My theory of Connolly's scheme

I was invested in two of Connolly's 30 properties.  There was a prospectus issued for each property, and I was sent one for each of the two properties I invested in.  The prospectus outlined a method of operation, a predicted return, an assumed vacancy rate, a standard 30-year mortgage, and an initial capital reserve.  Connolly was issued at no cost a certain number of shares, in exchange for managing each property.  A company was formed for each of the 30 properties.  The Operating Agreement for each company has a Separateness Covenants section that dictates, in part:

1. The company's assets will not be commingled with those of any other entity.
2. The company's assets will be held in its own account, AND in its own name.
3. Will pay its own debts out of its own assets.
4. Will maintain adequate capital.
5. The company Manager (David Connolly) is responsible for maintaining reasonable reserves.
6. The company Manager may borrow money for the general purposes of the company.

I invested in my first property in May 2007, and the second property in September 2008.  The prospectus for the second property showed that my first property was returning the predicted rate of return of 12%.  I learned later that in fact, for the year 2008, my first property had a loss of $378.74 on an investment of $3,593,750 - it broke even - there was no profit.  But Connolly paid 12% "dividends" to investors and himself, in the amount of roughly $482,000.  $431,250 of this to investors (12%), and an additional $50,750 to David and Donna Connolly for managing the operations with their company Connolly Properties, Inc. ("CPI").  Thus, Connolly turned a break even year for this property into a 12% loss, unbeknownst to investors who assumed their property actually profited and could return 12%.

CPI managed the 30 properties that Connolly formed.  CPI was 50% owned by David Connolly, and 50% by Donna Connolly.  Richard Colasuonno was also a partner of David and Donna, under at least two companies Connolly and Colasuonno, LLC and Connolly and Colasuonno Development.  He was the general contractor on Miners Cove and Hillside Valley, and did performed maintenance on Connolly-owned properties.  He was a 50% owner in Hillside Valley.  There was another partner Emmanuel Obiora, an architect, in a company named Connolly, Colasuonno and Obiora.

Signs of trouble

In November 2008, I received no distribution checks.  By the end of the month I was sent two checks, one for each company, and they bounced.  In December, I got word that Donna Connolly had said "we switched banks, and it was a huge mistake."  The payment issue was blamed on banks, but I later determined there was no change of banks that would have impacted any investor's distributions or company's cash flow.

In July 2009, I received a letter from the bank holding my first property's mortgage that the mortgage was in default.  On inspection, I further found that Connolly had taken out a second mortgage on my property on the very day that he obtained the first mortgage.

I then began cataloging all the Connolly-managed properties.  I visited the land clerk's office in each town a Connolly building was located in, and noted the purchase price and mortgage(s).  To my surprise, many properties had been refinanced - some twice.  Remember the prospectus stated there would be a 30-year standard mortgage, which appeared conservative and safe.  This was the opposite.

After an article in the newspaper, I visited a Connolly property called The Livingston in Allentown.  I found the front door open, and all the first floor apartments in state of total renovation.  I discovered that in that main building there were 3 tenants, and in a smaller second building 9 tenants, for a total of 12 tenants out of 53 apartments.  I called an investor in Livingston, who told me he was receiving full distributions and had no knowledge the main building was half torn apart.  Since Livingston was recently purchased, and had no refinanced mortgage, the obvious question was how it could be mostly empty, paying its mortgage, and paying investors full 12% dividends.  I sent Connolly a letter asking these questions, and he never replied.

Discovery that $36 million had been extracted through refinancing; all mortgages in default

I then visited the foreclosure unit for the State of NJ in Trenton, and discovered all of the mortgages of Connolly's properties were in foreclosure.  Similarly, in PA, the buildings there were as well.  The only exception was a 4-unit apartment building David and Donna Connolly owned themselves in NJ, which didn't go to foreclosure until over two years later in October 2012.  At the foreclosure unit, I discovered that the refinanced mortgages had aggressive terms, such as interest only for 2 years, then interest + principal.  If Connolly couldn't make only the interest payments, how could he ever make the payments once the mortgages converted?  The earliest conversions were to happen right around the time all the mortgages went to foreclosure - the Summer of 2009.  When I added everything up, a whopping $36m had been taken out of the 20 properties that had been refinanced.

One consequence of refinancing and extracting equity, is it increases the monthly debt payment.  If the proceeds from refinancing are absconded and not available to help pay the mortgage, it increases stress on the balance sheet.  This is why the downturn of the economy accelerated the crash of Connolly's scheme.

Discovery that Connolly raised excess capital at inception, which should have increased cash reserves

In combing through bankruptcy filings, court filings which included prospectuses, and speaking with investors, it was possible to compare the number of shares that were to be sold and granted to Connolly with the actual number that were sold and granted.  For only five properties examined, Connolly raised a total excess of $4.8 million above the prospectus predictions, primarily through selling more shares than advertised and obtaining a higher mortgage than advertised.  This excess cash should have remained in the respective accounts of each of the  properties, but did not.  It was transferred to Connolly's massive commingled master account and spent on fake distributions, company losses in miscellaneous properties, Connolly's private ventures (see below), etc.

Increasing the number of shares sold and obtaining higher mortgages than required may raise additional starting capital, but it also increases monthly payouts to investors if they are blindly paid 12% and higher distributions that were not actually earned, as Connolly did.  And if the starting capital is absconded, as Connolly did, it puts a property in grave danger of exactly what happened to each of Connolly's properties.

Discovery of "construction side" of Connolly Properties

I then discovered that Connolly Properties had a "construction side" that most investors and myself were unaware of.  From 2004 through 2008 Connolly and a partner named Richard Colasuonno had purchased four (4) different development plans/properties:

1. 200 unit apartment complex in East Allentown, PA - Hillside Valley (land $1.1m bought 2/2006)
2. 100 unit senior living complex in Allentown, PA - Madison Gardens (land $1.3m bought 6/2007)
3. 19 unit condominum property in Franklin NJ - Miner's Cove (land $750k bought 6/2004)
4. 179 apartment property in Allentown, PA - Central Park Apartments (land $1m bought 9/2008)

Construction on Miner's Cove began in 2006 and Hillside Valley in 2007.  When CPI-managed properties failed in 2009, one building (6 units) of three had been completed at Miner's Cove, and Hillside Valley was about 50% complete.  Hillside Valley went to foreclosure in October 2010, and Miner's Cove in November 2010.

Connolly's attempted coverup - thrusting investors unwillingly and unwittingly into Hillside Valley

The first notice to investors that mortgages were in default was received by investors on July 24, 2009.  At this time, Connolly had received approximately $9m to purchase properties he had issued prospectuses for in 2008-2009.  On the very next business day, Monday July 27, 2009, Connolly signed a document that purported to "purchase" equity on behalf of these investors in Hillside Valley.  At this time, Connolly and his long time business associate Colasuonno each had a 50% interest in Hillside.  Colasuonno was also the general contractor for Hillside.  The Hillside construction loan balance was over $13m at this time, and Connolly and Colasuonno had about a $1.1m investment in the land purchase (although the loan to purchase Hillside's land came from a CPI-managed property Allentown Apartments - it is unknown if it was actually paid back by Connolly and/or Colasuonno).  Appraisals in 2010 after another $2m is drawn on the loan for further construction, placed the value of Hillside at $13m or less.  Therefore, Hillside was worthless when investors were told their escrow had been used to "purchase" equity in Hillside in 2009.  Furthermore, the $9m in equity has never been located, and Connolly has stated "very little" of the $9m was actually put towards Hillside.

Connolly stated that investors purchased a 78% stake in Hillside, but all they got at most was 78% of $1.1m for their $9m.  If Connolly didn't actually pay off the Allentown Apartments loan on the land purchase, it was actually equity of Allentown Apartments investors that Hillside investors "purchased".

Commingling is the order of the day at Connolly Properties

During multiple investigations and civil court actions, it is determined that Connolly only maintained two accounts that all capital was funneled to, an investor account with investor escrow for properties to be purchased, and the "operating account" with the working capital of all the companies commingled.  This explains why all the properties failed within three months time - the terms of the Operating Agreement were explicitly violated.

As an aside, note that the only recorded loan that Connolly made between companies was the loan from Allentown Apartments to Hillside Valley.  While lending funds for a construction project is risky, at least it was documented.  Connolly has no other documentation that is public that would support a contention he was lending funds between companies.

The Connollys' mortgages fail last

Though David and Donna Connolly blamed the economy and inability of tenants to pay rent on the failure of all the apartment properties, somehow their own 4-unit apartment property in Plainfield at 136 Crescent Avenue paid its mortgage all the way until October 2012.  The identical property right next door at 132/134 Crescent Avenue, owned by Connolly investors, failed when all the rest did in 2009.  As noted above, Connolly cash lasted until October and November 2010 on the construction projects.  The mortgage on their $1.5m house was paid until the very same month he finally plead guilty - February 2013.  The Connollys first, everyone else last.

Connolly's version of what happened

Connolly initially blamed a pedophile, then a reporter, then a vicious news cycle, and finally the downturn of the economy for the wholesale failure of his entire investor-owned portfolio.  In the memo submitted in preparation for his sentencing, there is recognition that he engaged in fraudulent activity, but not until the economic downturn of the economy.  In fact his fraudulent activities may extend to at least the beginning of 2006.

In 2015, in a submission to the court in an action to amend or vacate his sentence, now Connolly claims the banks were at fault for the failure of his portfolio, because they would not lend his managed properties more money.  This is not credible - the banks had overextended themselves in lending money in the form of refinancings to the tune of $36m.

Now, what is true is that the private construction projects of Connolly and Colasuonno, which should have had no effect on investor properties, were speculative.  A real estate professional who spoke with Colasuonno prior to construction said Colasuonno and Connolly were expecting to get $2000 and up to rent Hillside units.  At Miner's Cove, a sign showed that each condo was expected to sell in "the $300's".  Today, the rent at Hillside is $1175, and none of the six Miner's Cove condos a developer who paid $475,000 for and completed that the Connolly's and Colasuonno put about $2.5m into have been sold.  Interestingly, Connolly has never and still does not mention the fate of the escrow that he purportedly put towards Hillside, but did not.

Lastly, recall that the only loan known of that could have affected an investor company was the Allentown Apartments loan, which was allegedly repaid in 2007.

My theory of David Connolly's Ponzi scheme

In Connolly's latest court filing, he denies running a Ponzi scheme by the government's definition.  However, many of the characteristics of Ponzi schemes were present.  These are taken directly from an SEC website:

1. Securities were unregistered.
2. Overly consistent returns.  Connolly paid full returns even after mortgages stopped being paid.
3. Issues with paperwork.  No financial statements other than a K-1 at the end of the year.
4. High returns with little risk.  >12% returns until investors found out their properties had failed.

What was Connolly's plan?  It appears that Connolly fancied himself a "player" in real estate (which he denies in the latest court filing).  This is the only explanation behind planning to quietly build one large and three very large development projects, while managing thirty existing properties.  Connolly's properties were not routinely renovated.  The Livingston is an outlier - there are no other known properties that Connolly did substantive renovations to after 2004.  And there was no refinancing of Livingston to allegedly fund the extensive renovations begun there.

What would Connolly's exit plan have been?  Sell the units at Miner's Cove to raise the capital to pay back the greatly increased mortgages that had ballooned by an additional $36m on numerous properties?  Assuming Connolly could sell all 19 units at Miner's Cove, that is only $5.7m, which would not have paid even the single largest mortgage.  Hillside was insolvent before Connolly fraudulently put his investors into it - partly due to the economy, and partly due to choosing a very expensive construction technique (three story solid concrete walls).  The possible success of the construction side of Connolly Properties, hidden from most investors, is the only explanation I can see to explain Connolly's actions.  But once he commenced construction on these projects, and kept taking from one operation/investment to fund others, his fate and that of his investors was sealed - there was no conceivable way to recover.  Perhaps he thought he could build out the other two projects in quick succession, and income from them would repay mortgages of the investor properties - but this is an extremely risky strategy few investors looking for a safe investment would consider.  Connolly fancied himself a mogul, but his plan to achieve that success was doomed from the start.  The economy only accelerated the failure of an ill-conceived scheme to use investor capital in unrelated projects at his whim illegally to further his vision of grandeur.

Losses

My estimate of total investor losses is approximately $31m, after distributions are accounted for.  Banks lost about $26m.

Analysis

To see analysis related to the research mentioned above, please see this Scribd page.

If you have other suggestions of what Connolly's plan may have been, please comment below.

Connolly Properties investor properties apparently reconstituted as Allentown Metro

Holdings LP, Siesta Realty LLC and Apex Plainfield 2011 LLC

In 2011, while on notice he was under investigation by the FBI and others, Connolly transferred three properties to his colleague Richard Colasuonno's son Joseph: the former Allentown Apartments LP (10 different apartment properties in Allentown PA), Siesta Park LLC (Plainfield NJ) and Apex Apartments (formerly part of Plainfield Apartments LLC).  The signature on the mortgages of each new company was Selim Zherka, a resident of New York.  Online comments of renters and indicate that Richard Colasuonno, and his sons Joseph and Frank are managing the operations of the Allentown properties day to day.  Siesta residents report sending rent checks to Allentown PA.

The mortgages of Allentown Metro Holdings and Siesta Realty were refinanced in 2014, and the grantor is a member of the company "Zherka Family Irrevocable Trust".

On September 18, 2014, Selim "Sam" "Sammy" Zherka was indicted for false loan applications, tax fraud, wire fraud and witness tampering.  The Zherka Family Irrevocable Trust is named as a defendant in the indictment.  Zherka is accused of signing mortgages for properties he claimed he owned, but did not.

The questions that need to be asked are, was Selim Zherka brought in as a straw purchaser of Connolly-managed properties, for the sole purpose of only using his credit to obtain mortgages?  If so, who really now owns these properties, which were owned by Connolly's investors and not Connolly himself, when he transferred them to companies with one or more Colasuonnos as members?  Did the Colasuonnos or Connolly put any funds towards these properties, and if so how much?  Where did those funds come from?   Does Connolly have any interest in Allentown Metro Holdiings, Apex Plainfield or Siesta Realty; properties he formerly managed but didn't own; properties he transferred out of investors' ownership without notifying them?  These properties are worth over $12m - Connolly tossed them away, and that is bad enough.  But he transferred them to control of his partner's family and possibly his partner himself.  For all anyone knows, Connolly and/or his wife have a financial interest in them.