It is hard to assess investor returns in the Reg D marketplace because there are no publicly available secondary market transactions in Reg D securities.
There is also no information on the financial performance of Reg D issuers except for a vanishingly small proportion of issuers who are also issuers of registered securities.
It is not even possible to catalogue the worst practices in the Reg D marketplace because offering documents including Private Placement Memoranda ("PPMs") are not generally available.
We have reviewed many PPMs and posted two notes highlighting Reg D abuse:
HJ Sims Reg D Offerings: Heads, HJ Sims Wins - Tails, Their Investors Lose, Craig McCann, Susan Song, Chuan Qin and Mike Yan available
at www.slcg.com/resources/blog/691.
"First National Realty Partners Reg D Offerings: Muppets Do Commercial Real Estate" Craig McCann, Susan Song, Chuan Qin and Mike Yan available
at www.slcg.com/resources/blog/693.
In this note, we provide a further example of Reg D abuse - this time with the benefit of a complete set of ex poste financial statements covering 11 years for a Reg D offering from Walton Group USA ("Walton"). [1]
Walton has set up at least 24 special purpose entities to issue Reg D securities. Table 1 contains a listing of Walton's Reg D issuers.
Please let us know if you, or someone you know, invested in one of these issues and have/has financial statements.
Walton's website touts a superficially impressive breath of experience and claims decades of profitable real estate management on behalf of its clients.[2]
Actual investor experience with Walton's Reg D offerings seems dramatically at odds with Walton's representations.
In fact, based on our review of Walton Land Fund 3, LP ("WLF3") financials and other Walton Reg D offerings, it is clear that the primary purpose of Walton's Reg D offerings is to aggressively fleece uninformed investors.
A stylized sketch of the Walton issuers based on our review of documentation for WLF3, LP is as follows.
Walton establishes a special purpose entity to issue Reg D securities.
Only 48% of the capital raised is used to buy undeveloped land.
The other 52% vanishes in payments to Walton and to third-tier brokers:
11% of investors' capital is paid to securities brokerage firms,
3% is taken by Walton "for making the opportunity available",
17% of investors' capital is taken by Walton as markups on land purchases ostensibly to cover expenses incurred by Walton,
21% of the capital is set aside for Walton to withdraw over-time as management fees and expenses for virtually nonexistent services.
Not only do we identify red flags in the WLF3 PPM, we document how Walton launders extraordinary fees through property transactions and reports inflated fair values for property holdings to shareholders in WLF3.
Walton Land Fund 3, LP Private Placement Memorandum
The WLF3 PPM describes the offering and selectively summarizes results of past Walton Group offerings.[3]
The initial PPM's Use of Proceeds table is reproduced below as Table 2.
Walton planned to charge WLF3 investors substantial markups for undeveloped land Walton was simultaneously buying and so much less than 56% of investors' capital was going to be used to buy land.
11% was going to be paid to brokers as selling commissions and expense reimbursements and over 40% of investors' capital was to be taken by Walton.
Table 2 Use of Proceeds, WLF3 PPM, Page 23
In addition to the upfront fees and expenses and fully reserved ongoing management fees, in the event properties are sold at a profit,
Walton intended to take 40% of any proceeds beyond what was necessary to provide investors with a return of capital and a 10.5% noncumulative return (preferred amount) on a per property basis.[4]
Thus, even if WLF3 investors never received any distributions and lost most of their money, if one property sold at a substantial profit, Walton could take additional fees as carried interest.
Shockingly, Walton took carried interest in 2014 and 2015 despite the fact there were no distributions to WLF3 investors and
Walton's own calculation of investors' IRR from inception to December 31, 2014 was -6.91% and to December 31, 2015 was -4.77%.
At page 25, the PPM describes the Sponsor Fee Walton will charge WLF3 investors.
With the First Supplement Dated to the WLF3 PPM, Walton listed this 3% as an Acquisition Fee in the Use of Proceeds table. Acquisition Fee is undefined in the
Supplements which say capitalized terms not defined in the Supplements are defined in the PPM. Interestingly, the Acquisition Fee is not defined in the PPM or in any Supplement.
Walton, without explanation, simply rebranded the 3% Sponsor Fee it was taking from investors as an Acquisition Fee - foreshadowing its fraudulent bundling of this Sponsor Fee
into the fair value of WLF3's property holdings.
The PPM discloses that WLF3 will purchase undeveloped land from Walton USA in non-arms' length transactions which Walton may have recently purchased at lower prices.
A reader of this disclosure could not fully appreciate the price gouging Walton intended to engage in or that these transfers from investors to Walton
for worthless services would be laundered through property deeds to inflate the properties' fair value subsequently reported on audited financial statements.
The Use of Proceeds table was updated four times as WLF3 raised money and closed on land purchases.
By mid-2013, WLF3 had raised $95,245,000 from investors and bought $65,516,658 in six undeveloped properties; the final Use of Proceeds table is reproduced below as Table 3.
Table 3 Use of Proceeds, Fourth Supplement, October 22, 2013 to WLF3 PPM, p.3.
The categories in this final Use of Proceeds don't line up with the initial WLF3 PPM's Use of Proceeds excerpted in Table 2 above or with the subsequent financial statements published to investors in WLF3.
According to land deed records WLF3 bought the six properties from Walton for $65,516,658 when Walton had simultaneously paid $46,007,624, or $19,509,034 less than what it charged WLF3 investors
Table 4 WLF3 Property Holdings, December 31, 2013
The Vista Ranch transactions illustrate how Walton laundered expenses through property records into inflated financial statement values.
Walton Arizona, LLC acquired 318.60 acres of vacant land located in Casa Grande, AZ from Auza Ranches, LLC in July 2013 for $6,180,000 ($19,398/ac).[5]
See Figure 1a). The same day, Walton Arizona, LLC sold 95% interest in the same 318.60 acres of vacant land to Walton U.S. Land Fund 3 for $8,505,151 ($28,101/ac).[6] See Figure 1b).
Figure 1 Pinal County Records Reflect Simultaneous Transactions for $6,180,000 and $8,505,151.
Walton Land Fund 3, LP Financial Statements
Financial statements covering inception in 2012 to the most recent statements as of December 31, 2022 illustrate the basic WLF3 economics which are devastating for investors.[7]
Investors contributed over $94,399,744 by the end of 2013. WLF3's 2013 financial statements show $84,114,838 in assets -
an immediate $10.2 investor loss mostly reflecting $10.5 million in payments to brokers and to Walton.
Table 5 Consolidated Balance Sheets
WLF3's true financial condition was much worse than the financial statements reflect. The land was not worth $66,100,000.
It had recently been purchased for $46,000,000 and coincidental with the purchases of the six properties WLF3 paid
Walton $20,000,000 in Sponsor/Acquisition Fees and for Walton Group USA' general operating expenses unrelated to the specific properties, all of it laundered through the property records.
PWC audited the WLF3 financial statements from 2013-2016; EY audited the WLF3 financial statements from 2016-2022. It is unclear what work PWC did to verify the $66 million fair value
assigned to properties as of December 31, 2013 which had changed hands in arms-length transactions for $45 million earlier in the year.
The $66 million valuation was based on the simultaneous non arms-length transactions between entities controlled by Walton which included a
$20 million markup unrelated to any improvement in the six properties bought for $45 million.
Truthful financial statements would have shown the December 31, 2013 property fair value to be $46,000,000 and the total assets, $64,000,000.
Even this would overstate the value of investors interest in WLF3 since $18,408,300 is pledged to Walton and segregated in a non-interest bearing account to be drawn out over time.
When Walton was done fleecing investors in 2013, there was really only $46,007,624 in assets available for investors who paid $94,399,744 in 2013 for their interests.
That is, WLF3 investors lost 51% in the very first year.
Table 6 Consolidated Statements of Operations
Table 7 Partnership Accounts
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[1] A 2019 Bloomberg article reported on Walton's activities: "Investors Pumped Billions Into Suburbs That Never Got Built", Bloomberg Michael Sasso, June 13, 2019,
www.bloomberg.com/news/articles/2019-06-13/-3-8-billion-bet-on-north-american-urban-sprawl-runs-aground
