Canyon Crest: New Owner, Old Questions, Part 5

In 2003, a class action lawsuit was filed by five investors (on behalf of all investors) against a slew of defendants: Metropolitan Mortgage and Securities Company; Metropolitan Investment Securities; Summit Securities; C. Paul Sandifur, Jr.; Reuel Swanson; Gary Brajcich; Harold Erfurth; Irv Marcus; Robert Ness; William Snider; John Trimble; Eric Skaggs; Tom Turner; Philip Sandifur; Gregory Strate; James Hawkins; and Ernst and Young, LLP.  All of the individual defendants were officers and directors in one or more of the three Sandifur-controlled companies, excepting Turner, who served as President, Executive Officer and Financial Officer of Summit.  Old Standard Life Insurance Company, owner of the Canyon Crest property proposed for 166 homes on 367 acres on the Brea side of Carbon Canyon, was a subsidiary of the larger Summit Holding Company and was purchased by it from Metropolitan, but it was all controlled by C. Paul Sandifur, who held the majority of the stock in Metropolitan and the other companies.

The basis for the lawsuit was that Metropolitan and its subsidiaries engaged in deceptive and illegal practices in selling investments (debentures, preferred stock and securities) to investors between 2000 and 2003 for the purposes of raising capital to pay the principal and interest owned to other investors, knowing full well that the second grouping of investors would never see the returns that were promised them.  This, in effect, was a classic Ponzi scheme.  The reason Ernst and Young were included in the suit was because that firm was to provide the unbiased accounting to verify the accuracy of information provided in financial reporting and filings made by the Metropolitan/Summit group of companies.  PriceWaterhouse, another of the "Big Four" accounting firms, also provided accounting and auditing services to the Metropolitan empire, but did not appear as a defendant in the suit because that company was replaced by Ernst and Young after 2000.  Still, both Ernst and Young and PriceWaterhouse were said to have "cooked the books" for the Metropolitan companies, which, in effect, gave a false sense of stability and security for investors like the plaintiffs and those they represented.

One particular example was cited in the suit:  Metropolitan's financing, in 2000, of the purchase of land in Hawaii that was purported to be prime logging property for much-prized koa wood.  Specifically, there were 16,000 acres of land near Hilo on the Big Island (Hawaii) that was being purchased by attorney and investor Kyle Dong for $10.3 million.  Metropolitan and Summit developed a financing package for the acquisition of the land and the start-up costs for the logging. 

The lending agency for $5.85 million to Dong?  None other than Old Standard Life Insurance Company, the owner of Canyon Crest. 

Summit came in with a $3.5 million loan, while Metropolitan, meanwhile, advanced $2.5 million for Dong's purported logging operation "provided that Dong agree to execute a timber harvesting agreement obligating him to pay back to Metropolitan $18 million over the ensuing five years regardless of whether any koa wood was ever harvested."

The suit noted that, while this deal was arranged, there were no property appraisals, inspection reports, logging feasibility study, cash flow report or other documents that would demonstrate that there was a viable project.  Moreover, Dong had not applied for a logging permit in 2000 and still had not received one in 2006.  As a matter of fact, Hawaii newspapers documented continuing problems with Dong's attempt to secure a permit and, at one point, a logging company hired by Dong was charged with illegal harvesting of the protected koa wood on the Big Island. 

And, who was providing the funds for this scheme?  Investors like the plaintiffs and those they represented.

Now, here's the "cooking the books" part.  Just after Metropolitan and Summit completed their loan and financing for Dong, the former sold to the latter, for a little over $13 million, the timber harvesting agreement that was to bring $18 million over five years, but which Metropolitan obtained for the $2.5 million advance to Dong.  In so doing, Metropolitan, with the auditing of PriceWaterhouse confirming the reporting, claimed a nearly $11 million profit on its books for the fiscal year ending 30 September 2000. 

The problem?  Dong defaulted on this loan and made one $250,000 payment.   Yet, Metropolitan claimed the $10.7 or 10.8 million profit in its financial reporting, never revealing (via PriceWaterhouse) that it obtained that timber harvesting agreement for $2.5 million nor that the timber land in question did not have a legal operating permit. 

Why this is at issue is because the company used that paper profit to claim a fiscal year net loss of $7.6 million, significant enough in itself.  But, the actual net loss was really over $18 million.  Could investors have assumed the company was in better (or at least, not as bad) shape because of the accounting "cookery"?

Indeed, in 2002, Dong's attorney notified Ernst and Young, Metropolitan/Summit's new accounting firm, of the irregularities involved in the koa land transactions.  Yet, the lawsuit claimed, Ernst and Young did not investigate the claim, revise the financial reporting that was made for the 1999-2000 fiscal year or subsequent years, or inform investors and the market of the questionable nature of the deal.

The suit outlined more accusations of inflated property values claimed by Metropolitan/Summit and cited examples of collusion with a company called Trillium, which "would then acquire the property at the over-inflated price by borrowing the majority of the purchase price from Metropolitan, Summit, or their affiliated entities."  In turn, the suit claimed, the latter would buy back from Trillium parts of these parcels, "in order to generate revenues for Trillium that could be used to both make payments on the loans made by Metropolitan or Summit and for Trillium to acquire additional properties from Metropolitan and Summit."  Resulting from these maneuvers, the plaintiffs claimed that Trillium owned Metropolitan/Summit some $70 million.

With balance sheets showing grossly overinflated values of property and assets, Metropolitan/Summit faced greater difficulties in raising the capital required to service the mounting debt that existed.  Still, investment instruments were sold to customers on the promise of healthy returns when those funds were instead used to try and pay down principal and interest owed on prior poor investments.

In June 2003, Metropolitan/Summit made a last ditch effort to secure capital from investment banking firms in New York and yet still sold securities that were asserted to be safe and conservative investments for customers.  Ernst and Young resigned as the companies' accounting firm on 22 January 2004, citing irregularities with 2002 financial reports and warning investors (uh, a little late) to ignore statements made in reports from 2001-2003.  Meantime, the SEC, ahead of the curve as always, launched a (shall we say it?) belated investigation.  In February 2004, Metropolitan/Summit declared bankruptcy and went into the receivership mentioned in earlier posts, the two creditors' trusts now managed by Maggie Lyons.

Note the following from the suit:

A significant volume of Metropolitan's and Summit's commercial real estate loans during the Class Period [period in the lawsuit, 2000-2003] involved raw, undeveloped land.  Many of these loans involved a significant degree of risk because the real estate asset securing the loan did not generate an income stream.  A large percentage of these loans went into default.

Remove the word "commercial" from this statement and it would appear that Canyon Crest fits the bill, except that the first priority deed of trust on Canyon Crest was issued to MRF Carbon Canyon II, L. P. (a Shopoff Group company created for the purchase and development of the land) in October 2005, a year and a half after Metropolitan/Summit/Old Standard went into bankruptcy and reorganization.  It would seem, then, that the issuance by Old Standard of the deed of trust for Canyon Crest was made in an attempt to obtain a favorable financial outcome for the purposes of getting creditors of Metropolitan/Summit something beyond what could be salvaged from the liquidation of those companies' existing assets.  Of course, MRF Canyon Crest (a.k.a. Shopoff Group) defaulted on its loan and Old Standard took over Canyon Crest in October 2009.

Well, this suit charged Metropolitan/Summit with violations of exchange and securities laws on six counts and sought compensatory damages, fees and costs, and applicable injunctions against the defendants.  It is believed that this case is still pending in the courts and has not gone to trial.

The next post will detail more on this case and provide what is known about it currently.  This will be followed by discussion of another class-action suit filed against brokers affiliated with Metropolitan/Summit, an action that has just within the last few weeks been settled.