RCS Capital (RCAP) doesn't want ARCP's troubles to weigh it down.

RCS Capital (RCAP) is doing nearly all it can to distance itself from Nicholas Schorsch and American Realty Capital Properties (ARCP), which revealed accounting errors last week totalling some $23 million.

That news prompted RCAP to call off a deal to buy part of Cole Capital from ARCP on Monday, and over the past few days, a number of independent broker-dealers, including LPL Financial (LPLA), said they are stopping sales of REITs tied to ARCP.

On Wednesday, Cetera Financial Group — part of RCS Capital, of which Schorsch is chairman — joined these rival IBDs and asked its affiliated advisors to suspend sales of three Cole nontraded REITs, according to a memo obtained by ThinkAdvisor

A statement released by RCAP late Wednesday explained, “Cetera Financial Group and RCS Capital are separate and distinct companies from American Realty Capital Properties and AR Capital LLC. Consistent with Cetera Financial Group’s longstanding processes, we conduct ongoing due diligence of all open nontraded REITs. Beyond this, and as a matter of policy, we do not publicly comment on specific products and product companies.”

This tone reflects that of a press release issued by RCS Capital earlier in the day, in which it said it and ARCP “are two separate and independent public corporations.” 

Still, Schorsch, who is board chairman for ARCP, remains executive chairman of RCAP. He co-founded ARCP in 2007 with Bill Kahane, who currently is an RCAP director. In addition, RCAP Chief Investment Officer Peter Budko is a former CIO of ARCP, and RCAP CFO Brian Jones acted as chief operating officer of ARCP for most of 2013.

“The fact that RCAP and ARCP are distinct corporate entities with separate boards and the like is technically true, but the scandal has tarnished the entire Schorsch brand. In other words, although these are two separate corporate entities, their brands are linked in terms of their public image,” said executive-search consultant Mark Elzweig, in an interview.

“This is unfortunate,”  Elzweig said, “considering that ARCP had built up a very strong brand and strong relationships with advisors who valued what the company brought to the nontraded REIT niche.”

The accounting errors revealed last week overstated adjusted funds from operations — a measure of REIT cash flow — and understated a net loss for both the first quarter and first half of the year. American Realty says it will reduce its adjusted FFO by $12 million for the first quarter and $10.9 million for the three months ended in June.

“That’s why four [unaffiliated] independent broker-dealer groups have stopped sales of some Schorsch products, and they are not going to resume the relationship [with ARCP] until they’re satisfied this is a one-off issue,” added Elzweig.  “Once the outside IBDs are satisfied that there are no more issues with other products, they should resume their relationships with ARCP.”

In addition to LPL Financial, the unaffiliated IBD groups that have suspended ARCP-related REITs include the AIG-owned Advisor Group, Ladenburg Thalmann (LTS)-owned Securities America and National Planning Holdings.

Meanwhile, RCAP management is hoping it can maintain friendly ties with the BD community. “The independent broker-dealer community remains supportive of RCAP,” the company said in a statement. “RCAP is providing the broker-dealer/custodian network the information [it is] requesting in order to maintain our distribution relationships. We believe those broker-dealers that have temporarily suspended sales are likely to reinstate the selling agreements.”

As corporations mature and their businesses become more complex, such messy entanglements can happen, analysts say.   

“Clearly there are a number of public and private entities that have been founded by Nicholas Schorsch and his partners,” explained Paul E. Adornato, a managing director of equity research-real estate, BMO Capital Markets, in an interview. “As each entity grows and evolves, it takes on a life of its own and pursues its own path. In some cases, the paths can cross again, as there are mergers between firms founded by Schorsch, for instance, or they may take completely different paths, with some being sold to third parties.” 

Ties at the executive level seem to be fairly extensive. 

According to RCS Capital’s website:

— Schorsch also holds CEO and board positions for all of the publicly registered, nontraded investments sponsored by AR Capital;

— Kahane has held and currently holds board positions for many of the publicly registered, nontraded companies currently sponsored by AR Capital;

— RCS Capital CEO Michael Weil serves as president and chief operating officer for a number of the publicly registered, nontraded REIT offerings sponsored by AR Capital;

— Peter M. Budko, chief investment officer and a director of RCS Capital, serves as executive vice president and chief investment officer of AR Capital and a number of the publicly registered, nontraded direct investment AR Capital sponsors; and

— Louisa Quarto, president of Realty Capital Securities, also is a senior vice president of AR Capital.

Regulatory Scrutiny

Sales of nontraded REITs in particular have drawn lots of attention from regulators in the past few years.

The Financial Industry Regulatory Authority fined LPL nearly $1 million earlier this year for “supervisory deficiencies related to the sales of alternative investment products, including nontraded real estate investment trusts.”

In early 2013, Massachusetts regulators ordered LPL to pay up to $2 million to investors who had bought shares of nontraded REITs and to pay a $500,000 administrative fine.

The case, announced in in December 2012, stemmed from about 600 transactions of nontraded REITs that took place between 2006 and 2009 and that were valued at about $28 million. These transactions included 36 trades worth about $2.1 million that were made in violation of prospectus rules and asset-concentration limitations.

Authorities said they had received complaints from multiple investors — including at least one who was 70 years old at the time — who had bought shares of Cole Credit Property Trust II, III and 1031 Exchange, along with a number of products from other REIT firms.

In May 2013, Massachusetts settled with five other IBDs to the tune of about $6 million in restitution and $975,000 in fines.

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