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The Southwest Exchange litigation ensnares an array of businesses in its web

BY MATT WARD

On a breezy, Midwestern summer day last July, about 1,500 people descended upon the Mitchell County Fairgrounds in the small town of Osage, Iowa, to celebrate the city's 150th anniversary. A week-long series of events culminated with the area's first All-School Reunion.

Area cattlemen and pork producers grilled up the fixings, while dairymen served homemade ice cream. Alumni from as far back as the 1930s danced under the stars.

Three distinguished graduates were tasked with giving the keynote speeches that day. One was George W. Bush's secretary of agriculture, Mike Johanns, class of 1968. Unfortunately, he couldn't make it.

But two other guest speakers, a husband-and-wife team from Las Vegas known for their local philanthropy, were delighted to come. High school sweethearts who graduated from Osage High in 1952, the duo made their family's fortune conquering the medical-device industry. They were honored by the hometown crowd for the examples their lives set for the youth of Osage.

Nearly a year later not many people, even in their tiny hometown, want to be in Donald and Shirley McGhan's shoes. The couple is accused of one of the largest, most brazen frauds ever alleged against a Las Vegas financial institution. Along with daughter Nikki Pomeroy, son Jim, longtime investment broker Peter DeMarigney, plus a number of insurance companies, brokerage firms, a local bank and related business associates, the couple are named as defendants in a consolidated civil case. The suit alleges more than two-dozen acts of malfeasance affecting victims in Missouri, California, Idaho, Arizona, Nevada and elsewhere.

The FBI is investigating. So too are state agencies that failed to detect the chicanery until more than 130 victims had lost more than $100 million. Those victims are all landowners who placed the proceeds from real estate sales into escrow accounts at the now-infamous Southwest Exchange in Henderson, which abruptly shut its doors in January. Instead of avoiding an IRS tax bill by parking their money in a supposedly safe, bonded institution for 180 days, these victims lost between $25,000 and $22 million each, some of which they will never recover.

The attorney for a group of plaintiffs that says it was swindled out of $22 million put it this way: "While this amount is astounding, the story underlying the loss is even more astounding."

After graduating from high school, Donald and Shirley McGhan went off to the University of Iowa. He graduated in 1956 with a degree in mechanical engineering. That year, the couple left for Midland, Mich., and fateful careers with chemical and plastics manufacturer Dow Corning Corp. By 1963, Donald McGhan was head of the company's medical-products facilities. It was here that he made his first claim to fame: He helped invent the first generation of silicone breast implants.

The couple left Dow Corning in the 1970s and moved to Santa Barbara, Calif. They started a series of businesses there, each capitalizing on Donald McGhan's expertise with medical devices, particularly the implants. They had opened eight successive companies by the early 1990s. Their ninth was launched in Las Vegas, where they moved in 1992 with their adult children.

It was here they formed Medicor, which they often bragged was the third-largest medical manufacturer of aesthetic medical devices in the country. At one time, it employed about 400 people. Today, its doors are closed and its Web site dormant.

The nearly three-decade moratorium on the use of silicone breast implants ended in this country in the 1990s. The U.S. Food & Drug Administration lifted the ban on the silicone devices after years of controversy about systemic complaints caused by fluid leaking from the devices. Thousands of women filed claims against the implant makers and the assorted others involved in the product's conception, manufacture and sales.

Eventually, Donald McGhan's former employer, Dow Corning, settled for $4.25 billion, which forced it into bankruptcy. Donald McGhan, or one of his companies, was named in over 400 individual breast-implant cases, according to federal dockets going back to 1992. This was merely the first -- albeit large -- sign of trouble for the McGhan clan.

In March 2000, Donald McGhan was forced to settle with the Securities & Exchange Commission, which accused him of filing fraudulent quarterly reports for the publicly traded Inamed Corp. in 1997. He was the founder, chairman and CEO of the medical-device company when the fraud took place.

The allegations mostly involved overstating profits by not accounting for millions in intra-company transfers of inventory and tax assets which should have been deducted from Inamed's earnings, but weren't. Donald McGhan eventually lost his job with Inamed, paid a $50,000 fine but admitted no wrongdoing. Then he left for his next venture ... Medicor.

That company was started in 2000 and, until earlier this year, operated out of an office at 4560 S. Decatur Blvd. The same address would eventually show up in corporate registrations for other Donald McGhan-controlled businesses, many nonexistent except on paper in the Nevada Secretary of State's office.

Medicor was traded on the Over-the-Counter exchange, filing SEC reports and generally reporting to investors that it was capturing up to 30 percent of the market outside the U.S. for silicone-gel breast implants.

Court documents allege that the Medicor filings from at least the last two years are probably full of misstatements. Like many of McGhan's past businesses, Medicor was teetering. When the company filed its quarterly report in November 2006, it stated that Medicor sales jumped 68 percent. It even had a courtesy quote from COO Jim McGhan touting the company's prospects.

What no one told investors, who are just now finding out is something that happened two years earlier. The first thing Donald McGhan did when he acquired Southwest Exchange was to set up a loan scheme to funnel $47.3 million in Southwest Exchange funds to Medicor accounts. Eventually, Medicor would get $70 million from a McGhan-controlled company that was siphoning funds from Southwest Exchange.

Betty Kincaid started Southwest Exchange in 1990, before the real estate boom hit Las Vegas. When she sold it, real estate investors were flocking to the city to profit from skyrocketing property values. In 14 years, Kincaid's 1031 exchange accumulated nearly $110 million in escrow accounts. Donald McGhan heard Kincaid wanted to sell and knew it would be a golden opportunity to enter an industry lacking any serious regulation, according to court records. All he'd need to operate the business was a $50,000 bond and registration with the state's real estate division, which doesn't have the statutory authority to investigate exchanges, much less examine their books.

On June 12, 2004, Donald McGhan, his daughter and Medicor President Theodore Maloney, now a civil defendant in this case, flew to Chicago to meet Kincaid and make her an offer. Kincaid agreed to the terms -- $3 million cash and a 25 percent stake in Southwest Exchange's future parent company, Capital Reef Management, as well as continued employment with the exchange.

The transaction was completed on June 30, 2004, despite the fact that more than $1.5 million was unaccounted for before Donald McGhan showed up. According to court records, the patriarch, his family members and various associates of Medicor took over Southwest Exchange trust assets totaling $108,018,261. The company's liabilities, however, totaled $109,682,365. The plaintiffs allege that ignoring the missing money proves the McGhan clan was planning to loot the company all along.

Kincaid would stay on at Southwest Exchange for almost two more years. She attempted to get Donald McGhan to open the exchange's books by suing the company when she "developed concerns about how Southwest Exchange was conducting business and managing its trust accounts," according to court filings.

Her concern, it seems, as well as her lawsuit, would soon dissipate, along with the remaining 25 percent stake she owned in the business. She sold it to Capital Reef for $3 million. For that, she is also a defendant in this complex case.

By mid-2006, the end was near for Southwest Exchange. The housing market was cooling. When Donald McGhan bought the company, only $30 million was required to keep the business humming along. Now more escrow accounts were closing than opening. By late November 2006, at least one former employee was alerting people to the eventual collapse. No one listened.

McGhan had even acquired two other exchanges, Arrow 1031 in Boise, Idaho, and Qualified Exchange Services in Santa Barbara, Calif.

Nothing stanched the collapse. Regulators were oblivious until January, mostly because state lawmakers hadn't given them the tools necessary to provide effective oversight. The Nevada Real Estate Division canceled Southwest Exchange's license to operate, which was all the agency could do. Investigators from Secretary of State Ross Miller's office are still poring over records, looking for the lost money and collecting evidence.

John Kelleher, a senior deputy attorney general, is set to prosecute any eventual cases of securities fraud. "I'm one of many," he said. "There are so many different aspects to this. Several state agencies could prosecute them."

He said his investigators are responsible for "chasing the money." Of that, he says, little has been recovered. Investigators may be far from submitting their final report, on which he could base a criminal case.

"There was some money recovered. There's so many different companies, so many entities," Kelleher said. "It's pretty outrageous."

Brandon Roos, an attorney for a group of plaintiffs, said he expects the case to wend its way slowly through the system, although he hopes victims will receive their money sooner rather than later. "It's going to be a very complicated case. We're just now into it," he said. "We don't know the full extent of this."

The cases against 15 or more defendants are presently in civil court. But Roos made his thoughts clear on the pending criminal investigations, saying, "They should all be in jail."

Many entities were involved in the collapse of Southwest Exchange, and many more are now ensnared in litigation because of it. Attorneys such as Roos have identified 19 McGhan-controlled companies, as having benefited from Southwest Exchange funds. Two internationally known investment brokerages, Citigroup Global Markets and UBS Financial Services, are also being sued for allowing DeMarigney to issue as much as $59.3 million in fraudulent securities.

Silver State Bank, US Bank and title companies Equity Title and American Title Corporation are also defendants. At least seven insurance companies are not only being sued in District Court but in Nevada and California federal courts as well. These defendants include industry leaders Lloyds of London, State Farm, United States Fire Insurance, Great American and Brown & Brown of California.

Many of Donald McGhan's businesses are in receivership, for which court-appointed receiver Larry Bertsch and his attorneys had earned well over $100,000 in fees as of early April.

Donald McGhan is recuperating from a heart ailment in an undisclosed location, his attorney recently told Forbes. For Osage residents who are just now finding out about the Southwest Exchange swindle, particularly those who benefited from McGhan's largesse, their hearts are just breaking.

What exactly did Donald McGhan mean by his keynote speech on that breezy, July day in Osage last year? He talked of Midwest values, of dreaming big, of taking risks to find rewards. He told children to mind their parents and to find heroes to emulate in their own communities.

When told of the events unfolding in Las Vegas, one organizer of that celebration last July, attorney Paul Demro, was rendered speechless.