With part of Nicholas Schorsch’s real estate empire fracturing into warring factions, a chunk of his fortune may depend on whether RCS Capital Corp. can distance itself from the accounting missteps at American Realty Capital Properties Inc.
RCS, an owner of broker-dealers that sell Schorsch’s real estate investment products, called off the roughly $700 million acquisition of a unit of American Realty Capital Properties, or ARCP, after the seller reported intentionally concealed errors. ARCP sued last week, saying RCS improperly reneged. Schorsch, who holds about 29% of RCS, is chairman of both firms.
The dispute is pitting two companies against each other despite ties that include the same Manhattan address and a shared phone number. RCS is down 40% since ARCP’s Oct. 29 disclosure through yesterday — more than the 29% drop in the company that actually had the mistakes. Schorsch’s real estate empire is reliant on the money-raising capability of RCS, making protecting that business from fallout a priority, said Kevin Gannon, president of investment bank Robert A. Stanger & Co.
“RCS is more important to him,” said Gannon, whose Shrewsbury, New Jersey-based company compiles data on nontraded real estate investment trusts. “Its reputation and the ability to distribute American Realty Capital product is more important to the net worth of the group of guys than ARCP.”
ARCP’s chief financial officer and chief accounting officer resigned after a company probe found that an error made in first-quarter results was covered up in the second quarter. The move has sparked an FBI investigation and a review by the Securities and Exchange Commission, according to people with knowledge of the matter.
It also is leading some brokers to halt sales tied to Schorsch’s AR Capital LLC, a separate company that’s the biggest sponsor in the $60 billion-plus industry of nontraded REITs, which are marketed to individual investors and depend heavily on the sponsor’s reputation. While ARCP is a landlord whose business is underpinned by more than 4,000 properties, RCS’s revenue is partly tied to sales of the AR Capital REITs.
RCS has sought to make it clear that it is separate from ARCP, saying in a Nov. 5 statement that its management teams are distinct and their independent directors don’t overlap. RCS reiterated that point on a Nov. 13 earnings conference call, where Chief Executive Officer Michael Weil said the company was confident in the integrity of its accounting after a review by an independent accounting firm.
Schorsch, 53, hasn’t been involved in discussions about the dropped deal to buy ARCP’s Cole Capital unit or the litigation, said Andrew G. Backman, managing director of investor relations and public relations for New York-based RCS.
“From a corporate-governance perspective, it’s a nightmare because he’s chairman of both litigants,” said Thomas Lys, a professor at the Kellogg School of Management at Northwestern University in Evanston, Illinois.Schorsch and AR Capital co-founder William Kahane declined to comment for this story, said Tony DeFazio, a spokesman for AR Capital. Brian S. Block, who resigned as ARCP’s CFO, didn’t return multiple e-mails and phone calls. Andy Merrill, a spokesman for ARCP, didn’t return e-mails seeking comment.
Backman said in an e-mailed statement that “RCS Capital’s independent directors, which meet the independent director requirements of the New York Stock Exchange, approve related- party transactions and material transactions.” Point72 Stake
RCS shares, which were down as much as 46% since the ARCP news, have pared some of that loss. The company has attracted at least one big investor: Point72 Asset Management LP, the family office for billionaire Steven A. Cohen, disclosed this week that it increased its stake to 5.1%. Weil bought almost $250,000 of RCS stock this week, according to a regulatory filing.
RCS today rose 1% to $12.02 as of 10:06 a.m. New York time. ARCP gained 2.6% to $9.
ARCP and RCS have a history of ties. Schorsch, who controls RCS with 11 other directors and executive officers, founded ARCP and was its chief executive officer until stepping down last month as part of a planned succession.
Block, 42, served on RCS’s board until July and was its financial chief until December. He also resigned from his positions at AR Capital REITs to focus on his full-time job at ARCP. He was key to the creation of AR Capital where, as his company biography states, he was “instrumental in developing ARC’s infrastructure and positioning the organization for growth.”
“Block was the CFO and a key member of the management team across many of the ARC entities over the last several years,” said Gannon of Robert A. Stanger.
An outside law firm and forensic auditor reviewed RCS’s financials from the first nine months of the year when Block was CFO and confirmed its books were clean. Previous financial statements remain as reported, and no material weaknesses have been identified, RCS’s Backman said
RCS and ARCP are both located at 405 Park Ave. in midtown Manhattan. RCS corporate filings list its main offices on the 14th floor, while ARCP’s are on the 15th. The contact number listed on the ARCP website is the same as for the CFO and managing director of investor relations on the RCS website.
RCS sent a letter on Nov. 3 saying it called off the Cole deal because those firms “have not devised and maintained a system of internal accounting controls sufficient to provide reasonable assurances regarding the reliability of financial reporting and the preparation of financial statements for external purposes,” according to the lawsuit.
ARCP, in its lawsuit last week, said RCS’s attempt to terminate the deal “had everything to do with curbing the price decline in RCAP’s stock (in which Mr. Schorsch owns a significant interest), and not with the breach of any representation or warranty made by ARCP.”
Schorsch has a $223 million stake in RCS, both direct and indirect, compared with ARCP holdings of $162 million, according to a Nov. 14 Bloomberg Intelligence analysis.
RCS ended the Cole agreement in light of the ARCP accounting disclosures, Backman said in an e-mailed statement.
“RCS Capital moved swiftly and decisively to protect its franchise, the interests of its shareholders and the ongoing prospects and continuing enterprise value of the company and its subsidiaries,” he said.
Schorsch doesn’t only earn money through his share of RCS, which collects broker-dealer and investment banking fees from the nontraded REITs. He and Kahane are managing members of the company’s external manager. The manager gets 10% of the pretax income from RCS, along with an incentive fee if certain return hurdles are met.
Schorsch is also chairman and CEO of privately-held AR Capital, which has generated more than $600 million in fees since it began in 2007, according to an analysis by Robert A. Stanger.
Until the ARCP investigation is complete, there will be a “taint throughout the larger ARC organization,” said Paul Adornato, an analyst with BMO Capital Markets in New York.
ARCP has completed more than 20 acquisitions since its inception in late 2010, according to data compiled by Bloomberg. RCS, alongside major investment banks, worked on some of the deals. They included the $9.85 billion takeover of Cole Real Estate Investments Inc. and the purchase of a nontraded REIT started by AR Capital.
In July, ARCP announced corporate-governance changes that included the mutual termination of its investment-banking relationship with RCS and Block’s resignation from the RCS board.
“It’s hard to keep straight who’s in what role at which company because there’s so much overlap,” said Barry Vinocur, the editor of REIT Wrap, an industry newsletter, said of ARCP and RCS. “They’re interrelated in a variety of ways.”
While he left his positions at RCS, Block remained a minority investor and equity owner in AR Capital. RCS was on its own acquisition tear, with deals closed or pending for nine companies, primarily broker-dealers, for at least $1.3 billion in the past year.
Schorsch has a lot to lose if RCS shares continue to fall. His direct and indirect ownership interest in RCS totals 19.2 million shares, including his interest in RCAP Equity LLC, according to Bloomberg Intelligence.
“They’ve lost trust and it was a tenuous trust from the beginning because of the perceived conflicts and inter-company dealings,” said Jeffrey Langbaum, Bloomberg Intelligence’s senior REIT analyst. “The conflict is, because he’s involved in all these companies, which shareholder base’s interest is he operating on behalf of?”
–With assistance from Phil Milford in Wilmington, Delaware.
— Check out SEC, FINRA Come Knocking at RCS After ARCP Accounting Errors on ThinkAdvisor.