Nicholas Schorsch co-founded American Realty Capital.

The Securities and Exchange Commission has moved against the former CFO and the former CAO of American Realty Capital Properties (ARCP) for overstating the publicly traded REIT’s financial performance. At the same time, the U.S. Attorney’s Office for the Southern District of New York said Thursday that it is pressing criminal charges against the former executives.

According to the SEC, then-chief financial officer Brian S. Block and then-chief accounting officer Lisa P. McAlister “devised a scheme to manipulate the calculation of ARCP’s adjusted funds from operations (AFFO),” which is a non-GAAP measure for sharing earnings guidance.

American Realty Capital, co-founded by investor and real-estate mogul Nicholas Schorsch, was the partnership that set up the REITs and a separate distribution entity RCS Capital (now Aretec, which owns Cetera Financial Group). Schorsch is no longer involved in any of these businesses or entitities. 

Block, 44, was arrested on conspiracy, securities fraud and other charges Thursday morning at his home in Hatfield, Pennsylvania. The securities fraud, false filings charges, and false certification charges that he faces each carry a maximum prison term of 20 years, while the charge of conspiracy carries a maximum prison term of five years.

McAlister, 52, pleaded guilty on June 29 before a U.S. district judge to one count of conspiracy to commit securities fraud and other offenses, one count of securities fraud, one count of making false filings with the SEC, and one count of making false statements in a matter within the jurisdiction of the executive branch of the United States government. The Arlington, Massachusetts resident faces the same maximum possible prison terms as Block but has been cooperating with authorities.

“After warnings from internal accounting staff that an incorrect method was used to calculate AFFO in ARCP’s 2014 first quarter financial results, Block falsified the company’s AFFO presentation in the final hours before filing the company’s second quarter results. With McAlister in his office, Block plugged in fake numbers that concealed the first quarter overstatement of AFFO and made it appear that the company had met second-quarter estimates when, in fact, it had fallen short,” the SEC explained in a statement Thursday.

U.S. Attorney Preet Bharara and Federal Bureau of Investigaiton (FBI) Assistant Director-in-Charge William F. Sweeney Jr. said they have unsealed an indictment in Manhattan federal court that charges Block with fraudulently inflating a key metric used to evaluate REIT performance in its SEC filings. The case is assigned to U.S. District Judge J. Paul Oetken.

“Inflating the performance of publicly traded companies places investors at a disadvantage. Block overstated adjusted funds from operations by millions of dollars and underestimated the consequences he would face as a result,” Sweeney said in a statement. “Today’s charges outline the FBI’s continued determination to root out those who unlawfully interfere with the principles of supply and demand in free-market trading.”

AFFO was used by the two former executives to present ARCP’s income before consideration of non-cash depreciation and amortization expense and to the exclusion of certain one-time charges and expenses.

“We allege that these senior executives conjured up numbers to purposely conceal ARCP’s true performance, misleadingly suggesting that the company had met AFFO estimates for the first and second quarters of the year,” said Sanjay Wadhwa, senior associate director of the SEC’s New York Regional Office, in a statement.

ARCP is now known as VEREIT Inc.

According to the U.S. Attorney’s office in New York, prior to the filing of ARCP’s Form 10-Q for the second quarter of 2014, Block, McAlister and others “came to understand that the method used by ARCP to calculate AFFO in the first quarter of 2014 and in certain previous quarters was erroneously inflated.”

Another ARCP employee allegedly brought this methodological error to their attention, but no corrective change was made to the first quarter 10-Q while the issue was under review.

They overstated the amount by approximately $0.03 per share. Thus, instead of $0.26 per share, “which was publicly reported by ARCP to its shareholders and the investing public, and which placed ARCP on track to meet its full-year AFFO per-share guidance, the correct AFFO for the first quarter of 2014 was $0.23 per share,” authorities explained.

Furthermore, though he knew of the material error in ARCP’s previous filings, Block “took no steps to advise the Audit Committee of ARCP’s board of directors, or ARCP’s outside auditors, of the error in the first quarter 10-Q,” authorities allege. In addition, he, McAlister and another staff member “knowingly facilitated the use of the same materially misleading calculations in ARCP’s second quarter 10-Q.”

The alleged fraud resulted in an intended overstatement of AFFO by some $13 million and an intended overstatement of AFFO per share of about 5%.

Attorneys representing Block say the charges against him are “entirely unwarranted” and expect him to “be exonerated in court.”

“These charges appear to be based on very fuzzy, poorly-defined, non-Generally Accepted Accounting Principles, applicable only to the sophisticated world of real estate investment trusts. Not surprisingly, there is little precedent for the notion that criminal charges are appropriate when accountants make decisions involving these sorts of accounting principles. However unusual these criminal charges are, one thing is certain – Mr. Block did not commit any crime in connection with his work at ARCP,” said Reid Weingarten and Mike Miller, partners at Steptoe & Johnson, in a statement.

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