Schorsch’s ARCP Plunges After Execs Replaced Over Accounting Errors

October 29, 2014 at 10:03 AM
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Shares in American Realty Capital Properties Inc., the biggest U.S. owner of single-tenant properties, plunged as much as 37% after the company said it had replaced two executives following errors in its financial statements.

Brian Block left as chief financial officer and has been replaced by Michael Sodo, while Gavin Brandon was named chief accounting officer in place of Lisa McAlister, the New York- based real estate investment trust said in a statement today. The company said that some amounts related to non-controlling interests likely were incorrectly included in adjusted funds from operations, an error the audit committee believes was identified but intentionally not corrected.

"The question is who knew what and when did they know it," Paul Adornato, an analyst with BMO Capital Markets in New York who cut his rating on the shares, said in a phone interview. "Until those questions are resolved, it will be difficult to recommend the stock."

American Realty shares slid 30% to $8.68 at 12:30 p.m. New York time. They had lost 3.7% this year before today, compared with a 20% gain in the Bloomberg REIT index. The company was the 16th-largest U.S. REIT by market value as of yesterday, according to data compiled by Bloomberg. (Shares were down about 19% at market close. –Thinkadvisor ed.)

Acquisition Spree

American Realty is the biggest owner of single-tenant properties such as pharmacies and restaurants, growing through an acquisition spree since it began trading three years ago. Founder Nicholas Schorsch, 53, stepped down as chief executive officer at the end of last month under a plan announced in June. He remains chairman.

The accounting errors resulted in an overstatement of adjusted funds from operations — a measure of REIT cash flow — and understated the company's net loss for the first quarter and first half of the year. American Realty will reduce its adjusted FFO by $12 million for the first quarter and $10.9 million for the three months ended in June, according to the statement.

The audit committee believes other financial statement errors were intentionally made, American Realty said. The investigation has expanded to include all audited 2013 numbers since Block and McAlister had "key roles in the preparation of those financial statements," the company said. The audit committee said nothing has come to its attention that leads it to believe there are errors in those statements.

Block had been chief financial officer of American Realty since its inception in December 2010, according to company regulatory filings.

Taking Actions

"The accounting issues are unacceptable and we are taking the personnel and other actions necessary to ensure that this does not happen again," CEO David S. Kay said in the statement.

American Realty has pared its acquisition activity since June, when it said Kay would become CEO. Activist investor Marcato Capital Management LP that month asked the REIT to curb its deal making, and complained that a $1.66 billion stock sale in May hurt existing shareholders.

"The fact that they have grown so quickly and the numbers are in question may not be unrelated," said Adornato, who cut his rating on the stock to market perform from outperform. "That is the conclusion many investors will draw from today's announcement."

Andy Merrill, a spokesman for American Realty, declined to comment beyond today's statement.

The company, whose purchases this year include about 500 Red Lobster locations, said it doesn't expect the accounting errors to affect the sale of its Cole Capital private-capital management unit to RCS Capital Corp., set to be completed next week.

Legal Battle

American Realty's disclosure that accounting problems were known but not addressed "suggests the likelihood of an ugly legal battle," Chris Lucas and Vineet Khanna, analysts at Capital One Securities Inc., said in a note to clients.

"The fact that the company issued $1.6B in equity in a period under review further complicates the investigation and increases the stakes for parties involved, which in our view makes the full and complete investigation likely to be incredibly thorough, take a long time, and be very expensive," they wrote.

Sodo, who will report directly to Kay and the audit committee, joined American Realty almost three months ago as director of financial reporting and treasury. He came to the REIT from Capital Automotive, where Kay had also worked.

Brandon had been senior vice president of accounting, overseeing acquisition accounting and property on-boarding, lease accounting, accounts payable, accounts receivable and process treasury services.

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