Official sees flaw in new measure

A legislator who helped write a regulatory bill designed to protect real estate investors believes the bill may need to be amended to remove a mysterious loophole in bonding requirements.

State Sen. Joe Heck, R-Henderson, said he was unaware of a provision that would allow real estate exchange facilitators to obtain a waiver from the requirement that they post a $1 million fidelity bond. Heck said Wednesday he wants to confer with the Nevada Financial Institutions Division about amending the bill.

"I'm not sure how (the waiver provision) got in there to be honest," said Heck, who chaired a subcommittee on Senate Bill 476, which the Senate Commerce and Labor Committee sponsored in the wake of the failure of Southwest Exchange of Henderson.

The Henderson firm was an exchange facilitator that closed in late January with $95 million missing. The money came from 130 investors, but Southwest Exchange has few assets that investors can recover.

Exchange facilitators exist because of a federal law that allows real estate investors to delay taxes on gains from selling real estate. If the investor uses the proceeds from the sale to buy another piece of property, the investor may avoid paying income taxes on the profit from the sale.

In this way, the individual may repeatedly parlay his investment into larger and more valuable properties before ultimately paying the income tax on his gains.

To qualify for the tax deferral, the real estate investor must have the buyer of the property send the money directly to a facilitator, such as Southwest Exchange. Facilitators promise to hold the sales proceeds while the investor finds a replacement property to buy with the money.

The Senate bill would require companies like Southwest Exchange to obtain a $1 million fidelity bond, up from the $50,000 bond now required. Heck said the $1 million fidelity bond would apply to each transaction handled by the facilitator. The bill also requires that exchange facilitators obtain $250,000 in errors and omissions insurance.

The Nevada Business and Industry Division is "technically neutral" on the bill, spokeswoman Amanda Penn said.

Critics question a provision of the bill that allows the commissioner of the Financial Institutions Division to waive the bond and insurance requirements although the waiver must be disclosed.

Brad Johnston, a plaintiff's attorney in the Southwest Exchange case, said a real estate transaction could easily exceed $1 million, but he also questioned the waiver provision.

"Under what circumstances, can the regulator issue a waiver?" Johnston asked. He wondered if the bond requirement was "a real regulation" or something on the books that would be routinely waived.

The bill states that the Financial Institutions Division could waive or modify bond and insurance requirements that "are not commercially reasonable."

David Turner, a Reno-based certified public accountant who did research for the bill, said requiring intermediaries to hold bonds large enough to cover potential losses would force intermediaries out of business, Turner said.

"The purpose of regulating that industry is not to put people out of business, but it's to get control of the industry," Turner said.

Heck said, "The person we're trying to protect is the little person" who relies on exchange facilitators for a small transaction one time in his life, not large real estate investors who should know how to take precautions.

Terrence Wright, owner of Nevada Title, doesn't believe Nevada is willing to spend the money necessary for strong regulatory oversight of the exchange facilitators.

"If they can't do that, they shouldn't let small, little companies with small asset bases into that business," Wright said. "The state has an obligation to make sure this (investor) money is protected."

Some facilitators around the country offer $10 million and $40 million fidelity bond protection, but even a $1 million bond requirement would provide some protection, a real estate developer said on condition of anonymity.

Before issuing even a relatively small $1 million fidelity bond, a bonding company will make sure that the client has "cash, credit and credibility," the developer said. That would weed out people who lack the needed assets or the character to be trusted, the developer said.

"We absolutely do want to run people of this business that don't have the finances or the character to be in this (exchange facilitator business)," the developer said.

Investors can reduce the risk of losing money by relying on title companies, which already are regulated, insured and generally have a large net worth, to handle money for exchange facilitators. If a title company employee embezzled money from a customer account, the title company probably would have enough assets to satisfy a judgment for the investor.

The Legislature could simply require exchange facilitators to rely on title companies for escrow services, the developer said.

The legislation also contains other measures designed to protect investors who rely on exchange facilitators. The Financial Institutions Division could suspend or revoke a license as well as refuse to renew a license and fine the facilitator up to $200 a day for violations. The bill orders the state to conduct an audit of all exchange facilities every five years.

Wright said that five years is too infrequent and said that time period would not have protected investors who depended on Southwest Exchange.

Robert Brace, a Santa Barbara, Calif., attorney who filed a class action lawsuit on behalf of Southwest Exchange investors, takes a different view.

"Nevada had the best law in the country, but it wasn't being enforced," Brace said. Under Nevada law, investors should have been required to sign when money was taken from the escrow account at Silver State Bank in Henderson. David Keys, former chief executive officer of Southwest Exchange, has said he was unaware of the legal provision for the client's signature, Brace said.