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United States v. Kaplan

United States District Court, S.D. California

June 22, 2017



          Cathy Ann Bencivengo United States District Judge

         On May 1, 2017, the Court heard the United States' Amended Motion for Order of Restitution in the above-captioned case. [Doc. No. 92.] The motion arises out of the guilty pleas entered by co-defendants Howard Kaplan, Stephen Kaplan and Eric Kaplan on March 16, 2015, to one count of conspiracy to commit wire fraud, under 18 U.S.C. § 371. [Doc. Nos. 7, 12 and 17.] The co-defendants were sentenced on January 7, 2016, however at that time the matter of restitution was deferred to a later date at the joint request of the parties. [Doc. Nos. 67-69.] It is now sixteen months later and the issue of restitution still remains unresolved.

         I. Background

         The following summary comes from the factual bases of the co-defendants' plea agreements. [Doc. Nos. 7, 12 and 17, ¶¶ B.1-10.] Beginning in or about 2001, and continuing to sometime in 2010, Equity Based Services (“EBS”) and its affiliates offered investment opportunities involving primarily the purchase and operation of self-storage facilities. EBS would enter into purchase agreements to buy self-storage facilities, and then seek investors through property syndication and/or 1031 exchanges. At the relevant times, defendant Howard Kaplan and his two sons, defendants Stephen and Eric Kaplan, were involved in the operation of EBS.

         Between 2001 and 2010, EBS syndicated approximately 77 self-storage projects. Investors in the various EBS syndicated self-storage projects were induced in part to invest by a representation that investors would be entitled to a “Preferred Return, ” usually in the amount of 8% per annum, that would generally be paid on a monthly, quarterly or other periodic basis, and if not paid would accrue until the property was sold. From approximately 2002 through August 2010, EBS regularly distributed the periodic payments of the Preferred Return to investors. Based in part on the prompt and regular payment of the Preferred Return, many earlier investors invested in one or more subsequent projects. These prompt and regular payments of the Preferred Return also helped attract new investors to EBS syndications.

         Beginning in or about 2006, some of the periodic payments of the 8% Preferred Returns received by investors in several of the projects were able to be made only by defendant Howard Kaplan's diversion of funds from better-performing properties (“lending projects”) to under-performing ones (“borrowing projects”), or by the use of fees paid to EBS that were generated by new project syndications. In addition, Howard Kaplan sometimes used these funds to pay the borrowing projects' debt service and/or operating costs.

         Howard Kaplan did not disclose to individual investors that their 8% Preferred Return distributions were often made despite the fact that their specific investment project was not generating enough operational profit to support the payment of an 8% Preferred Return or was, in fact, not generating sufficient funds to pay all operational costs and debt service. Howard Kaplan also failed to disclose to investors his commingling of funds and use of investor funds to pay borrowing projects' debt.

         Howard Kaplan further breached his fiduciary responsibility and duty to investors by: a) pre-funding Preferred Returns through a process of raising excess funds for individual projects; b) inducing investors to invest additional funds in projects without informing these investors as to the true financial condition of the properties; and c) creating new and sometimes undisclosed fees called “capital assignment considerations” and “equity consulting fees, ” including with respect to the acquisition of the AMS I Atlanta storage project.

         By no later than January 2010, Howard Kaplan had informed his sons, Stephen and Eric Kaplan of his misconduct. Despite this knowledge, Stephen and Eric allowed other individuals to invest in new EBS syndicated projects without disclosing Howard Kaplan's prior activities. [Doc. Nos. 7 and 12, ¶9.] This was not a sophisticated scheme or complicated fraud, according to Assistant U.S. Attorney Phil Halpern. Howard Kaplan “simply borrowed from one project to pay another.” [PSR, Doc. No. 37, ¶ 23.]

         By 2015, when the defendants were charged in this case, many of the EBS investors had lost money in their syndication projects. Recognizing intervening economic causes, the Government acknowledged the difficulty to accurately identify the number of “victims” and the losses attributable to the defendants' criminal actions. [United States Sentencing Memorandum, Doc. No. 49, at 6-7 (“Victims maintain that the losses are approximately $60 million. However, the Government concedes that the $60 million figure is an overstatement based on what could be proved.”).] The Government described the defendants' syndicated deals as “solid and lucrative, ” and acknowledged that one of the main reasons they started to fail was due to the economy, not because of any fraudulent activity. [PSR, Doc. No. 37, ¶ 23.]

         Even now a portion of the properties remain profitable and still make money, while others went into foreclosure when the market crashed and the whole financial infrastructure became “overly stressed.” [Id., ¶ 19.] At the time of sentencing the government conceded that the exact amount of potential loss or gain is “convoluted.” [Id., ¶ 20.] “Determining the actual number of victims was not a simple process since the money was lost due to the real estate crash.” [Id., ¶ 23.] Although the parties agreed the defendants would be subject to an award of restitution, there was no agreement as to the amount that could be causally linked to the fraudulent activity of which the defendants were convicted.

         II. The Motion for Restitution

         At the January 7, 2016 sentencing hearing, the Court set the restitution hearing for April 6, 2016. [Doc. Nos. 67-69.] On March 16, 2016, the parties jointly filed a motion to continue the hearing to June 2, 2016. [Doc. No. 75.] On May 6, 2016, the day after the Government's opening brief on restitution was due, the parties again requested to continue the hearing to October 19, 2016.[1] [Doc. No. 80.]

         The Government filed its initial Motion for Order of Restitution on September 21, 2016. [Doc. No. 85.] The motion sets forth the acts that constituted the conspiracy.[2] [Id., at 3-5.] Notwithstanding the multiple descriptions of the fraudulent activity, in essence the scope of the fraud remained, as defined in the plea agreements, the borrowing of money by Howard Kaplan starting in 2006 from one project to pay the investors or expenses in another, and the failure of the defendants jointly after January 2010 to disclose that activity to current and prospective investors to enable them to obtain further financing.

         Directly contradicting its prior representation at the time of sentencing that the scheme was neither sophisticated nor complicated and that the $60 million losses asserted by the victims was an overstatement of what could be proved, the Government in the initial restitution motion described the scheme as “complicated, ” and maintained the victims were in the “best position to estimate the losses.” [Id., at 7.] The Government submitted a restitution demand of $60, 006, 000 prepared by the investors, and an alternative demand of $56, 006, 000 that excluded “certain amounts the Government has deemed not allowable.” [Id., at 9; Doc No. 85-1, Appendix A & B.] The restitution claim consisted primarily of a list of EBS properties that were eventually foreclosed on, went bankrupt, were sold at a loss, or were underwater. The Government requested a five-day hearing at which it would presumably establish that the investments in these failing properties were lost as a direct result of the defendants' criminal conduct, and not as previously represented due mainly to intervening economic causes.

         Following service of the Government's opening motion for restitution, the parties again jointly moved to vacate the hearing date and requested a status conference. At a conference held on October 19, 2016, the parties requested time to negotiate, and ultimately on November 18, 2016, the Court directed the Government to file an amended motion for restitution by December 23, 2016. [Doc. No. 91.]

         On December 23, 2016, the Government filed an Amended Motion for Order of Restitution. [Doc. No. 92.] The motion included a revised and reduced restitution demand of $17, 609, 162 against Howard Kaplan and $3, 764, 156 against the three defendants jointly. [Doc. No. 92-1, Exs. 1 &2.] This revised demand included transactions not previously identified by the Government as part of the criminal conduct or within the scope of the described fraudulent activity.

         The briefing and hearing on this revised motion was continued twice at the joint request of the parties. [Doc. Nos. 95, 100.] Defendants filed responsive briefs on March 27, 2017. [Doc. Nos. 105-107.] Government filed its reply brief on April 17, 2017. [Doc. No. 112.] At the hearing held on May 1, 2017, the Government sought the Court's guidance as to ...

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