Banks and intermediaries liable to aggrieved FALK investors for failure to disclose IRR reinvestment implications
The formerly respected group of companies of the initiator Helmut W. Falk is bankrupt. Other companies, so-called investor KGs, are also insolvent. Numerous investors were misrepresented the conditions with subscription and/or purchase of their participation in FALK funds. Report Mainz uncovers: According to a current report of the transmission REPORT MAINZ a commercial fraud stands to debit of the investors in the area. Despite liquidity problems since the end of 1999/beginning of 2000, a FALK interest fund to the tune of more than €50 million was set up in 2003 to pre-finance the purchase costs of new properties. The liquidity problems of the group were concealed from investors and other parties involved. Bank liability: Since 2000, several banks (Commerzbank AG, HVB, Dresdner Bank AG) have had a “contract to control the use of funds” with FALK. In fact, according to capital markets lawyer Prof. Schwintowski, these banks have been “sitting at the board table” at FALK since 2000. The banks will now have to face the fact that, as so-called de facto managing directors, they may be liable for offences in connection with the insolvency. Inadequate BaFin supervision: In this context, it is also worth noting that banking transactions, e.g. lending money as credit, require approval by the Federal Supervisory Office (BaFin). The aim of the FALK interest fund from 2003 is to collect money from investors and lend it to other Falk funds and companies. Thus, prior BaFin approval is required for such lending transactions. According to research by the trade magazine “Immobilien vertraulich”, the BaFin has already failed to issue a clear statement in a comparable case (an H.F.S. fund lends money to other H.F.S.-KG�s, also without BaFin approval for the lending business). The chief researcher there, Dr.Sommer, assumes that BaFin has also mistakenly overlooked the necessary credit approval in the case of the FALK interest fund. Advisers and intermediary liability: According to the assessment of the well-known lawyer Johannes Fiala, Munich, financial advisers and intermediaries are also liable for the conclusiveness of the prospectus information. Several approaches come for it into question: First of all in the FALK yield funds regularly with the “theoretical” and/or artificial IRR net yield (internal interest foot method) one recruits. According to the ruling of the Federal Court of Justice (BGH) of 13.12.2000, the investment adviser must check this for plausibility. A net yield – comparable to the interest of a savings book – lies according to the computations of the financial analyst Dipl.-Kfm. Edmund J. Ranosch from Wöllstadt over nearly 3 per cent points per year with the ex-Falk fund (FF) 75 lower. That makes over the long running time a proper interest loss. The 7,98% p.a. noted in the folder. IRR yield is overstated by this percentage. In fact, the fund would have yielded only 5.08% p.a. if everything had gone according to the prospectus. But not even that is the case. According to the current fund information on the FF 75, distribution reductions or default are the order of the day. Other Falk yield funds are also affected. At least three yield funds are in insolvency. Investor protectors criticize IRR yield data: The advertising with the internal rate of return method has already been repeatedly warned off as unserious via the investment protector Heinz Gerlach from Oberursel. Also the Stuttgart public prosecutor Dr. Hans judge expressed itself here in the direction of an objective investment fraud after the penal code. Liability for leverage transactions or combination models: Numerous investors financed their FALK fund investments through loans. This possibility was expressly mentioned in FALK prospectuses. Investors believed that with “6.5 – 7% distributions” at an IRR yield of almost 8%, they could of course easily finance via a loan with 6% interest. After that, IRR returns were supposed to be even higher because there was a positive leverage effect and reinvestment was automatically built into the IRR method. But this was a mistake in real terms, because realistic return calculations do not provide for reinvestment, and in the case of unit financing, reinvestment is not even possible. There is nothing left for reinvestment because all returns must first go into debt service (for the loan for unit financing). Later returns (distributions) do not make up for this in reality. The financial analyst Ranosch computes that with real (so-called RKRM net yield of closed participation) only a net yield i.H.v. 5,08% in the FF 75 should adjust itself, but also only with prospektgemäßer process, which does not occur after all knowledge now any longer. This meant that the investor who financed his investment with a loan was unable to achieve the IRR target. As a result of the share financing in the absence of distributions, the IRR yield rises to 9.7% p.a. for a 10-year loan term and 6% p.a. interest on the loan. The actual return on invested equity is only 7.70%, without reinvestment of returns after full loan repayment. Numerous investment consultants did not recalculate this and often stand beside the banks here also in the adhesion. Adhesion with omitted reinvestment to the IRR: If an investor e.g. at that time 100,000 ? subscribed and also its 5,000 ? agio paid in, it might expect that this increases around annually 7.98%, which one suggested to it into the IRR indication also. If he pays interest on his capital investment at an annual rate of 7.98% after tax, then in just under 21 years he will be able to enjoy a final value of around €515,000 at the end of the fund. Measured against his capital investment, he would have gained approx. 410,000 € in the IRR method. However, he did not do this because the prospectus, including 12 times the sales proceeds, grants him distributions before tax of only approx. 336,000 €. After deduction of approx. 43,000 € current taxes remains to him only a surplus after taxes of approx. 293,000 €. If the capital investment of € 105,000 is deducted, only € 188,000 remains as growth, which deviates strikingly from the € 410,000 of the IRR. The difference of €212,000 to the IRR result is explained by the IRR reinvestment interest, which the IRR method automatically allocates to the investor whether he reinvests or not. The IRR method automatically makes the investor more favourable by this amount, even though the investor does not reinvest at all and certainly not at the internal rate of return. How should he also be able to invest capital at 7.98% over the last 10 years and all that even after deduction of taxes, where the long-term capital market interest rates themselves have yielded only between 3% and 5% p.a. before taxes ? Investors will feel actively deceived by folder data by this. Not only the reinvestment obligation in the IRR method is highly questionable, but even more so the assumption that the (fictitious and actual) reinvestment can, indeed must, take place at precisely this internal rate of return of 7.98% p.a. if the prophecy of the IRR return is to come true. Liability in case of impossibility of reinvestment: It is as clear as daylight that an investor who consumes the distributions cannot reinvest. The amount of the reinvestment interest rate is therefore irrelevant. The folder should have pointed to it in all cases. If the investor recalculates, it will ask itself whether it would not have decided with knowledge of the reality to another investment? Apart from penal implications the investor will consider then over back completion and adhesion of folder responsible persons. Liability with credit-financed participation: Also those investors, who credit-finance their participation, have nothing to reinvest, because usually the interest and repayment loads of the distributions leave nothing for reinvestment. Often there are larger additional payments. Nevertheless, the even higher IRR return (resulting from the supposed positive leverage effect) suggests to them that they can achieve even higher IRR returns from the reinvestment interest. Advisors who let their investors float on these IRR return clouds should not be surprised if they fall into the abyss themselves. The investor may expect an explanation of the assumptions and conclusions of the IRR yield method from the advisor and the share-financing banks. Banks can also be held liable for failure to provide information when financing tax-saving models.
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Dr. Johannes Fiala has been working for more than 25 years as a lawyer and attorney with his own law firm in Munich. He is intensively involved in real estate, financial law, tax and insurance law. The numerous stages of his professional career enable him to provide his clients with comprehensive advice and to act as a lawyer in the event of disputes.
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