1031 exchange - largely unregulated industry

A firm that acted as a middle man in a popular real-estate-investment strategy has closed its doors, leaving investors scrambling to recover millions and pointing to flaws in the largely unregulated industry.

The latest problems in the industry involve Vesta Strategies LLC of San Jose, Calif., which closed its doors this month and has yet to return millions of dollars of client money.

Vesta was founded in 2004 by Chicago businessman John Terzakis and his partner, Robert Estupinian. Prior to starting Vesta, Mr. Terzakis had a history of failed real-estate deals and soured relationships -- information Mr. Terzakis isn't required to disclose to potential clients. Now the two men are accusing each other in separate lawsuits of diverting millions of dollars from Vesta for personal use.

The firm was involved in the real-estate-investing strategy known as 1031 exchanges, which gained popularity during the real-estate boom of recent years because they allowed investors to buy and sell properties without paying taxes.


To avoid paying capital-gains taxes in these real-estate deals, investors need to buy a new property such as an apartment building or strip mall within 180 days of selling their old property, and in the interim they need to keep their cash with a "qualified intermediary." Vesta was one of hundreds of companies that played that role.

Californian Christina Pappas was seeking to carry out a 1031 exchange when, on the advice of her escrow company, she handed over $2.5 million to Vesta in April from the sale of a property. She soon found another building to purchase within the IRS-mandated 180-day time frame. But a Vesta representative failed to wire her money to complete the property exchange by the June 16 closing, and still hasn't done so, she says.

The 57-year-old Ms. Pappas filed suit against Vesta last month, but she fears she won't recoup the money, which accounted for much of her retirement savings. "If I would have known any of this, I would have paid my taxes instead" of attempting a 1031 exchange, she says.

Vesta held $10 million to $30 million in client money at any one time, according to Mr. Estupinian. But as real-estate markets have cooled, companies that manage the exchanges have gone through a shakeout, which in some cases has triggered losses for investors and allegations of fraud in the largely unregulated industry. Now, calls are mounting for regulatory oversight of the companies that handle money used in 1031s, so named for the section of the Internal Revenue Code where the strategy is described.


While most facilitators are reputable, the lack of regulation and disclosure means anyone can set up an exchange company "even if they have a criminal background or a lot of bad business deals in their past," said Mary Foster, president of the Federation of Exchange Accommodators, a trade group that has pressed the Federal Trade Commission and the Internal Revenue Service to set guidelines for the industry.

In 2005, at the height of the boom, 415,000 exchange transactions with a cumulative value of $230 billion were completed, according to Deloitte Tax LLP.

Problems at Vesta surfaced publicly in December, when Mr. Terzakis sued Mr. Estupinian, the firm's former chief executive, alleging he misappropriated several million dollars of Vesta's money for his family's use. Among the many payments Mr. Terzakis asserts Mr. Estupinian made with Vesta's money: a $96,000 salary for Mr. Estupinian's wife, who allegedly did little work for the company; a $1.3 million house; a $160,308 oceanfront apartment in Long Beach; $50,000 for a pair of dogs; and $42,795 in tuition toward Mr. Estupinian's doctorate degree.

Mr. Estupinian denies the allegations and filed a countersuit accusing Mr. Terzakis of embezzling about $25 million. "Beginning as far back as 2000, John Terzakis has been treating the client funds as his own personal piggy bank in order to fund his many personal business and development projects," Mr. Estupinian's countersuit states. The suits were filed in U.S. District Court in San Jose.

Mr. Terzakis declined to comment beyond issuing a statement noting that he "took over" Vesta in November upon firing Mr. Estupinian. "I then made the commitment to solve its problems during both Vesta's operations and, now, after its closure," he says in the statement. "I continue to stand behind that commitment and will do so until this matter is resolved."

For his part, Mr. Estupinian says he had started requiring separate trusts for clients' money last year and "no client funds were in jeopardy" when he left Vesta.

This isn't the first time a company headed by Mr. Terzakis has been sued by customers and business associates. For years, Mr. Terzakis and partners sold fractional interests in commercial-real-estate deals through a company called Urban Investment Trust in Chicago. Several of those deals ended up in court.

The allegations in the lawsuits, filed in U.S. District Court in Chicago, follow a common theme: Mr. Terzakis and partners would purchase a commercial property -- a shopping center or office building -- and sell shares in the property to investors, often based on claims that were later alleged to be misleading. The lawsuits allege that Urban, as manager of the property, would eventually quit paying taxes, maintenance and insurance costs on the property and also stop making payments to investors.

Clients accused Mr. Terzakis of misappropriating their investments. Mr. Terzakis denies the claims and countered in court filings that the investments just didn't work out. In many cases, Mr. Terzakis settled the claims.

Many of Mr. Terzakis's former investors won't speak of him due to the terms of their settlements. One who will is John Greytak Sr., a Sebring, Fla., investor who put money into five shopping centers early this decade at Mr. Terzakis's direction.

After Urban quit making payments to investors, Mr. Greytak forced out Urban as the properties' manager and spent the next several years trying to revive the foundering properties and salvage his money and that of other investors. He sued Mr. Terzakis in 2003 and settled with him in 2005.