Pooled Exchange Account Invested?
your exchange account isn’t in a separate
account, do you know what it’s invested in?
Last week one of the largest title companies in the
United States filed for bankruptcy. While that may
not be surprising is this time of trouble for the
real estate industry, what was surprising to most
people is that this was a $1.5 billion (with a B!)
publicly held company that was brought down by its'
1031 exchange operation.
by Gary Gorman
founding partner, 1031 Exchange Experts, LLC
I’m adamantly against pooling,
yet most intermediaries pool their client’s money.
By pooling, I mean the placing of all the client’s
exchange funds into one account. The benefit of pooled
accounts is that the intermediary is investing a larger
amount of money, and is therefore able to obtain a
Of course the intermediary is going
to keep some of the interest, which is the whole point
of pooling to begin with. In fact, the more the account
earns, the bigger the spread – the amount of
money they keep. The intermediary’s spread is
influenced by two factors: the balance in the account,
and the interest rate the account earns.
The very real and obvious incentive
is for the intermediary to maximize the amount of spread
the pooled account earns. As we all know: the greater
the yield, the greater the risk. Now, don’t
get me wrong; I am not saying these intermediaries
go too far out on a limb on purpose, or that they even
think or know, there is any risk in what they are doing.
Yet there may very well be greater problems in their
investments than even they know about. And if they
DO know, they certainly aren’t going to tell
Let’s assume that the entire
account is invested in a so-called money market
account. I say so-called because there are different
types of money market accounts (how many of you even
knew that?). So what the intermediary thinks is a true
money market account may be, in fact, something entirely
different. The SEC limits the investments of a true
money market account to short-term instruments that
mature in less than 13 months, with the average maturity
of the fund less than 90 days.
But then there are enhanced money
market funds which are allowed to invest in other types
of securities in order to ‘enhance’ their
return. Some typical examples of enhancements are asset-based
commercial paper. Asset based means investments
that may very well hold sub-prime loans and could be
worth pennies on the dollar. Another common investment
in these funds are structured investment vehicles:
entities that issue commercial paper. Currently they’re
having trouble selling new paper, which brings into
question their ability to pay off their outstanding
paper. What happens to the outstanding paper held by
an enhanced money market account if the entity can’t
pay it off? It means your exchange proceeds have just
vaporized – even though they were invested in
a money market fund.
So what intermediary would be so foolish
as to use enhanced money market funds? Unfortunately,
many have indeed invested their clients’ exchange
proceeds with such “safe” big-name companies
as Legg Mason, Sun Trust, Wachovia, Bank of America,
Northern Trust and the Janus Funds – all of which
have recently had to put money into their money market
funds to keep them solvent (even though they are not
legally required to do so).
Not all of the big names have stepped
up to take care of the problems in their own funds.
The Community Bankers Mutual Fund money market account
and General Electric’s Asset Management account
both closed and paid investors only 96 cents on the
dollar. The State of Florida, which operates an enhanced
money market account for those communities which have
excess property tax funds to invest, recently suspended withdrawals completely.
It didn’t have enough liquid cash because of
problems with the enhancements in their fund.
Wait, it gets worse. There is also
an investment vehicle called Auction Rate Securities,
which are long-term maturity vehicles that until recently
had weekly auctions where purchases and sales were
transacted and interest rates were adjusted. These
auctions have ceased, making these securities unmarketable.
Prior to the halt of the auction, ARS’s were
marketed as essentially the same as cash. Now they’re
worthless. This is what the title company’s pooled
exchange account was invested in, and which ultimately
brought down the company.
Interestingly, one of the most common
responses many of the intermediaries (including the
one that just filed for bankruptcy) offer when asked
about possible problems with their pooled account is “we’re
too big to have problems with our account.” Oh
really? Bigger than General Electric? Bigger than the
State of Florida? Or Enron, WorldCom, Bear Stearns,
Countrywide or AIG?
Pooled accounts can bring down even
billion dollar companies – remember that the
next time you let your intermediary pool your money.
Instead, make sure that your exchange funds are in
their own account, and that the name of the account
includes your name and the words “for the benefit
of,” in order to make it clear that they are
your funds. You may earn less interest, but at least
your funds will be secure.