FBI To Probe Accounting Fraud At Multi-Billion REIT

While the Fed and the BOJ were by far the biggest news of the past week, explicitly admitting that the world simply can not exist without one central bank passing the monetization torch to someone else, a surprising, and scare for its shareholders, development took place when REIT American Realty Capital Properties, with a then-market cap of over $10 billion, announced, under the cover of the Fed ending QE3, that it had overstated its adjusted funds from operation, a cash flow key metric used by REITs, from the first- and second-quarters of 2014.As the WSJ reminds us, while the amount of money involved, some $23 million, was "relatively small", the irregularities resulted in the resignation of the company’s chief financial officer, Brian Block, and chief accounting officer, Lisa McAlister.The result: a crash in the stock that wiped out nearly 30% or nearly $4 billion in market cap.

A bigger question of course is why did a multi-billion dollar company feel compelled to lie about what on the surface is peanutes, and what other lies plague the company's cash flow and income statements, not to mention its balance sheets. That, and also because there is never just one lack of cashflow cockroach, one wonders which other REITs have been systematically overstating their financial health.

We may learn soon, because as Reuters reports the Federal Bureau of Investigation is conducting the investigation along with prosecutors from U.S. Attorney Preet Bharara's office in New York, the sources said. Further details of the probe could not be learned.

American Realty Capital Properties said on Wednesday it would have to restate earnings after it discovered employees "intentionally made" accounting mistakes that caused it to understate net losses during the first half of 2014. Its chief accounting officer and chief financial officer resigned on Tuesday.

Andy Merrill, a spokesman for American Realty Capital, had no immediate comment when contacted by Reuters.

A criminal probe raises the stakes for the company, which has seen its shares fall almost 30 percent since the disclosure of the accounting issues on Wednesday, wiping out around $4 billion of its market value. The U.S. Securities and Exchange Commission is also investigating the company, according to the Wall Street Journal.

And once the FBI is ready done with ARCP, there are a whole lot of other "successful" real estate companies that are probably comparably rife with fraud. Because what ARCP has done is precisely the same as all those other "successful" roll ups have engaged in over the past few years : American Realty Capital Properties, which went public in 2011, is one in a web of investment companies and brokerages that have been rapidly built up over the past seven years by real estate investor Nicholas Schorsch.

Schorsch served as the chief executive of the company until Oct. 1, when he was succeeded by President David Kay.

Since then, Schorsch has turned his focus to RCS Capital, an affiliated investment management firm that he founded in 2012 and where he serves as executive chairman.

Schorsch, who began building a portfolio of commercial real estate properties in the mid 1990s and is considered a pioneer in non-traded REITs, has been expanding RCS into a broad retail brokerage platform that would serve as a one-stop-shop for alternative investments. Its legion of brokers hit 9,700 just a little over a year after Schorsch began building it through a series of acquisitions.

On the same day that Schorsch stepped down as CEO, American Realty Capital Properties said it was selling its private fund management business Cole Capital to RCS Capital for $700 million.

Over the past year and a half, RCS has also bought a number of independent broker-dealers and investment advisors as well, including Cetera Financial Group, VSR Financial and J.P. Turner.

Some did raise red flags...

Schorsch's fast-paced deal making has recently drawn some criticism, however.

The hedge fund Marcato Capital Management, which at the time held 2.4 percent of American Realty Capital's outstanding shares, said in a letter in June that the company was improperly diluting its stock with new issuances and engaging in too many acquisitions in too short a time.

... which ironically is precisely the same that Bill Ackman-darling Valeant has been doing as well. One wonders when that particular house of cards will implode under its own (hollow) cash-free, non-GAAP weight? Whenever it doe, one can be sure that the FBI will be on the scene... just after the fraud is revealed for all to see.

But the biggest question is when precisely will the FBI conduct a criminal probe in an accounting scandal before it becomes public and before thousands of shareholders are wiped out? Of course, that would mean admitting that the whole premise of "earnings" and "cash flow" is as credible and realistic as the "fundamental" case for the S&P at just why of 2050, or 19x "earnings."

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