ARCP insiders generated $900M in fees during buying binge: lawsuit

Plaintiffs allege company insiders artificially inflated a key metric to help it grow into a powerhouse with 4,400 properties and $21 billion in assets

Apr 20, 2015 @ 11:39 am

By Bruce Kelly

During a three-year buying binge, American Realty Capital Properties Inc. generated more than $900 million in fees, commissions and payments made directly or indirectly to company insiders, according to an amended investor class action lawsuit.

The complaint, initially filed in January and updated last Friday, alleges that months after ARCP completed its $69.8 million initial public offering in September 2011, its share price was languishing below the IPO price.

In turn, that was impeding ARCP's ability to raise substantial capital, according to the complaint, which was filed in U.S. District Court in the Southern District of New York. Annuities and retirement plan giant Teachers Insurance and Annuity Association of America is lead plaintiff in the lawsuit.

The suit alleges that in an effort to raise the share price and raise more capital — and insider fees — ARCP set off on an acquisition binge, growing from a modest entity that owned 63 properties and had $132 million in assets into a behemoth that, three years later, owned more than 4,400 properties and had $21.3 billion in assets.

The lawsuit alleges ARCP's acquisition strategy was aided by artificially inflating its “adjusted funds from operations,” what it calls “the single most important financial metric used by investors to assess a REIT's performance.

“ARCP's senior insiders recognized that the only way to generate the substantial fees, commissions and compensation payments they sought would be to supercharge ARCP's reported” adjusted funds from operations (AFFO) growth, according to the complaint.

“As part of ARCP's acquisition spree, ARCP's insiders ensured that more than $917 million was paid directly to ARCP insiders and their affiliates,” according to the complaint, which names Nicholas Schorsch, ARCP's former CEO and chairman, as well as a number of other former executives as defendants.

The direct or indirect payments to ARCP insiders allegedly included $333 million in commissions and fees and $176.6 million in payments dubbed “subordinated distribution fees” and triggered by ARCP's purchase of two related REITs, American Realty Capital Trust III Inc. and American Realty Capital Trust IV Inc., which are also defendants in the complaint.

The payments also included $63.4 million for strategic advisory services; $21.6 million for the purported sales to ARCP of furniture, fixtures and equipment, for which allegedly no evidence could be found that at least a third of such furniture or equipment were received; and $17.7 million in financing coordination fees, the complaint alleges. The payments also include $15.4 million in post transaction support services, which included $10 million to an entity controlled by Mr. Schorsch to provide public relations support and services relating to office supplies, the complaint claims.

(More: American Realty Capital Properties hit by lawsuit from institutional investors)

Andrew Backman, a spokesman for Mr. Schorsch, said, “We believe the amended complaint is meritless. AR Capital and the AR Capital principals and employees named as defendants intend to defend against these meritless claims vigorously, and will be filing a motion to dismiss promptly.”

John Bacon, a spokesman for ARCP, said that company did not comment on legal matters.

At the end of October, ARCP revealed it had intentionally not corrected a $23 million accounting error over the first half of 2014. Mr. Schorsch resigned from his role as chairman of ARCP in December. ARCP's CEO, David Kay, and a handful of other top executives also resigned at that time. The company's stock price collapsed following the revelation, declining from $12.45 a share to $7.53 the next month, erasing over $3 billion in market capitalization.

The original complaint from January alleged that ARCP “made false and misleading statements by misrepresenting the company's business and prospects and engaged in a scheme to deceive the market and a course of conduct that artificially inflated prices of American Realty securities.”

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