On Advice

Painful end for advisers who bought RCAP shares

The fate of Nicholas Schorsch's companies holds lessons for brokers who buy stock in their employers' firms

Oct 5, 2017 @ 12:34 pm

By Bruce Kelly

Nicholas Schorsch
+ Zoom
Nicholas Schorsch (Bloomberg)

For advisers and executives who owned shares of RCAP, the defunct, mammoth brokerage firm formerly controlled by Nicholas Schorsch, a painful financial chapter of their lives ended last month.

A federal judge in New York approved the settlement of a class action lawsuit filed by investors almost three years ago who bought stock in Mr. Schorsch's former brokerage, RCS Capital Corp. The complaint was filed in December 2014 in U.S. district court for the southern district of New York against the company and former executives, including Mr. Schorsch. The lead plaintiffs were Oklahoma Police Pension Fund and Retirement System and City of Providence, R.I.

RCAP filed for bankruptcy early last year. The value of the company stock was wiped out.

"I owned 11,000 to 12,000 shares of RCAP," said one Cetera Financial Group adviser who asked not to be identified for this column. "I need to put the past behind me. It's a quarter million-dollar loss."

PENNIES ON THE DOLLAR

If they choose to opt into the settlement, RCAP investors will get pennies on the dollar for their shares. The settlement will create a $31 million class fund, plus interest, minus $9 million in legal fees.

After paying the lawyers, that translates into 47 cents "per allegedly damaged share," according to court documents.

The settlement covers investors who bought common stock from Feb. 12, 2014, to Dec. 18 of that same year. Over that time, RCAP shares traded between $22 and just under $12.

RCAP and its executives were not honest with its investors, the class action complaint alleged. Mr. Schorsch was executive chairman of RCAP at the time, as well as its controlling shareholder.

"Throughout the class period, defendants, among other things, allegedly made false and misleading statements and omissions regarding the strength of RCAP's business prospects, emphasizing RCAP's ability to leverage its relationship with Schorsch-related entities," meaning the REITs, according court papers.

RCAP was launched about a decade ago as a privately held broker-dealer, controlled by Mr. Schorsch and his partners, that would wholesale American Realty Capital nontraded real estate investment trusts. In other words, ARC, also owned and controlled by Mr. Schorsch, created and managed the REITs, and RCAP sold them through broker-dealers with retail reps and advisers. Nontraded REIT wholesalers work with independent broker-dealers such as LPL Financial and Ameriprise Financial Services to get in front of advisers and talk about their products. Those firms, two major sellers of nontraded REITs, did not sell ARC products.

Mr. Schorsch's timing could not have been better. RCAP grew to become a behemoth. After struggling for sales at first, RCAP by 2012 and 2013 was the industry leader in selling nontraded REITs, raising billions of dollars per year in investor equity.

ADVISERS BOUGHT IN

RCAP prospered. It rode the wave of the recovery in the commercial real estate market after the crash of 2007 and 2008, and it also earned the ardor of advisers eager to earn fat commissions of 7% for selling the REITs.

It listed as a public company in June 2013, selling 2.5 million shares in its IPO at $20 per share. A year later, RCAP's management, including Mr. Schorsch and his ARC partners, sold close to $100 million of company shares to the public.

At the time, RCAP shares were trading at about $20.

And that's when some advisers bought in.

Brokers and executives at Cetera Financial Group, which RCAP had bought in April 2014 for $1.1 billion in cash, and other Schorsch-owned broker-dealers, bought a total of $22 million of company stock in that secondary offering in the summer of 2014. RCAP also used a mix of its now worthless shares and cash to buy other broker-dealers, including Summit Financial Services Group Inc. and Investors Capital Corp.

"I'll probably just accept the settlement and move on with my life," the Cetera adviser said. "I'll take the cash and say it's a life lesson and don't do it again."

Mr. Schorsch's REIT and brokerage empire began to unravel in October that same year. That's when a giant REIT run by Mr. Schorsch, American Realty Capital Properties Inc., or ARCP, revealed $23 million in accounting mistakes from earlier in the year that were intentionally not corrected. Sales of ARC REITs dried up and, burdened by debt, RCAP slid into bankruptcy in early 2016 and wiped out shareholders.

POST-BANKRUPTCY

RCAP emerged from bankruptcy later that year under new ownership with a new name, Aretec, or Cetera spelled backwards. Mr. Schorsch now has nothing to do with Cetera Financial Group, which is home to more than 8,000 reps and advisers.

Mr. Schorsch and his partners, one of whom, Brian Block, was convicted this summer of securities fraud relating to the accounting scandal at ARCP, have also taken a severe financial hit with the collapse of RCAP. Their 30 million shares of common stock in the company were wiped out, just like the shares of the advisers who bought company stock.

Previously, those shares had been worth hundreds of millions of dollars. Mr. Schorsch also put back $37 million of his own money to keep RCAP afloat near the end of 2015, but to no avail.

"The fewer people who respond to the settlement, the more money there is for other investors," said a former RCAP executive who also owned RCAP shares and did not want to be identified. "Institutional investors will sue on their own, and they were the largest shareholders."

While this settlement has been reached, it doesn't mean that lawsuits involving RCAP are over, the executive said. "It's most likely a hedge fund is not going to be willing to accept 50 cents per share and give up right not to pursue other potential litigation," he said.

Jesse Galloway, a spokesman for AR Global, a privately held real estate company where Mr. Schorsch is the lead partner, did not return a call to comment.

What a mess. Mr. Schorsch and his partners still face other suits involving RCAP and ARCP.

Brokers buying stock of the firms they work for can end badly, as it did in this case. Advisers beware.

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