Investors have filed a class-action lawsuit against David Lerner & Associates Inc., of Syosset, accusing it of deceptively selling real estate funds that operate “in the manner of a Ponzi scheme.”
The Manhattan law firm Labaton Sucharow Llp filed suit June 16 in U.S. District Court, Brooklyn.
It comes after a formal disciplinary complaint filed by the Financial Industry Regulatory Authority in May, containing similar accusations. David Lerner Associates has responded saying it “vehemently denies” the allegations.
The basic claim in the lawsuit, and in the FINRA complaint, is that David Lerner Associates used improper sales methods to persuade “unsophisticated and elderly” clients to buy more than $300 million in risky investments in 2011 alone -- and $6.8 billion since the mid-1990s to more than 122,000 customers.
The investments, known as real estate investment trusts, named in the lawsuit are Apple REIT Ten and its predecessor, Apple REIT Nine. Both were based on the purchase of extended-stay hotel properties, mostly Marriott and Hilton hotels.
Joseph C. Pickard, general counsel for David Lerner, said the allegations are false and misleading.
"These are nothing more than frivolous lawsuits filed by attorneys seeking a quick payday," Picard said in a statement. "The allegations are baseless and rife with falsehoods, distortions, and misleading statements and we look forward to the opportunity to be vindicated in a court of law.
Picard said, "David Lerner Associates Inc. is proud of its 35-year history of serving its customers and is proud of its 19-year history as principal underwriter of the SEC registered Apple REIT programs."
David Lerner Associates was the sole distributor of the Apple investments, generating more than $600 million in fees -- representing about two-thirds of all the firm's income since 1996, investigators said.
David Lerner took 10 percent off the top of all investments, with 7.5 percent paid to salespeople as commissions and 2.5 percent paid to the company as a marketing fee, the lawsuit says.
“Many of DLA's customers are senior citizens and/or unsophisticated, and DLA solicits customers by general means such as the internet, radio, cold calling, mailings and open invitation seminars at senior centers,” the lawsuit says,"…Its entire selling effort was materially false and misleading.”
The key allegation in the lawsuit is that Lerner salespeople failed to tell investors that the previous issues of Apple investments had sharply dropped in value from the original $11 per share.
Lerner also failed to disclose that the REITs were using new investors’ money to pay previous investors’ 8 percent distributions – and in some case the REITs borrowed from lines of credit to fund the 8 percent payments, the lawsuit said.
Lerner should have investigated Apple REIT’s practice of maintaining an $11 share price even as the underlying hotel properties plummeted in value and in per-room revenues beginning in 2009, the lawsuit says.
With Apple Six, Seven and Eight, cash flow, total revenues, net income, funds from operations and revenue per room dropped sharply from 2008 to 2009, yet David Lerner & Associates failed to disclose this to investors in Apple Nine and Ten, the lawsuit says.
The entire investment model was unworkable, the lawsuit says, because in addition to David Lerner’s 10 percent commissions, the investment company charged account handling fees. Also, the REIT itself took a 2 percent commission from every transaction, leaving only 88 cents available for property purchases, out of every dollar invested.
To make up for the 12 percent deductions off the top, the REIT’s hotel properties would have had to return 9.14 percent in order to reach the promised distribution level of 8 percent, the lawsuit says.
Another factor that doomed the investment model, the lawsuit says, is that the REIT bought the wrong hotels – choosing sites with a history of lower returns on investment, in the range of 4 percent; or new, even unbuilt, hotels with no track record at all. The REITs “deliberately overpaid” for the hotels, the suit says.
The lawsuit seeks the return of the clients’ investment, mostly of $11 per share, plus interest.
Photo: David Lerner in the Syosset office of David Lerner & Associates. (August 2004)