Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-casd-3_12-cv-02164/USCOURTS-casd-3_12-cv-02164-18/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:0077 Securities Fraud

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UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF CALIFORNIA

SECURITIES AND EXCHANGE

COMMISSION,

Plaintiff,

CASE NO. 3:12-cv-2164-GPC-JMA

ORDER KEEPING GENERAL

PARTNERSHIPS UNDER

v. RECEIVERSHIP

LOUIS V. SCHOOLER and FIRST

FINANCIAL PLANNING

CORPORATION, dba Western

Financial Planning Corporation,

Defendants.

I. INTRODUCTION

Before the Court is the issue of whether all, some, or none of the approximately

86 general partnerships (“GPs”) currently under receivership in this case should be

released from the receivership and under what conditions, if any. Receiver Thomas C.

Hebrank (the “Receiver”) has filed a Receiver’s Report and Recommendations

Regarding General Partnerships (the “Report and Recommendation”) on this issue.

(ECF No. 852.) The parties, (ECF Nos. 874, 880), and the investors, (see, e.g., ECF

Nos. 854, 869, 871, 882, 884, 886, 888, 890, 892, 894, 896, 900, 902, 904, 906, 908,

911, 913, 915, 917, 919, 921, 929, 931, 933, 937, 939, 941, 943, 945, 951, 953), have

responded to the Receiver’s Report and Recommendation, and included both critiques

and counterproposals. A hearing on the Receiver’s Report and Recommendation was

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held on January 23, 2015. (ECF No. 947.)

Upon review of the Receiver’s Report and Recommendation, the responses

thereto by the parties and investors, and all submissions and arguments to the Court

regarding this issue that have been put forth throughout the entirety of this case, the

Court concludes that maintaining the receivership over the GPs through the conclusion

of the case is necessary in order to preserve, to the extent possible, assets owned by

Western and its affiliates that will be available as investor restitution in the event that

Defendants are held liable for securities fraud. This is the only practical result given

the extent to which Western’s assets are intertwined with investor assets, and the lack

of alternative viable means to preserve Western’s GP interests.

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II. BACKGROUND

A. Receivership

This is an enforcement action brought by Plaintiff Securities and Exchange

Commission (the “SEC”). (See ECF No. 1.) The SEC alleges that Defendants Louis V.

Schooler (“Schooler”) and First Financial Planning Corporation d/b/a Western

Financial Planning Corporation (“Western”) (collectively, “Defendants”) defrauded

investors in the sale of general partnership units which were, as a matter of law,

unregistered securities. (Id.) Because the SEC had demonstrated a probability of

success on the merits of this case and the possibility that Defendants would dissipate

assets, on September 6, 2012, Judge Larry A. Burns ordered that Western and the GPs

be placed under a temporary receivership (the “Temporary Restraining Order”). (ECF

No. 10, at 1.) The Temporary Restraining Order, among other things, directed the

Receiver to oversee Western and entities that it controlled, including the GPs. (ECF

No. 10.) On October 5, 2012, following further briefing by the parties, Judge Burns

concluded that the SEC had made out a prima facie case that the GPs were securities

At oral argument, Defendants objected to the Court’s use of the term 1

“commingling.” (ECF No. 949, at 8:13–17.) While the Court recognizes that

commingling can have various meanings, (see, e.g., 34 C.F.R. § 303.123), the Court

simply usesthe termhere to assessthe extent to which Western’s assets are intertwined

with investor assets.

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and ordered that the receivership be permanent (the “Preliminary Injunction Order”).

(ECF No. 44, at 21–22.) 

On October 22, 2012, the case was transferred to the Honorable Gonzalo P.

Curiel. (ECF No. 52.) On May 29, 2013, Defendants moved to remove the GPs from

the Receivership in a motion to modify preliminary injunction. (ECF No. 195.) The

Defendants asserted thirteen grounds for removing the GPs from the receivership,

including the arguments that: (1) the imposition of costs on investors before the SEC

carried the burden of proving its case at trial was unwarranted; (2) removal of the GPs

from the receivership would not hinder the SEC’s ability to fully litigate all pending

claims; and (3) there was no danger or risk to the GPs that necessitated a receivership

over the GPs. (ECF. 195-1 at 6-7.) On August 16, 2013, this Court issued its Order

Granting in Part and Denying in Part Defendants’ Motion to Modify Preliminary

Injunction Order (the “Modification Order”). (ECF No. 470.) Based upon the status of

the case at the time, the Court concluded that the GPs should be released from the

receivership upon the satisfaction of certain conditions. (Id. at 25–27.) The

Modification Order was thereafter appealed by the Defendants and the SEC filed a

cross appeal. (ECF Nos. 499, 514.) While the appeals were pending, on April 25, 2014,

the Court issued its Order Granting in Part and Denying in Part Plaintiff’s Motion for

Partial Summary Judgment (the “Partial Summary Judgment Order”). (ECF No. 583.)

The Partial Summary Judgment Order concluded that the SEC had proven that the GPs,

as a matter of law, were securities. (Id.) Based upon these legal developments, the

Court, sua sponte, found good cause to reconsider the Modification Order. (Id. at 16,

20.)

On July 22, 2014, the Court issued its Order on Sua Sponte Reconsideration of

August 16, 2013 Order to Release General Partnerships from Receivership (the

“Reconsideration Order”). (ECF No. 629.) Because the Reconsideration Order

maintained the GPs in the receivership, the Court concluded that the GPs’ due process

rights were implicated and the GPs were entitled to a hearing. (Id. at 7–8.) On October

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10 and 15, 2014, an investor hearing was held and the GPs were afforded the

opportunity to speak (the “Investor Hearing”). (ECF Nos. 790, 794.) On October 17,

2

2014, the Court issued its Order Regarding Investor Hearing (the “Investor Hearing

Order”) and ordered the Receiver to file a report and recommendation addressing the

question whether it was appropriate to treat all GPs the same in light of their varying

financial conditions. (Id. at 3–6.) . (ECF No. 808.)

B. Alleged Investment Scheme

Defendants’ investment plan generally involved: (1) purchasing an undeveloped

property, (2) forming between two and four general partnerships to take undivided

fractional interests in the property, and (3) raising money from investors to become

general partners in those GPs. (See ECF No. 182, at 1–2.) For the 46 GPs that the

Receiver has performed a forensic accounting,Western paid approximately $21 million

to purchase the 13 underlying properties and raised approximately $101 million from

investors. (Id. at 15.) Western retained the approximately $80 million difference. (Id.)

The Dayton Valley II property serves as an illustrative example. (See id. at 5–7.)

Western purchased the Dayton Valley II property from a third party for approximately

$1,989,393 in 2003. (Id. at 5.) The $1,989,393 was divided as follows: (1)

approximately $309,393 was paid in cash; (2) $1,500,000 was owed to the seller in the

form of a note (i.e., a mortgage); and (3) $180,000 as commission was owed to Schafer

Pacific Properties in the form of a note (Id. at 5–6; ECF No. 504, at 3.)

Western then created four GPs—Storey County Partners, Comstock Partners,

Silver City Partners, and Nevada View Partners—that would take title to the Dayton

Valley II property as cotenants. (ECF No. 182, at 6.) Western raised approximately

$8,994,800 from the investors in these four GPs. (Id.) The $8,994,800 was divided as

follows: (1) approximately $7,554,550 in cash paid by investors; (2) $92,368 in

“Western Notes” representing funds advanced by Western to GPs for the investor down

The Court additionally gave all investors who wanted to speak an opportunity 2

to do so, even if another investor who represented their GP had already spoken. (See

ECF No. 790.)

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payment; and (3) $1,347,882 in “Partnership Notes” payable from investors to the four

GPs (the four GPs, in turn, had notes payable in the same amount to Western). (Id. at

6–7.) Any interest in each GP that Western had was nominally as a nonvoting partner,

(see ECF No. 195-3, Ex. 1), but Western collected loan payments from investors

directly on behalf of the GPs. (ECF No. 504, at 4.)

Though Western raised significantly more cash than the price it had paid for the

Dayton Valley II property, the mortgage that Western took out on the property was not

immediately paid off and a balance was still owed on the mortgage as of October 1,

2014. (See ECF No. 852-1, Ex. A.) Additionally, several investors have indicated that

they were not informed that the property they were investing in was encumbered by a

mortgage. (See, e.g., ECF No. 7 ¶ 8; ECF No. 8 ¶ 9.)

III. LEGAL STANDARD

A. Authority of the District Court

District courts have extremely broad authority to supervise and determine the

appropriate action to be taken in a federal equity receivership. Sec. and Exch. Comm’n

v. Capital Consultants, LLC, 397 F.3d 733, 738 (9th Cir. 2005). Though the GPs are

legally separate entitiesfromWestern, the NinthCircuit has made it clear that the Court

has authority to place a nonparty’s property under a receivership even where the

nonparty is not accused of any wrongdoing. See In re San Vicente Med. Partners Ltd.,

962 F.2d 1402, 1408 (9th Cir. 1992). To include the properties of third parties in

receivership, three requirements must be met: (1) the third party must meet

International Shoe’s minimumcontacts standard, (2) the third party must receive actual

notice, and (3) the third party must be given an opportunity for a hearing. Id.

First, for legal entities such as general partnerships, International Shoe’s

minimum contacts standard is satisfied in the state under whose laws the entity is

formed or in the state where the entity has its principal place of business. Daimler AG

v. Bauman, 134 S. Ct. 746, 760 (2014). The GPs in this case were formed under the

laws of California and list their principal place of business as “5186 Carroll Canyon

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Road, San Diego, California, 92121.” (See, e.g., ECF No. 195-3, Ex. 1.) Second, under

California law,where one general partner receives notice, the entire general partnership

is deemed to have received notice. In re San Vicente, 962 F.2d at 1407 n.3 (citations

omitted). The Receiver, per this Court’s order, gave notice of the Investor Hearing to

the GPs by: (1) posting the Reconsideration Order to the Receiver’s website, (2)

emailing the Reconsideration Order to individual investors, and (3) mailing the

Reconsideration Order to the address of record for each GP. (ECF No. 629, at 9.) Third,

a hearing was held on the inclusion of the GPs within the receivership at which all GPs

who wished to speak were given the opportunity to do so. (ECF No. 790.) Thus the

Court has authority to include third party property, such as the GPs, within the

receivership and has respected the due process rights of the GPs. See In re San Vicente,

962 F.2d at 1407.

B. Authority of the Receiver

Some investors have argued that the Receiver has exercised more authority than

Western did prior to the receivership, (see, e.g., ECF No. 869), and that the Receiver

has operated beyond the scope of the GPs’ partnership agreements. (See id.) Contrary

to the investors’ assertions, the Receiver’s authority to manage the GPs does not stem

from the GPs’ partnership agreements, rather it stems from the Receiver’s authority as

an officer of the Court tasked with managing the property under the Court’s control.

See In re San Vicente, 962 F.3d at 1409–10. As such, the Receiver has the legal

authority to take actions beyond the scope ofthe GPs’ partnership agreements and ones

that could not have been taken by Western in order to protect the status quo. See id.;

see also Sec. and Exch. Comm’n v. Am. Capital Invs., Inc., 98 F.3d 1133, 1143–45 (9th

Cir. 1996) abrogated on other grounds by Steel Co. v. Citizens for a Better

Environment, 523 U.S. 83 (1998).

Ultimately, the Receiver may only take action pursuant to thisCourt’s orders and

the Receiver is tasked with preserving receivership assets, administering receivership

property suitably, and assisting in any equitable distribution of those assets if

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appropriate. See Liberte Capital Grp., LLC v. Capwill, 462 F.3d 543, 551 (6th Cir.

2006) (citation omitted). Additionally, the preliminary injunction in this case protects

the investors by preventing litigation againsttheGPs or concerning GP properties, such

as for the recovery of debts or for foreclosure. (ECF No. 10, at 15–16; ECF No. 44.)

IV. DISCUSSION

A. Clarification

Before turning to the Receiver’s Report and Recommendation, the Court finds

it appropriate to clarify several issues as well as to address concerns that have been

brought up by investors through their letters and briefs.

1. Paying Receivership Fees

Some investors have claimed that they are paying for the Receiver’s fees and that

such fees are unreasonable. (See, e.g., ECF No. 906.) This is an argument that

Defendants have previously made. (See, e.g., ECF No. 869; see also ECF No. 790.)

These investors argue that, because the investors are paying their debts to the GPs, the

GPs are paying their debts to Western, and Western is paying receivership fees, the

investors are therefore paying receivership fees. (See id. at 1–3.) What this argument

ignores is that the investors would be paying the debts they owed the GPs and the GPs

would paying the debts they owe Western, even if the receivership were not in place.

Here, the Receiver is billing GPs so that those GPs’ operational funds, such as property

taxes, mortgage payments, and other expenses, can be met. The Receiver is not billing

the GPs to pay receivership fees and this Court’s orders specifically require that any

fees paid by Western are not paid out of money needed to make mortgage payments on

GP properties. (See ECF No. 470, at 26–27; ECF No. 922, at 12.) Moreover, the

Receiver is required to submit his fees to this Court for approval before he can collect

them and this Court has reviewed all fees requested by the Receiver and ensured that

the Receiver only collects reasonable amounts. (See, e.g., ECF Nos. 511, 637, 922.)

2. Increased Operational Bills

Several investors have indicated incredulity at the fact that the operational bills

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sent by the Receiver have been significantly higher than those sent by Western. (See,

e.g., ECF No. 969.) For example, Investor David Butler statesthat “[s]omething smells

fishy” because he is now being billed $109.44 per month for SunTec Partners whereas

his previous bills averaged $19.25 per month. (Id.) However, the Receiver’s report

makes clear that the Receiver is not doing anything “fishy.” Rather it is the failure of

investors to pay their bills that is resulting in higher overall bills to all investors. (See

ECF No. 852-1, Ex. C.) Because only a certain percentage of investors pay their bills,

the Receiver has increased the amount billed to ensure that he can recover sufficient

funds to pay for GP expenses and prevent any potential default on mortgages or taxes

relating to GP properties. (See id.)

Turning to SunTec Partners specifically, SunTec will have a total of $27,314 in

expenses for 2014–2015. (ECF No. 852-1, Ex. A.) This comes out to approximately

$1,138 per month. Multiplied by Mr. Butler’s 2.356793% share in SunTec, his share

of expensesis approximately $26.82 per month, which is close to his previous monthly

average. (See ECF No. 969.) The problem liesin the fact that SunTec’s general partner

investors are, collectively, only paying 7% of their operational bills. (ECF No. 852-1,

Ex. C.) Thus Mr. Butler’s bill is higher not because of the receivership but because his

fellow investors in SunTec are not paying their share of SunTec’s expenses.

Moreover, if such nonpayment had occurred in the past, the investors would

likely not have seen an increase in their bills. This is because any shortfalls due to

investor nonpayment that occurred prior to the receivership were often covered by

Western loaning money to the GPs without investor knowledge. (ECF No. 852, at 26.)

Prior to the receivership, Schooler himself put funds back into Western to cover

shortfalls that Western itself incurred. (See ECF No. 519, at 2.) Because Western has

had minimal capital since before the receivership was put in place, Western, through

the Receiver, is unable to cover any shortfalls as it had in the past. (See ECF Nos. 519,

524.)

/ /

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B. Receiver’s Report and Recommendation

1. Receiver’s Recommendation

The Receiver’s overall recommendation is that the receivership be continued as

to all GPs pending a determination of whether Defendants defrauded investors. (ECF

No. 852, at 6.) The SEC agrees with this recommendation. (ECF No. 880, at 9.)

2. Receiver’s First Proposal

The Receiver’s First Proposal categorizes the GPs into three categories, A, B,

and C, from most to least financially stable, based on their cotenancy’s ability to pay

its operating expenses through the end of 2015. (ECF No. 852, at 12–19.) Because

most cotenancies include multiple GPs in varying financial condition, each cotenancy

is categorized according to the least financially healthyGP in the cotenancy. (Id. at 14.)

There are seven Category A cotenancies, fifteen Category B cotenancies, and three

Category C cotenancies. (Id. at 13.) Under the Receiver’s First Proposal, a renewed

appraisal on each GP property and an informational packet would be sent to all

investors. (Id. at 17.) Cotenancies in three groups would then be liquidated and any

proceeds distributed to their investors: (1) Category A and B cotenancies where a

majority of each GP votes to sell; (2) Category B cotenancies that do not raise

sufficient capital to pay their 2015 operating expenses; and (3) all Category C

cotenancies. (Id. at 18–19.) Cotenancies in two categories would then be released from

the receivership: (1) Category A cotenancies without majority votes of all GPs to sell;

and (2) Category B cotenancies without majority votes of all GPs to sell that raise

sufficient capital to pay their 2015 operating expenses. (Id. at 18.) GPs that exit 3

receivership would be required to meet additional requirementssuch as assuming their

respective mortgages and liquidating Western’s interest. (Id. at 14–15, 18.) This

proposal allows each cotenancy that is financially able to cover its 2015 operating

Essentially the default presumption is that Category B cotenancies that raise 3

sufficient capital and Category A cotenancies will be released from the receivership.

Though opposed to the Receiver’s First Proposal, the SEC argues that if the Receiver’s

First Proposal is adopted, the default presumption should be that cotenancies stay in

the receivership. (ECF No. 880, at 12 n.6.)

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expenses to achieve the outcome that a majority of its investors want.

3. Receiver’s Second Proposal

The Receiver’s Second Proposal divides investors between those who wish to

remain in their GP and those who wish to exit their GP. (ECF No. 852, at 20–22.)

Investors who wished to remain in their GP would be asked to raise sufficient capital

to buyout their co-investors who do not wish to remain in the their GP. (Id.) If the

buyout amount is raised, the capital is transferred and the cotenancy exits the

receivership in the hands of the investors who wish to retain control. (Id.) If the buyout

amount is not raised, the cotenancy’s property is liquidated. (Id.) This proposal

attempts to allow investors with differing desires but who are in the same cotenancy

to get what they want. However, it is not clear what the Buyout Amount for each GP

would be until a ballot was sent to investors and it is also unclear whether it would be

feasible for some investors to raise enough capital to buyout dissatisfied investors.

4. Post Proposal

Investor Gregory M. Post makes an alternate proposal where each GP would

seek out volunteersto serve on a committee to manage the GP. (ECF No. 869, at 8–11.)

4. Defendants’ Proposal

Defendants simply propose that the receivership over all the GPs be “dissolved.”

(ECF No. 874, at 15.)

C. Objections

1. Receiver

The Receiver argues that all GPs should be treated similarly because “investors’

losses cannot be determined until the GP has sold its property interest and investors

have received their distribution.” (ECF No. 852, at 7.) Thus, the Receiver states,

allowing GPs to hold on to their properties would delay the recovery of those GPs’

investors. (Id.)

2. SEC

The SEC argues that treating GPs differently would be inequitable. (ECF No.

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880, at 9–10.) The SEC also argues that releasing the GPs would prohibit those GPs’

investors from recovering fromany distribution plan that may be instituted in this case.

(Id. at 12.) While the investment scheme was, at least in part, “factually similar” for

each investor, the investors were investing in different pieces of property which does

distinguish them from each other and may merit different treatment in a distribution

plan. Capital Consultants, 397 F.3d at 738–39; (see also ECF Nos. 8-2, 8-3, 8-4). The

Court must do what is the most equitable, even if that equitable relief treats victims

differently and thusresultsin some investors being treated more favorably than others.

See Sec. and Exch. Comm’n v. Credit Bancorp, Ltd., No. 99-cv-11395-RWS, 2000 WL

1752979, at *29 (S.D.N.Y. Nov. 29, 2000). As discussed above, the Court has broad

authority in fashioning equitable relief and does not see why releasing a GP from the

receivership requires that the GP’s investors therefore forfeit any claim towards any

distribution plan that may be instituted. While the Court acknowledges that a

distribution plan, if ordered, may give investors a choice of either retaining their

interest or receiving proceeds from Western’s assets, it is too early to assess whether

such a binary choice is appropriate.

The SEC also reiterates the bases that this Court previously found for

permanently including the GPs in the receivership. (ECF No. 880, at 13–18.) The SEC

requests that the Court vacates the portion of its order releasing the GPs from the

receivership, (ECF No. 470), and formally deny in full Defendants’ initial motion to

remove the GPs from the receivership, (ECF No. 195). (ECF No. 880, at 6.)

3. Investors

InvestorCurt Johnson, speaking on behalf of hundreds offellow investors, states

that a certain number of his fellow investors have declined to pay their operational bills

because of the receivership. (ECF No. 917.) He further statesthat these same investors

indicate that they would resume payment if the receivership was ended. (Id.) While Mr.

Johnson interprets this as justification for ending the receivership, (see id.), the Court

does not see it the same way. The debts that investors owe to their GP are valid and

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owed whether or not the property is in receivership. The fact that some investors

believe it appropriate to ignore their legal obligations when something happens to their

investment that they do not wish for is troubling. This does not lend any confidence

that such investors would be able to adequately guide their GP going forward.

Mr. Johnson also makesseveral requests: (1) stop the Receiver from making the

GPs payWestern beyond any valid and outstanding debts that the GPs owe to Western;

(2) compel the Receiver to sign the listing agreement presented by Rainbow and

Horizon Partners; (3) require the Receiver to pay Western’s share of operational

expenses before he takes any fees; (4) do not require a repurchase of Western’s

ownership interest in the GPs; and (5) release all GPs from the receivership. (Id.)

As the Court discussed above, the Court is only ordering increased payment by

the GPs to Western so that expenses can be paid. (See ECF No. 524.) While this may

mean that the GPs are paying more than they owe on their notes, the Court authorized

these increased payments to ensure that the mortgages for those GPs’ properties were

paid. (See id.) As the Court discussed in its prior order, the Court believesthis to be the

most equitable way to ensure that those GPs do not lose their properties to foreclosure

even though the investors may not have agreed to or even known about their property

securing a mortgage paid by Western. (See id.)

The Court has already reviewed the proposed listing agreement from Investor

Nancy Kemper that Mr. Johnson is referring to. (See ECF No. 629, at 6–7.) As the

Court previously discussed, there are significant flaws with the listing price and thus

the Court does not find it appropriate to use that listing agreement at this time. Listing

the property owned by Rainbow and Horizon Partners at a price that would almost

assuredly not sell would be a waste of the receivership estate’s resources as the

Receiver would be required to oversee and manage the listing agent.

With regards to Western’s share of operational expenses, the Court notes that

Western has been covering shortfalls that occurred due to GP expenses exceeding GP

payments to Western. (See ECF No. 519, at 2.) The Court is cognizant that Western is

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an investor in most of the GPs, and thus has required that any fees paid to the Receiver

by Western are not paid out of money needed to make mortgage payments on GP

properties. (See ECF No. 922, at 12.) Finally, the Court, as discussed below, does not

find it equitable to release the GPs from receivership or to consider a buyout of

Western’s interest prior to the conclusion of this case.

4. Defendants

Defendants object that the Receiver is attempting to engage in a “fire sale” of GP

properties. (ECF No. 874, at 7.) Specifically Defendants object that the Receiver’s

proposals prevent investors from choosing what to do with their investment. (Id. at 8.)

While the proposals may temporarily remove some control from investors, the Court

must do what is equitable. Moreover, Defendants’ argument stands on questionable

footing as at least some investors have claimed that Defendants or their agents stated

that the investment would be passive and managed by Defendants. (See ECF No. 8 ¶

9.) The Court must ensure that the investors, as a whole, are treated as fairly as

possible. Such action may mean that some investors are prevented from taking certain

actions so that the investors as a whole may benefit.

Defendants object to the GP property appraisals, arguing that they are

unsupported and dated. (ECF No. 874, at 4–5.) However, the Receiver has already

addressed this contention, in part, by proposing a new appraisal for every GP property.

(ECF No. 852, at 12.) Additionally, Defendants’ objection to the Receiver’s appraisals

is mostly attorney argument and contains scant evidence. The only evidence that

Defendants point to is a single appraisal for a single property. (See ECF No. 874, at 5.)

Merely because Defendants’ attorneys argue that thisis a “historically low market” and

imply that “development” will “reach[]” the GPs’ properties does not make such

arguments true. (See id.) A single appraisal does not suffice to counter the dozens of

appraisals already obtained by the Receiver and that would be obtained if further

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appraisals are ordered by the Court.4

Next, citing a Western brochure, (ECF No. 12-1), Defendants argue that there

is a “track record[]” showing success by prior GPs in obtaining “a 239% profit” on

their investment that counsels against liquidating any GP properties. (ECF No. 874, at

6–7.) Ignoring the fact that the brochure lacks support and is marketing material

published by Western, it is unclear whether the brochure actually supports Defendants’

argument. The brochure simply refers to “Purchase Price” and “Sold Price.” (ECF No.

12-1, at 2–3.) First, it is not clear whether the “Purchase Price” refers to the amount of

money actually invested by GP investors or whether it refers to the amount that the GP

or GPs paid for the land itself. As the Receiver’s forensic accounting reports have made

clear, in many instances, the amount paid for a property was significantly less than the

amount invested. (See ECF No. 852-1, Ex. A.) Second, it is not clear whether either of

these prices includes the amount paid by GP investors in operational expenses each

year or includes any amount that would not go to investors, such as to pay Western’s

interest in the GP or to pay closing costs. In light of the information regarding the

investment process revealed by the Receiver’s forensic accounting reports and the

limited information supplied by the brochure, the brochure does not support

Defendant’s proposition that these investments have proven to be successful.

In addition, Defendants object to the acceleration and payment of the GPs’ debt

obligations to Western. (ECF No. 874, at 10-11.) Defendants further object that the

Receiver has a conflict of interest as receiver over both Western and the GPs. (Id. at

11.) The Court’s duty is to treat the investors as a group equitably, even if, in some

instances, the most equitable course of action overall is less favorable to some

individual investors. The Receiver’s goal isto maximize the receivership estate so that

its funds may be available for possible investor restitution. See Liberte Capital, 462

F.3d at 551. While both Western and the GPs are under the receivership, the Receiver

Overall it appears that Defendants seek to perpetuate the investment scheme

4

that Defendants were engaged in prior to the SEC filing suit and not what is equitable

to all the investors. (See ECF No. 874, at 5–6.)

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can ensure that any obligations are met. However, any GPs that leave the receivership

may not meet their obligations to Western and would no longer be protected by the

preliminaryinjunction’s litigation hold. Such action would harmthe investors whomay

lose their properties to foreclosure. Moreover, Defendants have repeatedly advanced

the argument that the loans the GPs owe to Western constitute unsecured, subordinated

debt and that, if the Receiver were acting in the best interests of the GPs, the GPs

would object to paying this debt to Western. (See, e.g., ECF No. 470, at 12.) As the

Court has previously discussed, these payments are made to ensure that expenses, such

as mortgages, are paid. If the GPs did not make these paymentsto Western, they would

risk foreclosure and loss of their property. As should be obvious, such a result would

be problematic and would harm the investors in this case.

Defendants also make several additional objections that do not relate to whether

it is appropriate to release the GPs from the receivership such as that the Receiver has

been biased by his interactions with the SEC and that Western’s investments have a

“track record[]” of success. (ECF No. 874, at 6–7, 12–14.) As these objections are

irrelevant to whether it is appropriate to keep the GPs in the receivership and do not

address the issue of Western’s assets being intertwined with the investors’ assets, the

Court does not address them.

Finally, at oral argument, Defendants argued that receivership over the GPs on

the basis of Western’s intertwined assets was improper because the GPs were legally

separate entities. (ECF No. 790.) Defendants analogized that if Western owned shares

of a completely separate company, e.g., IBM, it would be inequitable to place IBM

under receivership merely to create district court oversight of the actions of IBM

executives to ensure that the value of those shares would be maximized. (Id.)

Defendants’ IBM analogy overlooksseveral key factors regarding this case. First, there

are no allegations that Western ever managed IBM whereas there are allegations that

Western managed the GPs. (See ECF No. 1.) Second, there are no allegations that

Western defrauded investors during the formation ofIBM whereas there are allegations

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that Western defrauded investors during the formation of the GPs. (See id.) These

allegations distinguish the GPs from other third party entities and make receivership

over them appropriate even where receivership over other third party entities may not

be.

D. Analysis

1. Alleged Fraud

The first issue isthat, though the GPs have been found to be securities, (ECF No.

583), the SEC has not yet moved on any other element of its securities fraud causes of

action. Whether or not Defendants are liable for securities fraud, independent of any

15 U.S.C. §§ 77e(a)–(c) violations, may bear significantly on whether investor

restitution is appropriate. See Sec. and Exch. Comm’n v. Fischbach Corp., 133 F.3d

170, 175 (2d Cir. 1997) (noting that disgorged funds “may often go to compensate

securities fraud victims for their losses”). TheCourt will not know whether Defendants

defrauded investors until after summary judgment or trial. Even though the SEC

represents that it will seek to return any disgorgement from the SEC’s sale of

unregistered securities cause of action to investors, (see ECF No. 880, at 9), the SEC’s

motion for disgorgement, (ECF No. 685), isstill pending and has not yet been reviewed

by the Court.5

2. Investor Preferences

The second issue is that there is a split between investors. Some investors desire

to either continue the receivership or at least liquidate the property of their GP so that

they can be done with the investment. (See, e.g., ECF Nos. 884, 888, 896, 900, 904,

953.) Other investors desire that their GP’s property be released from the receivership

so that they can manage their investment themselves, pursuant to the partnership

agreement they signed when they invested. (See, e.g., ECF No. 917.) Additionally, a

The SEC believes that Defendants will only be opposing the amount of 5

disgorgement, not the liability. (ECF No. 880, at 9.) However, the Court has not

reviewed the briefs on the SEC’s motion for disgorgement and finds it inappropriate

to reach the merits of those briefs until the Court actually considers the SEC’s motion.

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certain number of investors have changed their mind as this litigation has gone on.

(See, e.g., ECF No. 888; compare ECF No. 352 with ECF No. 884.) As a factual matter,

conflicting information from investors makesit unclear whether the investors were led

to believe that they would actively manage the investment or led to believe that the

investment would passive. (Compare ECF No. 8 ¶ 9 (stating that “Western took care

of everything related to land investment”) with ECF No. 917 (stating that “[o]ur intent

was to have the control necessary to make the decision”).) It is entirely possible that,

despite investing in the same venture, different investors were told different things.

Unlike cases where the investments were in actual securities, see, e.g.,Credit

Bancorp, Ltd., 2000 WL 1752979, honoring the differing desires of investors would

be difficult if not impossible in this case. If a GP contains investors who wish to be

done with the investment and those who wish to continue managing it, the Court cannot

easily fashion relief that allows both groups to get what they want. Had the investment

been in actual securities traceable to each investor, the Receiver may have been able

to transfer those securities to investors who wished to keep them while simultaneously

liquidating the securities of investors who wished to walk away. Here, each GP is made

up of nearly a hundred investors and many GP properties are held by up to four GPs.

Even if the Court were to make a property by property determination as to whether to

continue the receivership, this would still leave hundreds, if not thousands, ofinvestors

unsatisfied with the outcome.

While the Receiver’s Second Proposal presents a compromise, the Court is

skeptical about its feasibility. Such a compromise may also create an inequitable result

between investors or groups of investors who have significant funds and can afford to

buy out dissatisfied investors and those who lack funds and thus cannot buy out

dissatisfied investors.

3. Perpetuating the Scheme

Allowing GPs to exit the receivership also risksfurther perpetuating the scheme

created by Defendants; a scheme that may have been fraudulent. (See ECF No. 1.)

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Many GP properties are under mortgages that pre-receivership were paid by

Defendants and post-receivership have been paid by the Receiver. (See ECF No. 852-1,

Ex. A.) Moreover, due to the general partnership structure of the GPs, the general

partner investors are personally liable for all debts of their partnership under California

law. Mariani v. Price Waterhouse, 70 Cal. Rptr. 2d 671,684 (Cal. Ct. App. 1999)

(citation omitted). Indeed several investors have expressed concern that they may face

personal liability. (See, e.g., ECF No. 871; ECF No. 880, Ex. 5.) As it stands, the GPs

collectively owe approximately $3.6 million to Western. (ECF No. 852-1, Ex. A.) An

additional approximately $1 million is owed on mortgages secured by GP properties.

(Id.) While Western, not the GPs, is the debtor on the mortgages, the approximately

half of GPs whose properties are mortgaged risk losing their land to foreclosure if

Western were to fail to make timely mortgage payments. (See ECF No. 852, at 14–15.)

Currently, the receivership protects GP properties from foreclosure because the

preliminary injunction in this case prevents such action against receivership entities

without leave of this Court. (See ECF No. 174, at 6–7.) Releasing a GP risks that

mortgage payments may not be made by the GP, ultimately resulting in foreclosure and

the GP’s loss of its property. Additionally, if a GP is released from the receivership

estate, the Receiver would no longer be under a fiduciary duty towards that GP. At that

time, it may be appropriate for the Receiver to attempt to collect what is owed by the

GP to Western, for which investors would be personally liable pursuant to their status

as general partners.

D. Keeping the GPs in Receivership

The Court understands that no matter the decision it makes, a certain number of

investors will not get the outcome they desire. While releasing all or some of the GPs

from the receivership is an appealing option, the Court does not believe such a course

to be the most equitable. The Court finds that, consistent with “the public interest in

maintaining the receivership estate’s assets while the SEC pursues charges against the

Defendants,” the most equitable decision is to keep all the GPs within the receivership

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until the conclusion of this case. Sec. and Exch. Comm’n v. Small Bus. Capital Corp.,

No. 5:12-cv-3237-EJD, 2013 WL 6701928, at *4 (N.D. Cal. Dec. 19, 2013).

Generally, during the pendency of an SEC enforcement action, property related

to the allegedly fraudulent investment scheme is held in receivership. See Small Bus.

Capital Corp., 2013 WL 6701928, at *4; see also In re San Vicente Med. Partners Ltd.,

962 F.2d at 1404–05. While Defendants and some investors argue that the general rule

should be departed from in this case, the Court disagrees.

In SEC enforcement actions, defendants may be ordered to disgorge their illgotten gains. Sec. and Exch. Comm’n v. First Jersey Sec., 101 F.3d 1450, 1474 (2d Cir.

1996). These funds can then be then be distributed pro rata back to investors, which

the SEC has indicated it intends to seek. (See ECF No. 880.) In this case, the SEC has

moved for disgorgement, (ECF No. 685), but the hearing on the SEC’s motion will not

be held for several months. (ECF No. 849.) Outside of moving to establish that the GPs

are securities, the SEC has not yet moved on its fraud causes of action. (See ECF No.

1.) Whether disgorgement is granted and whether investors were defrauded bear

significantly on whether distribution to investors is appropriate. See Fischbach Corp.,

133 F.3d at 175 (noting that disgorged funds “may often go to compensate securities

fraud victims for their losses”). An order on either disgorgement or fraud will take

months if decided on summary judgment, and potentially upwards of a year if decided

at trial. (See ECF No. 850.)

Western’s assets include an interest in at least one GP that holds each GP

property except one—Washoe I—and notes from nearly two-thirds of GPs, including

two of the GPs that own Washoe I. (See ECF No. 852-1, Ex. A.) The value of

Western’s interest in GP properties and the debt owed to Western by the GPs is

approximately $4.6 million. (Id.) If Western is ordered to disgorge its ill-gotten gains,

that disgorgement may include its share of each GP property and the GP notes. Though

the investors own the vast majority of the GPs and thus the GP properties, Western has

essentially intertwined its assets with those of investors by taking an interest in at least

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one GP that owns almost every GP property and holding notes from nearly two-thirds

of GPs. If restitution to investors of Western’s disgorged funds is appropriate, every

Western investor would arguably have an interest in every GP property. Were the Court

to release the GPs, a GP property would be subject to the control of its several hundred

general partner investors who would have no obligation to consider the interests of the

thousands of investors who may be able to lay claim to Western’s interest through

investor restitution. Continuation of the receivership ensures that the Receiver and the

Court maintain oversight of these properties and that any action taken in relation to the

GPs or GP properties isthe most equitable overall. See Credit Bancorp, Ltd., 2000 WL

1752979, at *13, 43.

Though the Court could order Western to divest its interest and the GPs to pay

the notes, and thus release the GPs without the aforementioned issue, this too is

problematic. Western may not be liable for disgorgement or fraud and altering the

structure of the GPs at this stage may be prejudging Western’s liability. As the

appropriate course of action issignificantly influenced by Western’s liability, the Court

finds it appropriate to wait until these issues are resolved before removing the GPs

from the receivership or altering their structure.

E. Administration of the Receivership

1. Information

While the Court finds that continuation of the receivership over all the GPs is

appropriate, the Court does have some concerns regarding their current financialstatus

as well as the information available to their investors. As the Receiver has indicated,

some investors are not paying their share of costs and these costs are shifted onto other

investors who are paying more than their share of costs. (See ECF No. 852-1, Ex. C.)

Due to comments at the investor hearing, it appears that the operational bills sent to

investors lack detail. Thus the Court finds it appropriate to order that additional

information be provided to investors so that they can make a choice as to whether to

pay the higher operational bill or not. Though choosing not to cover their delinquent

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co-investors may result in the sale of a property if insufficient funds are raised to pay

operating expenses, the investors should be informed and knowledgeable as to exactly

why they are paying an outsized share of costs before they are asked to do so. To that

end, the Court orders the Receiver to take three actions to help inform investors: (1)

include a detailed list of expenses in any future bills sent to investors, (2) obtain

updated appraisals of all GP properties, and (3) prepare an informational packet to be

sent to investors.

2. Liquidation

At this juncture, it is unclear whether liquidation of some GP properties is

appropriate. However, the Receiver’s Report and Recommendation appearsto indicate

that liquidation of GPs that will be unable to pay their bills may be warranted. It may

also be the case that billing investors to maintain GP properties is not the wisest course

of action based on the valuation of their GP and its property. Thus the Court orders the

Receiver to provide a report and recommendation whether liquidation is warranted for

any GP that is unable to meet its payment obligations.

3. Property Company

Finally, based on issues with the partnership administrators as well as the

savings that could be provided by a professional management company, the Court

grants the Receiver’s request to transition administration of the GPs to the Lincoln

Property Company.

V. CONCLUSION AND ORDER

Based on the reasons stated above, IT IS HEREBY ORDERED that:

1. The portion of the Modification Order, (ECF No. 470), granting in part

Defendants’ Modification Motion, (ECF No. 195), and releasing the GPs

from the receivership is VACATED;

2. Defendants’ Modification Motion, (ECF No. 195), is therefore DENIED

and the GPs shall be kept in the receivership through the conclusion of

this case;

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3. The Receiver’s request to transition administration of the GPs to the

Lincoln Property Company is GRANTED;

4. The Receiver shall include a detailed list of expenses in any future bills

sent to investors;

5. The Receiver shall obtain updated appraisals of all GP properties as soon

as is practicable;

6. On or before March 27, 2015, the Receiver shall file a proposed

comprehensive informational packet that includes—in lay terms—the

following:

a. the SEC’s allegations;

b. the Receiver’s findings to date, including the original purchase

prices of the GP properties, the funds raised by Western from the

GPs, how the difference between the purchase prices and the

money raised was spent by Western, and the results of the

appraisals on the GP properties;

c. the current and projected financial status of the GPs and their

properties;

d. the amount and purpose of the expenses being billed to investors,

the amount of billed expenses that are actually paid, and what may

occur if insufficient funds are raised from investors to pay

operational expenses; and

e. any other information the Receiver finds necessary to include;

7. On or before April 17, 2015, the Receiver shall file a report and

recommendation regarding the appropriate course of action with regards

to each GP in light of the Court keeping the GPs in receivership.

DATED: March 4, 2015

HON. GONZALO P. CURIEL

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United States District Judge

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