(Bloomberg) -- Behind the accounting errors that knocked $4 billion off American Realty Capital Properties market value was a hidden scheme that generated more than $900 million in managers fees and bonuses, investors said in a lawsuit against the company.
Ex-Chairman Nicholas Schorsch turned a small real estate investment trust into a massive engine of payments for himself and cronies, adding $20 billion of assets in two years and charging for services rendered by 47 entities he controlled, according to court documents filed this week.
As American Realty Capital Properties, or ARCP, grew, Schorsch was in line for $94 million in incentives over five years, on top of $28 million in potential 2014 compensation.
In their class action, begun in January, teachers pension funds that lost money on American Realty shares accused managers of manipulating cash flow data to inflate the stock for takeovers. Those deals were designed to generate fees for the executives and didnt deliver the promised benefits to the REIT or its shareholders, the funds said.
This complex and opaque web of interrelated companies is permeated with conflicts of interest and was used to transfer hundreds of millions of dollars to Schorsch-controlled entities in connection with the acquisitions, they said, pointing to $55 million in fees from two big deals alone.
Schorsch didnt return messages seeking comment on the allegations. John Bacon, an American Realty spokesman, declined to comment.
$917 MILLION
The updated complaint, filed April 17 in Manhattan federal court, adds details on American Realtys deals with other Schorsch entities, tracing the movement of $917 million in fees to insiders and their affiliates.
ARCP was charged $510 million in deal-related commissions and fees, $63 million for advice, and assorted sums for public relations work, services relating to office supplies and furniture, much of which had no record of being received, according to the complaint.
The chairmans acquisitions quickly made American Realty, started in December 2010, the biggest U.S. owner of single-tenant buildings such as drugstores, banks and Red Lobster restaurants.
The U.S. Justice Department, SEC and state investigators in Massachusetts are probing American Realtys accounting errors and coverups, the Phoenix-based company said in a March regulatory filing.
OCTOBER REPORT
American Realty said in October that it inflated cash flow and wrote down assets by $406 million in the fourth quarter, mostly tied to an earlier takeover. A deal to sell its Cole Capital units broker-dealer to a Schorsch firm fell apart after American Realty disclosed the concealed accounting errors, sticking it with a $309 million writedown.
After the October report, ARCPs top five executives and most directors resigned or were fired.
Schorsch has resigned and ARCP says its putting its house in order, ending deals with the web of companies he controlled. It said in March that some payments to Schorsch entities warrant scrutiny and the compensation committee should only have approved $120 million of a $222 million incentive plan, keyed to the companys growth.
The investors say there was a multi-year long accounting fraud that ultimately required ARCP to admit that it had falsified its reported operating performance and/or financial statements for every reporting period since it went public in 2011.
'ACCOUNTING TRICKS'
Their scheme had been breathtaking in both its breadth and magnitude -- a collage of accounting tricks designed to inflate cash flow and line senior insiders pocketbooks, investors said.
Recurring expenses were classified as one-time costs, while executives delayed reporting many expenses, used so-called goodwill from acquisitions as a slush fund to absorb losses on property sales and devised unusual metrics to swell their bonuses by $100 million, the investors said in their complaint, citing a report by ARCPs accountants.
The fraudulent accounting was necessary to oil the fee engine, investors said: American Realty was borrowing money for acquisitions so it had to show good numbers, and it was using cash and stock for the acquisitions so the stock had to be propped up by rigging the numbers.
'OVERVALUED' SECURITIES
In the investors words, the deals were predicated on the use of ARCP securities that were overvalued as a result of defendants misconduct.
Complaining of misleading registration statements, investors are also suing underwriters of bonds and stock, including Morgan Stanley. Mary Claire Delaney, a Morgan Stanley spokeswoman, declined to comment.
American Realty has dropped to less than $10 from its 2014 peak of almost $15. Led by TIAA-CREF, the investors want compensation and damages.
Darren Robbins, the lawyer handling the lawsuit, has experience with accounting maneuvers. He wrested $7.3 billion for Enron investors, mostly from banks that settled allegations of engineering sham transactions to keep debt off Enrons balance sheet.
The case is In re American Realty Capital Properties Inc. Litigation, 15-mc-00040, U.S. District Court, Southern District of New York (Manhattan).
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