A group of investors has accused Nicholas Schorsch, the former nontraded REIT czar, and his partners of siphoning off revenue in RCS Capital, or RCAP, a company once controlled by Mr. Schorsch that went into bankruptcy.
The allegation, which surfaced in a lawsuit filed by the investors on Wednesday in Delaware Chancery Court, claimed that Mr. Schorsch and his partners enriched themselves by funneling revenue from RCAP to AR Capital, another company they controlled.
RCAP was the publicly traded brokerage holding company that had its initial public offering in 2013. Initially, RCAP's chief assets was Realty Capital Securities, a wholesaling broker-dealer that sold AR Capital-branded, nontraded real estate investment trusts. Until RCAP's IPO, Realty Capital Securities operated under AR Capital's control.
Crushed by more than $1 billion in debt raised for Mr. Schorsch's binge buying of retail broker-dealers, RCAP declared bankruptcy at the start of last year. It emerged from bankruptcy in May as Aretec, the holding company that now controls Cetera Financial Group, a large broker-dealer network.
The investor plaintiffs in the new suit, the RCS Creditor Trust, represents unsecured creditors who claim their investment was wiped out.
The crux of the investor lawsuit is the allegation that Mr. Schorsch and his four partners, William Kahane, Peter Budko, Edward "Michael" Weil and Brian Block, exploited their control of RCAP to "enrich" their wholly owned, nontraded REIT business, AR Capital.
Mr. Schorsch, his partners and various related companies, "raised hundreds of millions of dollars in public stakeholder investments, then caused RCAP to operate unprofitably for AR Capital's benefit, and to make boldly imprudent investments that served only AR Capital's interests," the complaint alleges. "This abuse, together with the foreseeable impact of financial fraud they perpetrated at an affiliated entity, was so severe that after less than three years RCAP declared bankruptcy, having lost nearly $1 billion in investors' money."
"As a result, stockholder value has been wiped out, and creditors owed more than $250 million stand to collect little beyond the proceeds of this litigation," the complaint alleges. "Meanwhile, the defendants have collected and continue to reap hundreds of millions of dollars in ongoing fees, all resulting from investments procured by RCAP. A large portion of those profits fairly belong to RCAP."
Starting in 2008, Mr. Schorsch and AR Capital raised billions of dollars from investors through a series of ARC-branded nontraded REITs. In pitching the product to investors, Mr. Schorsch typically stressed AR Capital's ability to produce liquidity and returns for investors in a product that had been roundly criticized for high fees and a lack of transparency.
Jesse Galloway, the general counsel for AR Capital, which is now called AR Global, did not immediately return a call on Friday morning to comment.
Mr. Schorsch controls more than 63% of AR Global, which manages more than $10 billion in assets. One of Mr. Schorsch's partners at AR Global, Mr. Block, is currently under indictment for conspiracy and securities fraud for actions when he was chief financial officer of a listed REIT Mr. Schorsch formerly controlled, American Realty Capital Properties Inc., or ARCP. Mr. Block's trial is scheduled to start June 12.
Mr. Schorsch is no longer involved in ARCP, which is now called Vereit Inc.
Mr. Schorsch and his partners typically held multiple positions at various AR Capital branded companies, including RCAP. For example, Mr. Block was a director and CFO of RCAP from February 2013 until July 2014. He was also CFO of ARCP during that period of time.
"Without RCAP to bring in the money, AR Capital would be nothing," according to the investor complaint. Because Mr. Schorsch and his partners "ran both companies, but had a far greater interest in AR Capital (which they wholly owned) than in RCAP (where they owned approximately 25% on a fully diluted basis), they had a built-in motivation to skew contract terms and transactions in favor of AR Capital."