A former high-ranking executive at American Realty Capital Properties Inc. testified on Tuesday afternoon and Wednesday that in emails and meetings in 2014 he repeatedly raised the warning of an accounting mistake in the real estate investment trust's calculation of an important cash flow metric known as adjusted funds from operation.
The executive, Ryan Steel, the former director of financial reporting at ARCP, is a key witness for the federal government in its case against Brian Block, ARCP's former chief financial officer. The Justice Department last September charged Mr. Block with conspiracy, securities fraud and making false filings with the Securities and Exchange Commission.
In October 2014, the company revealed that its financial statements for the first half of the year were inaccurate, reducing its AFFO by about $12 million for the three months ended March 2014 and $10.9 million for the three months ended June 2014.
At the time, Mr. Block resigned, as did the company's former chief accounting officer, Lisa McAlister. The founder of ARCP, Nicholas Schorsch, resigned weeks later that December as executive chairman of ARCP. He is no longer involved in the company, which changed its name to Vereit Inc. in 2015.
Mr. Block's trial started Tuesday. Asked by a reporter if he would testify in his defense, Mr. Block said, "I have no comment on that. To be determined."
Mr. Steel has cut a deal with federal prosecutors not to be charged in the ARCP accounting matter.
Mr. Steel said that he first identified the accounting problem in April 2014, weeks before the company was to file its financial statements for the first quarter of the year. Management's focus on hitting AFFO targets at ARCP was "severe," Mr. Steel said. Over the next three months, he raised the issue with other executives in meetings and emails, and they generally were receptive to revising the AFFO accounting methods, he said.
Testifying in U.S. district court in Manhattan, Mr. Steel said pressure over the AFFO accounting culminated in three meetings on July 28 in Mr. Block's Park Avenue office of ARCP, with the last one starting at about 9:00 p.m.
Along with Ms. McAlister, who was seated alone at a conference table, Mr. Steel and Mr. Block discussed the company's AFFO results and two different types of methods used to calculate that number. The first, and the one the company had been using since 2012 was referred to as a "hybrid" method, and Mr. Steel said he believed it to be incorrect. The second was called the "net" method, which Mr. Steel testified was correct.
That evening, Mr. Steel stood over the shoulder of Mr. Block, who was seated behind a desk with a handful of documents scattered over it, Mr. Steel said. Mr. Block quickly populated a blank spreadsheet for AFFO, using an incorrect accounting method, Mr. Steel said. He then turned his computer screen to show Mr. Steel and Ms. McAlister the results. "There you go," Mr. Block allegedly said. "What do you think?"
"I was shocked. My jaw dropped," Mr. Steel said. "I thought we were starting the conversation [about AFFO accounting], not ending it."
"I was shocked because I knew the numbers were wrong," he said, adding that Ms. McAlister started to nod and said that worked and looked good.
Mr. Steel said he protested that there was nothing to support those numbers. Mr. Block and Ms. McAlister responded by saying they would handle it and it would be OK, he testified. He was particularly concerned with presenting the numbers to ARCP's auditor, Grant Thornton, he said. Ms. McAlister offered to speak to Grant Thornton, he said.
The meeting lasted approximately two-and-a-half hours, he said. "I was trying to get them to come to my side."
Mr. Block and Ms. McAlister were calm throughout the meeting, he said. Mr. Block then emailed Mr. Steel the spreadsheet and told him to use it when filing the second quarter financial statement with the SEC, Mr. Steel said. Afraid of losing his job, he did so and was "distraught and upset" that Grant Thornton did not initially catch the AFFO accounting miscalculation, he said.
Mr. Steel said he was fired by ARCP in December 2014.
Michael Miller, one of Mr. Block's attorneys and a partner at Steptoe & Johnson, worked to knock down Mr. Steel's credibility on Wednesday afternoon, peppering him with questions about an apparent lack of concern over AFFO accounting methods in certain of Mr. Steel's emails to its auditor and other ARCP executives in the days and weeks before the financial report in question was filed.
"Isn't this the methodology approved by ARCP's audit committee?" he asked. "You caused that [accounting] methodology to be sent to Grant Thornton three or four times, correct? Did you ever communicate to Grant Thornton that the method was anything other than what you wanted?"
Mr. Miller's cross-examination of Mr. Steel is scheduled to continue Thursday.