Investment fraud case reveals need for more oversight up front

Nevada finally put its foot down in the Southwest Exchange scam -- right on Nikki Pomeroy's neck.

Pomeroy, former director of Southwest Exchange, which is suspected of separating $97 million from investors in one of the largest embezzlement cases in state history, was indicted Monday and buried under 22 felony counts alleging embezzlement and manipulation of a tax-free land exchange as a 1031 Qualified Intermediary.

Under IRS Rule 1031, a person can avoid paying taxes when selling investment real estate by reinvesting the profit in another qualified property in a process known as a "1031 exchange." A qualified intermediary processes the exchange and, in Nevada, is licensed and bonded by the state.

In fact, Nevada is among a handful of states with a land exchange law, which makes us sound as if we're a national leader when it comes to regulation and oversight. (Don't kid yourself. We're not. But I'll get to that.)

In the case of Southwest Exchange, Pomeroy is accused of conspiring with her father, owner Donald McGhan, in diverting millions in company holdings for other purposes, including McGhan's plan to buy French breast implant maker Medicor Inc. One question insiders are asking is whether Pomeroy was merely McGhan's shill.

When Southwest Exchange failed two years ago, it was initially believed most of the money was lost. But much of it has been recovered, according to court filings. Monday's indictment reiterates a loss in excess of $97 million, and a state official reported approximately 70 percent of the total, after attorney fees and costs, is expected to be returned to customers.

Attorney General Catherine Cortez Masto picked a whale of a scam to test the land exchange law. This is the first time her office has brought charges under the statute.

In lauding the two-year investigation by the secretary of state's office, Masto added, "Scam artists must know that Nevada's lead constitutional offices will work together to prevent criminal activities in this state."

She's right, of course. The state investigators, prosecutors and regulators will do their jobs and then some. The investigation and indictment not only are important to Southwest's alleged victims, but they send the message Nevada takes its financial transactions seriously.

Alas, not so seriously that there's much oversight once a qualified intermediary company is licensed and bonded for a measly $50,000. The law appears sound enough, as Masto's office is illustrating in the Pomeroy case.

But without oversight, the imagery conjured by the phrase "licensed and bonded Nevada Corporation" becomes more of a marketing pitch than a deterrent to professional scammers.

Attorney Terry Coffing represented former Southwest owner Betty Kincaid, who saw the company she built scandalized by McGhan and Pomeroy. Coffing won a settlement for his client and came away with a perspective on what's needed. In short, he said, there's regulation without oversight.

"This Ponzi could not have withstood even nominal oversight," Coffing said. "Even if you had cursory reviews, this would have been caught early on. The money wasn't there."

Currently, 1031 exchanges are filed with the Financial Institutions Division, which like other state agencies is long on responsibility and short on personnel. Secretary of State Ross Miller, whose office investigated Southwest, said he believes "there's a tremendous need for oversight of these types of entities." One option, he said, would be to force the exchanges to "register as brokers. It would allow us to inspect them and audit them ... beforehand."

Then Miller uttered the words that wind up in so many stories of financial scams in Nevada.

"Ultimately, it comes down to a question of resources," he said.

That line should be printed on T-shirts.

Miller said his office has seen the number of auditors dwindle from seven to three because of budget cutbacks. Three auditors can't handle the workload generated in 1990, much less 2009.

One stopgap might be to force land exchange outfits to bond at a higher rate. A $50,000 bond for a company doing $50 million in business is a joke. Mandating a cash-reserve account is another avenue to explore, Miller said.

Without increased oversight, Coffing said, "It's window dressing. And we may have provided some legitimacy to otherwise illegitimate people."

The state is making an example of Nikki Pomeroy.

Will we learn from this example before history repeats itself?

John L. Smith's column appears Sunday, Tuesday, Wednesday and Friday. E-mail him at Smith@reviewjournal.com or call (702) 383-0295. He also blogs at lvrj.com/blogs/smith/.