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.

RCS Capital then decided to shutter Realty Capital Securities and agreed to pay $3 million to the state of Massachusetts to settle charges tied to alleged fraudulent proxy-voting schemes in late 2015.

In addition, Massachusetts’ regulators charged registered representatives of Realty Capital Securities 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 Schorsch and William Kahane that manages nontraded REITs.

(After RCS Capital went public in June 2013, it went on a buying spree — gobbling up broker-dealers such as First Allied, The Legend Group, Investor’s Capital, Cetera Financial Group, Summit Financial, J.P. Turner and others. These BDs were spun off from the troubled entity in early 2016 under the leadership of Larry Roth, and now operate as part of Cetera Financial; they are now led by Robert Moore, a former executive of LPL Financial, which has made headlines over the years for compliance woes tied to nontraded REIT sales.) 

Nontraded REIT Developments

Still, the Blackstone Group started selling its first nontraded REIT several months ago, and the product had raised over $886 million as of May 31, according to Robert A. Stanger & Co. Broker-dealers selling the product include UBS, Morgan Stanley and Bank of America Merrill Lynch.

“Blackstone is coming into the market because it recognizes that self-directed retirement plans are growing rapidly,” said Keith Allaire, managing director of Robert A. Stanger, a real estate investment banking firm, in an interview.

“The long-term perspective is that institutional real estate managers see money migrating from corporate pension plans to the retail investor marketplace,” he said.

Still, at least one major player, W. P. Carey, has decided to leave the market.

“There is a temptation to conclude that W. P. Carey’s exit from offering new nontraded REIT products bodes poorly for the long-term prospects for nontraded real estate investment vehicles. But I believe W.P. Carey’s motivations had more to do with a desire to become a pure net lease REIT instead of a hybrid net lease–asset manager REIT,” Allaire explained.

“The simple fact is that individual investors should have a portion of their portfolios invested in nontraded real estate,” he added, “and that reality will ultimately drive the market to provide these investment products.”

In 2016, nontraded REIT fundraising — or sales — totaled about $4.5 billion, according to Stanger, which is down more than 50% from some $10 billion in 2015.

The first five months of 2017, though, saw fundraising of $4.5 billion as Blackstone rolled out its nontraded REIT, which has seen “dramatic success,” Allaire says.

A mixture of upfront commissions and rolling fees has attracted the attention of regulators, attorneys and investors. At the same time, though, multi-share class structures are now available in nontraded REITs, providing investors with more flexibility in terms of choosing how their advisor gets compensated.

“Besides a share class which pays all sales commissions up front, nontraded REIT investors can also select share classes with upfront sales commissions as low at 2.5% to 3% with a trailing shareholder servicing fee paid to the advisor, or share classes with no upfront sales commissions when held in wrap accounts,” he said.