Former CAO’s Suit Against ARCP Could Shake Up Non-Traded REIT Sector

Last week’s defamation suit brought against American Realty Capital Properties by its former chief accounting officer, Lisa McAlister, fits a common enough pattern: A company and an ousted executive go to war over whether there was or was not just cause for the exec’s involuntary departure.
Brad Thomas

Brad Thomas, The Intelligent REIT Investor

Last week’s defamation suit brought against American Realty Capital Properties Inc. by Lisa McAlister, its former chief accounting officer, fits a common enough pattern: A company and an ousted executive go to war over whether there was or was not just cause for the exec’s involuntary departure.

In this case, of course, the company, after a period of meteoric growth, is beleaguered on other fronts as well, and other events since McAlister’s departure might be seen as bolstering her side of the story. Those other factors add extra gravitas to this affair, and so does the particular circumstances of just how entangled recently departed ARCP executive chairman Nicholas Schorsch is in the whole public non-traded REIT industry, says a long-time REIT consultant and blogger.

Brad Thomas, of The Intelligent REIT Investor, has gone through certain phases regarding ARCP. He was not a big fan of the company when it was first launched, he said, but reassessed them as their diversification grew.

More recently, though, even before McAlister and Brian Block were terminated, Thomas was getting nervous about them again. “I think they overpaid for Cole” [Real Estate Investments] to get the revenue stream that Cole would provide them, he says, adding that he believes that the Cole model was not sustainable.

Furthermore, Thomas said that if McAlister’s allegations are true, “It’s going to have a tremendous impact on the non-traded REIT business.”

The total value of public REITs in the neighborhood of $750 billion, and about 10 percent of that is in public, non-traded REITS, according to Thomas. And of that 10 percent, about half is in entities affiliated with Schorsch. “People have finally caught on to all the conflicts of interest,” he said. “All of these conflicts of interest are coming to the table.”

“I fear for the non-traded REIT investors,” he added. “There’s a lot of risk out there, and these investors don’t know it.”

McAlister’s suit alleges that Schorsch directed her and Block, the then CFO, to move numbers around to hide previous accounting errors, and that she was a whistleblower for which she was fired. The suit was first reported by The Wall Street Journal last Thursday.

More specifically, the civil complaint, filed in a New York State court on Thursday, asserts that last February McAlister “repeatedly informed Mr. Schorsch, Mr. Kay and senior management she had discovered that the Company had, in the fourth quarter of 2013 … and possibly in earlier quarters, suddenly and without any apparent justification or basis, changed the method by which it had historically reported its adjusted funds from operations … relative to previous financial quarters.”

Despite these warnings, “and in an apparent effort to avoid public disclosure of its faltering financial performance,” McAlister alleged, ARCP continued to use the improper accounting approach, at Schorsch’s and Kay’s direction, through July.

A call to McAlister’s law firm was not returned as of press time.

Schorsch had led ARCP through a $15 billion, three-year string of acquisitions to become the world’s largest net-lease REIT.
For a review of recent developments, here’s a timeline:

Oct. 1: David Kay was appointed CEO and Lisa Beeson was appointed president of ARCP, after Schorsch relinquished the CEO title and Kay moved up from president.

Oct. 2: ARCP announced an agreement to sell Cole Capital, its private capital management business (acquired as part of ARCP’s $11.2 billion merger with Cole Real Estate Investments), to sister company RCS Capital Corp. for at least $700 million.

Oct. 28: McAlister and Block were terminated (or they resigned; take your pick).

Oct. 29: ARCP announced errors in financial statements, including overstatements of adjusted funds from operations for the first quarter of calendar 2014 that were intentionally not corrected. (McAlister’s suit alleges that the ARCP press release defamed her by falsely blaming her for these irregularities.)

Nov. 3: RCS Capital Corp. withdrew from the purchase of Cole Capital Partners. Later that day, ARCP alleged that RCS had no basis on which to withdraw and called the action a breach of the purchase agreement.

Dec. 4: RCS Capital agreed to pay ARCP $60 million to settle a lawsuit over the canceled $700 million Cole Capital Partners deal. About three weeks earlier, ARCP had filed suit in the Court of Chancery in Delaware over the terminated deal.

Dec. 15: ARCP announced that Schorsch, Kay and Beeson had resigned. Schorsch stepped down not only as executive chairman of ARCP, but also from the boards of ARCP and of the non-traded REITs managed by Cole Capital, a sponsor owned by ARCP.

In the announcement, William Stanley, the lead independent director who took over as interim CEO & chairman, said ARCP was “unwinding all of its relationships with entities in which Mr. Schorsch maintains an executive chairman or director-level role or is a significant stockholder. These steps will not only enhance the company’s corporate governance structure but will also lead to further simplification of its business relationships.”

Dec. 16: Moody’s downgraded ARCP’s senior unsecured debt to Ba1 and issued a negative outlook, citing “the continued uncertainty surrounding the unsecured debt rating from the accounting, legal and investment banking reviews.”

By all means, stay tuned for further developments.