lawsuits against the company and McGhan believe millions of dollars were diverted to support a McGhan-related business that manufactured breast implants.

Johnston's clients are California investors who lost $22 million before Southwest Exchange closed down suddenly in February. The total losses may total more than $90 million , and state officials have said the FBI is investigating.

Attorneys for McGhan say the investments in other companies were legitimate because Southwest Exchange didn't face limitations on the uses of the money it received from investors.

Lawsuits by former clients of the company now pending in courts in Las Vegas and California also contend the company's insurers and investment bankers bear a portion of the responsibility for Southwest Exchange.

Given the number of plaintiffs, the number of defendants and the complex issues, Johnston said no one expects early resolution.

"It's going to take a while," he said last week.

Even before the new rules took effect this week, Nevada was the only state to provide any oversight of qualified intermediaries registering intermediaries, but providing little additional oversight.

The new regulations were supported by an industry group, the Federation of Exchange Accommodators, which said Nevada's law closely follows model laws developed by the federation.