After a three-week trial, the former CFO of American Realty Capital Partners has been found guilting of “inflating” a key metric used to measure the performance of publicly traded REITs and will be sentenced in October.
Brian Block, 44, was convicted of securities fraud, making false filings and three related charges, which each carry a maximum prison term of 20 years. (He was also found guilty of a conspiracy charge, which has a top sentence of five years.)
At the time Block committed the fraud, ARCP’s chairman was Nicholas Schorsch, who also led AR Capital, the biggest nontraded REIT sponsor in the U.S. several years ago. Schorsch has since resigned from these and other posts. Some entities he was asociated with have gone into bankruptcy (such as the former parent firm of the Cetera Financial Group of broker-dealers, RCS Capital), closed or been reorganized.
“As a unanimous jury found today, Brian Block, the former CFO of ARCP, intentionally misled investors by overstating the health and profitability of his company. This trial revealed that when it looked like ARCP would not meet investors’ expectations, Block made up numbers and fudged the books,” said Joon H. Kim, acting U.S. attorney for the Southern District of New York, in a statement.
Block’s co-defendant, former Chief Accounting Officer Lisa McAlister, pleaded guilty to securities fraud and related charges a year ago.
“We were hoping for a different outcome,” Michael C. Miller, a lawyer for Block, said after the verdict, according to a Bloomberg report. “We still believe Brian Block is innocent. We will appeal.”
The publicly traded REIT industry generally shrugged off the scandal — which was first revealed in October 2014 — according to industry data compiled by the National Association of Real Estate Investment Trusts. In the first five months of this year, for instance, it has raised $40 billion in total capital — at or above the level of earlier years; plus, four IPOs have taken place year to date.
In 2014, ARCP — a publicly traded REIT — was set to file its financial statement for the second quarter, when an employee told Block and McAlister that there was a methodological error in some of the firm’s calculations and that its average funds from operations (or AFFO) were overstated by roughly $0.03 per share. However, the executives took no corrective action while the issue was under review, the U.S. Department of Justice says.
Moreover, the executives then “knowingly facilitated the use of the same materially misleading calculations in ARCP’s second quarter 10-Q” report, according to the DOJ.
“The integrity of our markets rests on the truth of the financial information provided to investors,” Kim said. “And those like Block who lie and manipulate the markets must be identified and held to account.”
Good News, Bad News
Despite the ARCP debacle, the equity REIT industry has remained stable over the past few years. In fact, the market capitalization of the FTSE All REIT Index has a total return of about 5.4% year to date and a price improvement of nearly 3.3% so far in 2017.
As of May 31, the FTSE NAREIT All Equity REITS had an equity market capitalization of $985 billion.
Non-traded REITS, however, have experienced a much tougher time. In addition to the impact on sales from regulations such as the Department of Labor’s new fiduciary standard, which went into effect June 9, and other industry shifts that have taken place in anticipation of DOL, there also is likely to have been some fallout from the RCS Capital’s bankruptcy announcement of Jan. 31, 2016.
At the time, RCS Capital—or RCAP—said it was “winding down” the troubled wholesale-distribution business of Realty Capital Securities, which included nontraded REIT sales via advisors and broker-dealers.
These developments occurred several months after RCAP board member Edward Michael Weil resigned; earlier, he had served as CEO of the firm, as well as president, treasurer, secretary and director. In addition, he had leadership roles at American Realty Capital Properties, or ARCP, and of nontraded REITs sponsored by AR Capital.
The entwined entities — founded by Schorsch — came under intense scrutiny after ARCP reported a $23 million in accounting errors in October 2014; next, a deal to sell some of RCS Capital’s assets fell apart when Apollo Global Management cancelled the transaction.