American Realty Capital Properties is continuing to face heat following yesterday’s bombshell announcement that it had knowingly released inaccurate financial statements overstating its funds from operations and understated its net loss. The Securities and end Exchange Commission (SEC) has opened an inquiry into the REIT’s accounting.
The REIT lost a fifth of its market share in trading yesterday and the stock’s value has continued to plummet today, losing another 8 percent in value during trading Thursday morning. In addition, in the options market, 91,482 contracts traded on Wednesday, according to CNBC.
The company said yesterday that CFO Brian Block and Chief Accounting Officer Lisa McAlister resigned and that financial statements going back to 2013 can’t be relied upon. It also overstated its adjusted FFO by $12 million in the first three quarters of 2014 and $10.9 million in the second quarter ended June 30. Worse, the accounting errors were reportedly intentionally concealed.
“We don’t have bad people, we had some bad judgment there,” CEO David Kay said during a conference call yesterday, according to Bloomberg. “We had two employees which have resigned as the result of the effects of that calculation and the non-disclosure of the error in the first quarter.”
Bloomberg further reported:
The probe began when an employee contacted the audit committee in early September, Kay said on the call. Forensic investigators interviewed employees, read journal entries and went through hundreds of thousands of e-mails. Non-implicated executives were informed of the results late last week, he said.
“I’m not happy about these announcements -- Friday was a pretty crushing blow,” Kay said. “This is not the parade of horribles the market might view it as today. We have an exceptional team that runs this company. It’s an ethical team.”
On the heels of the news, law firms Johnson & Weaver and Ademi & O'Reilly announced they were launching investigations into possible securities fraud claims against ARCP.
And now the SEC is investigating the REIT as well, according to the Wall Street Journal.
The damage from the announcement has not been confined to American Realty Capital. Share prices of other entities tied to Nicholas Schorsch, the REIT’s founder and chairman, have also taken a hit.
According to Reuters:
Shares of RCS Capital closed down 14.0 percent to $16.99.
A spokesman for RCS Capital said it and American Realty Capital are "unrelated entities" with different audit committees, management and boards.
Schorsch also owns AR Capital, which sponsors and advises private real estate investment trusts, lease programs and other nontraditional investments sold through independent brokerage firms.
Michael Weil, RCS Capital's cofounder and president, previously served as president of American Realty Capital Properties, according to RCS's website. Peter Budko, another RCS Capital founding partner, was once chief investment officer of the REIT.
For his part, Schorsch has attempted to downplay the news in a conference call with 300 broker-dealer executives, according to Investment News.
According to Investment News:
In the conference call, Mr. Schorsch said that the problems with accounting at ARCP in no way would affect the number of nontraded REITs that are created by American Realty Capital, and sold by RCS Capital Corp., the leading wholesaler of nontraded REITs. Both firms are controlled by Mr. Schorsch.
“How does it impact any [ARC] programs? It doesn't,” Mr. Schorsch said on the conference call. “It doesn't impact any programs by Cole [Capital],” another of the nontraded REIT brands controlled by Mr. Schorsch, he added. .
RCS Capital and American Realty Capital “are not involved,” he said. “None of those programs are part of this transaction. If you remember, ARCP is a publicly traded company with $23 billion in assets. [They] have different boards [and] no affiliation.”
“The headline is mistakes were made, identified and the people involved were identified,” Mr. Schorsch said. “It will be fully corrected. It's not something I'm proud of or happy about. It's a very difficult situation to sever relationship with Brian Block after all these years.”
Schorsch’s empire has always been a difficult web to untangle. RCS, for example, has faced questions about its pace of growth in the independent broker dealer market, where it has acquired companies at a dizzying pace.
As it stands, several non-traded REITs tied to Schorsch are currently exploring sales or mergers, according to CoStar.
According to Costar:
The combination of Select Income REIT and Cole Corporate Income Trust will create a single tenant net lease office and industrial REIT with more than 43 million square feet of real estate in 35 states with an average portfolio occupany of 98%.
Nicholas Schorsch, chairman, CEO, and co-founder of the investment services firm American Realty Capital, figures into two other of the potential liquidity events.
Disappointed that the stock market has not fully valued the company as much as its individual property assets, ARC’s sponsored New York REIT Inc. said it is evaluating its strategic options for the company and its portfolio of New York City office and retail properties totaling 3.3 million square feet.
The REIT’s enterprise value (market cap + outstanding debt) is more than $3.1 billion.
Also, another ARC-sponsored entity, Phillips Edison-ARC Shopping Center REIT Inc., has engaged BofA Merrill Lynch and RCS Capital as financial advisors to evaluate possible strategic alternatives. As of August 2014, the REIT owned and managed an institutional quality retail portfolio consisting of 120 grocery-anchored shopping centers totaling approximately 12.6 million square feet.
Investors in the options market, however, were generally bullish on American Realty Capital Properties.
According to CNBC:
In fact the most popular American Realty options contract, the January 10-strike calls, were one of the most heavily traded options lines of the day for any stock.
American Realty closed Wednesday at precisely $10, for an annual yield of exactly 10 percent.
"If the complete dividend isn't in jeopardy, then there's no reason to think that it won't bounce back," said options expert Scott Nations. "On the other hand, if the problems are deeper, there is no bottom in the stock. So instead of buying the shares at $9.25 and risking it all, somebody is saying 'Let's pay $0.87 for the January 10-calls,' and if the stock bounces back, you've already tripled your money."