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RCS Capital Running Out of Cash as It Shuts Wholesale Unit: Moody’s

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RCS Capital (RCAP) said early Wednesday that it is shuttering its troubled wholesale distribution unit, Realty Capital Securities, and has agreed to pay $3 million to the state of Massachusetts to settle charges tied to alleged fraudulent proxy-voting schemes.

This news follows a decision by Moody’s Investors Service on Tuesday to downgrade RCAP’s credit ratings on $750 million of debt. The downgrades reflect “RCS’ diminished ability to satisfy its debt load from its ongoing activities, and also the risk that it may not be able to attract a sufficient and timely amount of new investment that is necessary to fully protect creditors’ interests, as it seeks to recapitalize its balance sheet,” Moody’s explained in a statement.

With its stock trading around $0.50, the company is urgently trying to raise funds. Reports of about a possible sale of the Cetera Financial Group of broker-dealers emerged in October, several weeks after Apollo Global Management reneged on its plans to buy the wholesale business for $25 million and to form a joint venture with RCAP.

According to Mark Auerbach, RCAP’s non-executive chairman, the company’s latest moves are part of the firm’s “strategic plan to reposition the company as a pure-play, Cetera-only focused retail advice business.” (Cetera includes a number of broker-dealers and about 9,500 affiliated independent financial advisors.)

“These latest steps, which are extremely difficult but necessary, along with our recently announced capital raise, lender modifications and other initiatives, will enable us to further rationalize our business while we continue to work with Lazard to explore options to raise additional capital and complete further asset divestitures,” Auerbach explained in a statement.

RCAP expected to close the wholesale distribution business by March 31.

Moody’s, though, remains quite bearish on RCAP’s future.

RCS Capital “is now dependent upon the value of its independent retail advisory activities, since its investment banking and capital markets business has been further impaired by an affiliate’s recent announcement that it will cease activities in products for which RCS had earned significant advisory fees,” the credit-ratings firm says.

Cetera may be “a reasonably strong franchise, yet [it] has significantly underperformed compared to management’s expectations and is not producing sufficient cash flows to service RCS’ existing level of debt,” Moody’s explained in a statement.

The unit’s “underperformance,” it adds, “might adversely affect potential investors’ valuation of the franchise.”

Furthermore, the Department of Labor’s anticipated update of the fiduciary standard for retirement account advisors — along with low interest rates and regulatory compliance issues at RCS’ non-core operations — “could further adversely affect investors’ assessment of RCS’ value … [and] inhibit RCS’ ability to attract sufficient new investment to adequately transform its capital structure, or could prolong the decision-making process and result in RCS encountering liquidity issues,” according to a statement from Moody’s.

The credit-ratings group says that unsuccessful attempts to “timely raise significant new capital on terms that provide sufficient creditor protection” or more business weakness at Cetera could lead to further downgrades. However, RCS’ credit could be upgraded if it is able to “successfully complete its recapitalization in a manner that protects creditors’ interests and strengthens its ability to focus on improving its retail financial advisory business.”

RCS Capital has a total of $850 million in debt and $300 million in preferred equity. It bought Cetera for $1.15 billion in early 2014.

Regulatory Matters

In addition to agreeing to pay a $3 million fine, Realty Capital Securities says it is withdrawing its broker-dealer license in Massachusetts and all other state and federal jurisdictions.

Massachusetts’ regulators charged registered representatives of Realty Capital Securities — a broker-dealer that is part of RCAP — with impersonating shareholders and casting proxy votes in favor of management proposals at meetings of an investment program sponsored by American Realty Capital, a company owned by Nicholas Schorsch and William Kahane that manages nontraded real estate investment trusts or nontraded REITs.

Specifically, the regulators cite the case of 65 accounts for which votes were cast by broker-dealers’ agents who claimed to have the authority to cast these votes for investors in May; Realty Capital Securities, though, does not appear to have verified this authority. A similar arrangement was organized by BD agents in September 2015, when a vote was taken for the now-failed sale of Realty Capital, affiliated entities and assets to Apollo Global Management.

The case does not name the broker-dealers, and Galvin’s office declined to do so on Friday. The 33-page complaint, though, does give the names of several Realty Capital registered reps who pretended to be shareholders. It also names Realty Capital managers who pushed reps to produce proxy votes.

Despite being a wholesale broker-dealer and retaining a professional proxy services firm, Realty Capital conducted proxy solicitation services for all AR Capital-sponsored funds and received “significant compensation” for this work, according to the Nov. 12 case filed by the Massachusetts Securities Division.

In addition, the case brought against the company asserts that Realty Capital Securities made efforts “to obtain documentation from broker-dealer agents to facilitate voting of client shares.”

Realty Capital would ask broker-dealers to confirm their authority for proxy voting on behalf of clients. They would then talk with the agents about which shareholders had not voted and ask that either they be allowed to contact the investors or for the agents to contact the investors directly.

“Upon information and belief, RCS never verified if broker-dealer agents had authority to vote client shares,” the securities division explains.

Realty Capital received a letter from a BD agent who claimed to have authority to vote as a proxy for 65 client accounts, which all voted for Realty Capital management on all proposals.

Proxy firm data found that just 50 of the accounts had been asked to vote in May by phone. It also found that 15 accounts had voted online or by paper ballot.

A second letter was received by Realty Capital from a BD agent that asserted that the agent could vote for clients in the September vote concerning the sale to Apollo.

However, according to the 2015 Special Meeting Proxy Statement, BD agents “did not have discretion to vote client shares unless clients provided express instructions to the broker-dealer agent,” the suit explains. Again, such authority was not verified by Realty Capital.

These developments followed the debacle of October 2014, when American Realty Capital Properties (now VEREIT) reported $23 million of accounting errors. After that news broke, many broker-dealers stopped selling nontraded REITs and other products associated with American Realty Capital Properties, AR Capital and RCAP, ventures founded or led in the past by Schorsch.

— Check out RCS Capital’s Proxy Vote Scandal Ensnaring More Broker-Dealers on ThinkAdvisor.


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