Two major sponsors of nontraded REITs, American Realty Capital Advisors and KBS Capital Advisors, have been locked in a legal battle for the past several years over the alleged lifting of proprietary information and trade secrets, including contact information for registered representatives.
The most recent iteration of that fight was a KBS lawsuit filed in January in state court in Orange County, Calif., in which it alleges a “misappropriation of trade secrets” by ARC Advisors.
Being heard both in California state court and Financial Industry Regulatory Authority Inc. arbitration, the dispute goes back to 2009, just as Nicholas Schorsch, chief executive of ARC, was launching his company.
That was when KBS Capital Markets Group, the wholesaling broker-dealer for the KBS REITs, first began a Finra arbitration case against Realty Capital Securities, the wholesaling broker-dealer for Mr. Schorsch's ARC REITs..
That complaint alleged that three former KBS broker-dealer employees misappropriated trade secrets and committed a breach of contract arising from the downloading and use of KBS information to aid ARC's broker-dealer, Realty Capital Securities, in its competition against KBS.
In 2011, KBS filed a complaint in Orange County.
ARC's broker-dealer wasn't named in the suit, and KBS eventually dropped nine of the original 13 claims against ARC, according to ARC spokesman Tony DeFazio.
“KBS filed this Orange County action in 2011 as a means of circumventing the Finra dispute resolution process,” he said. “[ARC] believes the few remaining claims are also without merit and is vigorously defending this action.”
A KBS response, provided by spokesman Mike Besack, said that it and its affiliates commenced their action against ARC Advisors and American Realty Capital II, a nontraded real estate investment trust, in Orange County court “to ensure that KBS entities could recover complete economic relief based on the ARC business enterprise's unjust enrichments as a result of ARC/Realty Capital Securities unlawful conduct, but which flowed through entities other than” the broker-dealer.
Nine of the 13 claims were dropped, not because of lack of merit, but because the court indicated that they were already included as part of the other existing claims, according to the statement from KBS counsel.
"We are looking forward to presenting our cases in both the Finra arbitration and Orange County action,” said KBS chief executive Charles Schreiber.
ARC and KBS are both major players in the industry for nontraded REITs, which are sold almost exclusively through independent broker-dealers. Since 2006, KBS has formed five nontraded REITs, which have acquired over $11 billion in real estate and real estate-related assets.
ARC was the leading seller of nontraded REITs last year and sponsors five nontraded REITS.
ARC and KBS have both dug their heels in over the dispute. The Finra arbitration involving the two broker-dealers and the separate California lawsuit involving other businesses related to the wholesaling broker-dealers are continuing.
Allegations in the KBS complaint “are not uncommon,” said Robert Milligan, a partner with Seyfarth Shaw.
“It's becoming more and more competitive in the REIT space," he said. "It's a relationship-driven business, and those people can be highly valuable.”
KBS would need to show ARC is using the information to prove its claim, Mr. Milligan said.
“The definition of trade secret is information that has independent economic value as a result of its secrecy,” he said.
“You have to show the information is secret. If it's on the Internet or in a government filing, that makes it challenging to maintain a trade secret claim," Mr. Milligan said.
The KBS claim centers on three former employees, James Frank, Jeff Kinney and Steven Williams, who left the company in 2009 and joined Realty Capital Securities.
Those three “worked in concert with” ARC Advisors and ARC II and “engaged in an unethical and disloyal conspiracy with which [they] stole KBS Holdings, KBS Advisors and [KBS broker-dealer's] confidential, proprietary and trade secret information for the benefit of” ARC Advisors and ARC II, according to the California complaint.
KBS “believes that this conspiracy was formulated in advance of the resignations of the former employees, and carried out in a deliberate manner to cause significant damages to KBS' business,” according to the complaint.
On the day he resigned in June 2009, Mr. Frank allegedly sent a large spreadsheet containing a record of all KBS' sales via e-mail to a Realty Capital Securities employee.
In July 2009, both Mr. Kinney and Mr. Williams downloaded confidential information from KBS' proprietary sales database, including contact information for registered reps who sold the company's REITs, according to the complaint.
The two allegedly used that information as employees of Realty Capital Securities, according to the complaint.