Brokers Accused of ‘Targeting’ the Elderly

     BROOKLYN (CN) – A federal class action accuses David Lerner Associates of “targeting unsophisticated and elderly customers” to sell more than $300 million of a $2 billion real estate investment trust “without performing adequate due diligence.”



     Lead plaintiff Laurie Brody sued David Lerner Associates Inc. and five of its top officials: president and controlling owner David Lerner, executive vice president and CFO Alan Chodosh, senior vice president of sales John G. Dempsey Jr., executive vice president of sales Martin Lerner, and chief compliance officer Steven Sormani. Also sued are Apple REIT Six Inc., Apple REIT Seven Inc., those entities’ chairman and CEO Glade M. Knight, and Apple Suites Realty Group, wholly owned by Knight.
     The complaint states: “Since January 2011, David Lerner Associates Inc. (‘DLA’) has recommended and sold over $300 million of a $2 billion real estate investment trust (‘REIT’) without performing adequate due diligence in violation of its suitability obligations. Earlier Apple REITs under the same management inappropriately valued the REITs’ shares at a constant artificial price of $11 notwithstanding years of market fluctuations, performance declines, increased leverage and excessive return of capital to investors. DLA has sold and continues to sell Apple REITs targeting unsophisticated and elderly customers to buy the illiquid security.
     “The performance results for Apple REIT Six and Apple REIT Seven are misleading because (i) they do not reflect the recent reduction in distribution rates and (ii) DLA does not disclose that income from those REITs was insufficient to support their 7-8 percent returns and that the distributions were partially funded by debt that further leveraged the REITs.”
     David Lerner Associates is a privately held brokerage firm that “purports to specialize in fixed income, government bonds, municipal bonds, and conservative investments for individual investors and retirees,” according to the complaint. Founded by David Lerner in 1975, the firm is based in Syosset, N.Y. and has branches in New York, New Jersey, Connecticut and Florida.
     The complaint states: “Since 1992, DLA has served as the underwriter and sole distributor of a series of ten REITs that have issued nearly $6.8 billion in securities to date. A REIT is a company that owns and usually operates income-producing real estate. To qualify as a REIT, a company must have most of its assets and income tied to a real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
     “Apple REIT Six and Apple REIT Seven were founded and managed by defendant Knight and his affiliates, and as both REITs Six and Seven closed to new investors, defendant Knight opened another.
     “Apple REIT Six and Apple REIT Seven opened between April 2004 and 2006 and both completed offerings at a price of $11 per share. Apple REIT Six and Apple REIT Seven have never changed the value of their shares from the $11 price despite (i) market fluctuations, including the economic downturn for commercial real estate in general and the hotel and hospitality industry in particular; (ii) net income declines; (iii) increased leverage through borrowings; and (iv) return of capital to investors through distributions.”
     Brody claims: “Most of DLA’s revenue derives from sales of Apple REITs.
     “Although there is no formal affiliation between DLA and the Apple REIT companies, defendant DLA has sold nearly $6.8 billion of Apple REIT securities into approximately 122,600 customer accounts in its role as sole distributor (managing dealer) of the offerings.
     “Although all of the Apple REITs are illiquid and concentrated in one subsector, extended stay hotels, a substantial number of defendant DLA’s customers own two or more of the Apple REITs. Many of defendant DLA’s customers are senior and/or unsophisticated, and defendant DLA solicits customers by general means such as the Internet, radio, cold calling, mailings, and open invitation seminars at senior centers.
     “Defendant DLA earns 10 percent of all offerings of Apple REIT securities, composed of 7.5 percent in commissions and 2.5 percent in selling fees. The firm also earns fees for account maintenance services. The nearly $600 million generated from Apple REIT sales has accounted for 60-70 percent of DLA’s business annually since 1996.
     “Defendant DLA has earned over $30 million in commissions and marketing allowances related to sales of Apple REIT Ten shares alone.
     “All or nearly all of defendant DLA’s sales of the Apple REITs were solicited.” (Parentheses in complaint).
     Brody claims the Apple trusts issued shares at $11 each, which were “unsupported … valuations,” that did not change, despite fluctuating market conditions and declining performance of extended-stay hotels.
     “The performance of all of the Apple REITs has varied due to a number of factors since each REIT’s inception,” the complaint states. “In particular, Apple REIT Six and Apple REIT Seven suffered substantial performance declines in 2008 and 2009, which did not fully recover in 2010. …”
     Brody says the trusts’ cash flow, total revenue, net income and revenue per room substantially declined from 2008 to 2009, according to their SEC filings.
     She adds: “Defendant DLA knew or should have known (with adequate due diligence) of changes and declines in performance that were affecting the value of Apple REIT Six and Apple REIT Seven. Most or all of the data reflecting performance changes and declines were available in public filings by the Apple REIT companies.” (Parentheses in complaint).
     Brody claims the Apple REIT companies did not pay investors entirely from income generated by the trusts, which lacked the income from operations needed to pay the 7 and 8 percent distributions.
     She says the trusts maintained an artificially high return on investment by paying investors with borrowed money and with their own capital, which further affected their value.
     “Returning capital to investors and taking on debt (which must be serviced out of future income and new investor proceeds) would reduce the REIT’s ability to acquire income producing assets to generate future income for distribution to investors,” according to the complaint. “Increasing leverage in this manner decreased the REIT’s ability to maintain distribution levels in the future and reduced the value of the REIT.” (Parentheses in complaint).
     Brody claims that David Lerner Associates advertised the trusts’ performance using misleading return figures and failed to disclose that income from operations was insufficient to support the high returns and that the distributions were partially funded by debt that further leveraged the REITs.
     She adds: “The DLA defendants advanced their own interests in continuing the sale of Apple REIT Six and Apple REIT Seven shares and the commissions those sales generated to the detriment of plaintiff and class members.”
     Brody seeks class certification and damages for breach of fiduciary duty, unjust enrichment, negligence, breach of contract and violations of the New Jersey Securities Act.
     She is represented by Thomas McKenna with Gainey & McKenna, of Manhattan.

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