A former high-ranking executive at American Realty Capital Properties Inc. testified last week in federal court in New York that in emails and meetings during the spring and summer of 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.
Just months after those warnings, ARCP revealed that its financial statements for the first half of 2014 were inaccurate, and reduced its AFFO by almost $23 million. ARCP shares dove after the announcement, wiping out billions of dollars in investor equity. Angry investors, meanwhile, have filed class-action complaints against the company, which changed its name to Vereit Inc. in 2015 to distance itself from its founder, Nicholas Schorsch, who is no longer involved in the company.
The executive who testified, 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.
Mr. Block faced discrepancies over the REIT's AFFO accounting in July 2014 as he was preparing ARCP's second quarter financial statements, according to Daniel Tehrani, assistant U.S. attorney.
"He could make up numbers to make problems disappear," Mr. Tehrani said last Tuesday in the government's opening statements.
"He chose to lie. He chose to deceive the marketplace."
"Boy, do we disagree," countered Mr. Block's attorney, Reid Weingarten, a partner at Steptoe & Johnson.
"I'm asking you to look for good faith in every nook and cranny in this trial."
AFFO can be a tricky financial metric to measure, and ARCP in its filings cautioned against relying on the metric. Indeed, there was no obfuscation of AFFO at the company, said Mr. Weingarten.
Mr. Steel has cut a deal with federal prosecutors not to be charged in the ARCP accounting matter. He said he was fired by ARCP in December 2014.
In the spring of 2014, Mr. Steel said he first identified problems with ARCP's AFFO calculation. At the time, AFFO was calculated by taking funds from operation, or FFO — which adds back depreciation to net operating income — and then adding back other financial figures, such as mergers-and-acquisitions costs.
Mr. Steel testified that the problem with ARCP's accounting was that while shareholders accounted for roughly 96% percent of the company's operating partnership units, the add-backs were computed on 100% of the units, causing the AFFO to be inflated. Making appropriate adjustments to ARCP's accounting for AFFO would result in a per share decrease in the metric.
The company said in its quarterly filings that the AFFO was net of any noncontrolling interests, which Mr. Steel said accounted for about 4% of the company.
In his testimony, Mr. Steel repeatedly referred to such a calculation of AFFO as double-dipping and called it a "hybrid" method.
Mr. Steel said pressure over the AFFO accounting culminated in three meetings on July 28, 2014. The next day, ARCP was to publicly file its second quarter results with the SEC.
Along with Lisa McAlister, ARCP's former chief accounting officer, Mr. Steel and Mr. Block discussed the company's AFFO results and two different methods to calculate that number: the "hybrid" method, which Mr. Steel said he believed to be incorrect, and the "net" method, which he testified was proper.
Mr. Block quickly populated a blank spreadsheet for AFFO using an incorrect accounting method, Mr. Steel said.
"There you go," Mr. Block allegedly said. "What do you think?"
"I was shocked. My jaw dropped," Mr. Steel said. "I knew the numbers were wrong." He said Ms. McAlister started to nod and said that worked and looked good.