Opinion ID: 746484
Heading Depth: 2
Heading Rank: 1

Heading: The Core Scheme to Defraud.

Text: 5 From 1984 to 1994, Lefkowitz was President of Citi-Equity Group, Inc. (CEG), a California corporation that formed real estate limited partnerships to build low- and moderate-income housing. In 1987, CEG began concentrating on projects that would qualify limited partners for low-income housing tax credits under 26 U.S.C. § 42. To qualify, investors must build, rehabilitate, or acquire buildings in which a prescribed percentage of the apartment units are occupied by low-income tenants. The federal government allocates tax credits to the States, with at least ten percent reserved for ventures in which nonprofit organizations participate. State and local housing agencies allocate the credits to specific projects. 6 In a typical project, CEG would find land in a desirable location, develop plans for an apartment complex, hire a builder, and apply to the appropriate housing agency for tax credits. With credits allocated to the project, CEG would form a limited partnership, with Lefkowitz and CEG as general partners, and release a Private Placement Memorandum (PPM) to securities broker-dealers who marketed the investment to prospective limited partners. Money raised from limited partners was the project's equity, generally between one-quarter and one-third of the total project cost. Upon completion of the building, CEG's management company leased out the apartments, the state housing agency released the allocated tax credits, remaining debts to the builder were paid, and limited partners began receiving their annual tax credits. 7 During the late 1980's, CEG's builders obtained construction loans to build the projects, while CEG obtained permanent financing to replace the construction loan once a building was completed. Beginning in 1990, with construction loans hard to obtain, CEG began marketing First Secured Mortgages (FSMs) to individual investors. FSM investors made non-recourse loans at construction loan interest rates to the limited partnerships that owned one or more designated projects, with the expectation that CEG's permanent lenders would take out the FSM loans with long-term mortgages. 8 Fraud on Investors. When Lefkowitz left CEG in May of 1994, properties in which limited partners and FSM investors had invested more than $80,000,000 were unbuilt, unfinished, or lost in foreclosure. The evidence demonstrates that Lefkowitz had managed CEG so as to defraud investors. Funds from limited partners and FSM investors were first deposited in an operating account for each particular investment. But Lefkowitz and CEG as general partners immediately transferred all investor funds to a central CEG account. From there, Lefkowitz personally controlled all expenditures, and CEG employees had standing instructions first to pay Lefkowitz's personal bills, then CEG's general operating expenses, and finally expenses for the various ongoing projects. From January 1990 to May 1994, $9,500,000 was used to pay Lefkowitz's personal expenses, including over $5,000,000 in deposits to Mrs. Lefkowitz's bank account and $2,000,000 in American Express bills. CEG employees referred to the resulting shortfall--the difference between money on hand and money needed to replace project funds spent elsewhere--as the black hole. In 1990, the black hole was $3,000,000 to $4,000,000. By January 1994, it had grown to $25,000,000 to $30,000,000. When CEG employees expressed concern about the growing black hole, Lefkowitz replied that he could always raise more money. 9 As the black hole grew, Lefkowitz increasingly relied on funds from new projects to complete old projects. IRS agents traced new partnership deposits that cleared negative balances in the central CEG account and then were used to meet Lefkowitz's personal needs and to fund older projects. This practice was not disclosed to CEG investors, as each PPM included an Estimated Use of Proceeds section that showed only a small portion of the funds going to CEG for general partner expenses, salaries, and fees. Lefkowitz denies that this was fraudulent, pointing to Article IX of the PPM's, which permitted CEG to lend money on behalf of the Partnership to others, including the General Partners and their Affiliates. However, while this provision would alert investors that idle limited partnership funds might be loaned to other productive projects, it did not describe Lefkowitz's practice of repeatedly lending limited partners' entire investment to projects whose funds were exhausted. 10 There was evidence Lefkowitz intentionally concealed these internal transfers from investors. Prior to one visit from a due diligence officer representing broker-dealers, Lefkowitz asked an in-house accountant if anything in the partnership tax returns might hurt him. The accountant replied that pages reflecting the loans from the partnerships to CEG were his biggest concern. Lefkowitz promptly ripped those pages out of the tax returns. On another occasion, CEG's securities counsel asked Lefkowitz about his wholesale borrowing of investor funds. Lefkowitz replied that it was limited to short-term loans on a few occasions when partnerships had idle funds. 11 Lefkowitz also misused FSM funds. FSM loan documents provided that the borrowing partnership shall not use or permit any related person to use the FSM loan other than in connection with the construction and development of the Property. Numerous investor witnesses described meetings and conversations in which Lefkowitz represented that monies raised in FSM offerings were construction funds that would be used to build specific projects, secured by mortgages on those projects, and that the money would be held in escrow and drawn down as construction proceeded. Notwithstanding these representations, FSM funds were transferred to the central CEG account and spent at Lefkowitz's discretion. 12 CEG's real estate construction projects could not be marketed to limited partners, FSM lender/investors, and builders without commitments for permanent financing from long-term lenders. Indeed, by 1990, many housing agencies required proof of permanent financing before allocating tax credits to a proposed project. When CEG encountered difficulties in obtaining permanent financing, Lefkowitz persuaded the presidents of two lenders to provide commitment offers conditioned on CEG signing an acceptance and paying a fee within a specified period. Lefkowitz told the lenders that he would not use their letters, but he then referred to the letters in investor PPMs, sent them to housing agencies as part of CEG's applications for tax credits (in one case even providing a copy of a bogus check as evidence the commitment fee had been paid), and provided them to builders who used the letters to obtain construction loans. As a result of this deception, investors contributed money, housing agencies allocated tax credits, and builders built projects that CEG could not close. 13 Fraud on Builders. Because it commingled project funds, CEG sometimes failed to make progress payments to builders. When progress payments were in arrears on a project for which CEG did not disclose a lack of permanent financing, the result was devastating to the builder, who could not pay employees and subcontractors and could not undertake new projects because its capital was tied up in the CEG project. In these situations, Lefkowitz coerced builders to extend their construction loans and wait while CEG looked for permanent financing. If a builder became impatient, Lefkowitz threatened legal action, and in some cases fabricated claims and filed suit. In one such dispute, Lefkowitz testified that CEG was unable to obtain permanent financing because the lender found severe construction defects, code violations and shoddy workmanship, when in fact the lender's inspection revealed only minor defects that would not have prevented permanent financing. These tactics forced several builders into bankruptcy. 14 Fraud on Housing Agencies and the IRS. Lefkowitz's scheme included two different types of fraud on government agencies. First, CEG with Lefkowitz's personal approval represented to housing agencies that the National Development Council (NDC) was a nonprofit general partner in certain projects. In fact, NDC did not have a partnership agreement with CEG, and in many cases was unaware that CEG was using its name on tax credit applications. Based on those misrepresentations, nonprofit tax credits were allocated to CEG projects and ultimately claimed by their investors. 15 Second, to mollify investors when projects were late, Lefkowitz instructed CEG employees to file tax returns claiming that buildings finished late in the year had been completed and leased to tenants in January. This misrepresentation permitted CEG to wrongfully claim and distribute to investors tax credits for the entire year. There is ample evidence that Lefkowitz knew the properties were unfinished and the claimed credits unearned. He once told a CEG accountant not to worry about claiming false completion dates because CEG had lots of property and Lefkowitz could always claim he was confused. In addition, on several occasions, Lefkowitz had CEG claim tax credits for periods during which CEG was negotiating to purchase low-income housing projects built by others. 16