(Bloomberg) -- With part of Nicholas Schorsch's real estate empire fracturing into warring factions, a chunk of his fortune may depend on whether RCS Capital can distance itself from the accounting missteps at American Realty Capital Properties.
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 ARCPs Oct. 29 disclosure -- more than the 29% drop in the company that actually had the mistakes. Schorschs 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, N.J.-based company compiles data on nontraded REITs. 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.
ARCPs 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 SEC, according to people with knowledge of the matter.
REIT SALES
It also is leading some brokers to halt sales tied to Schorschs AR Capital, a separate company thats the biggest sponsor in the $60 billion-plus industry of nontraded REITs, which are marketed to individual investors and depend heavily on the sponsors reputation. While ARCP is a landlord whose business is underpinned by more than 4,000 properties, RCSs 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 dont overlap. RCS reiterated that point on a
Schorsch, 53, hasnt been involved in discussions about the dropped deal to buy ARCPs Cole Capital unit or the litigation, said Andrew G. Backman, managing director of investor relations and public relations for New York-based RCS.
CORPORATE GOVERNANCE
From a corporate-governance perspective, its a nightmare because hes chairman of both litigants, said Thomas Lys, a professor at the Kellogg School of Management at Northwestern University in Evanston, Ill.
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 ARCPs CFO, didnt return multiple e-mails and phone calls. Andy Merrill, a spokesman for ARCP, didnt return e-mails seeking comment.
Backman said in an e-mailed statement that RCS Capitals 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, 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.
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 RCSs 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 ARCs 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.
AUDIT REVIEW
An outside law firm and forensic auditor reviewed RCSs 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, RCSs 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 ARCPs 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.
STOCK DECLINE
ARCP, in its lawsuit last week, said RCSs attempt to terminate the deal had everything to do with curbing the price decline in RCAPs 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 doesnt 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 companys external manager. The manager gets 10% of the pretax income from RCS, along with an incentive fee if certain return hurdles are met.
$600 MILLION
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 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 Blocks resignation from the RCS board.
COMPANY OVERLAP
Its hard to keep straight whos in what role at which company because theres so much overlap, said Barry Vinocur, the editor of REIT Wrap, an industry newsletter, said of ARCP and RCS. Theyre 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 CS totals 19.2 million shares, including his interest in RCAP Equity, according to Bloomberg Intelligence.
Theyve lost trust and it was a tenuous trust from the beginning because of the perceived conflicts and inter-company dealings, said Jeffrey Langbaum, Bloomberg Intelligences senior REIT analyst. The conflict is, because hes involved in all these companies, which shareholder bases interest is he operating on behalf of?
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