Vanguard Funds Sue Vereit REIT for ‘Billions’

PHOENIX (CN) - Top executives who formerly worked for American Realty Capital Properties, now known as Vereit, cost investors billions of dollars in a multiyear accounting fraud, the Vanguard Funds claim in court.

The Vanguard Group and affiliated trusts and investment companies sued Vereit, Vereit Operating Partnership, AR Capital, ARC Properties Advisors, RCAP Holdings, RCS Capital Corporation, and five former company executives on Tuesday, in Federal Court.

Vereit, one of the largest real-estate investment trusts in the world, formerly operated as American Realty Capital Properties (ARCP) before changing its name to Vereit in July 2015.

According to the 147-page lawsuit, defendant Nicholas Schorsch, who launched ARCP in 2010, acquired real estate companies "on the premise that they would help grow ARCP."

Vanguard claims the true motivation for Schorsch's "buying spree" was to "rob from shareholders and to give to himself and his friends."

It claims that Schorsch transferred "hundreds of millions of dollars" to entities owned or controlled by him and other senior insiders.

ARCP purchased seven major real estate companies as part of the acquisition strategy, from February 2013 to July 2014, at an average of $3 billion, the plaintiffs claim. The largest and "most important" transaction was acquiring Arizona-based rival Cole Real Estate Investments for $11.2 billion, according to the lawsuit.

ARCP "ballooned" from a moderate-sized company with $132 million in assets in 2011 to a real estate "empire" with $21.3 billion in assets in 2014. ARCP assured investors that its internal controls "were effective" and financial statements "were accurate and could be trusted" during the growth period, the plaintiffs say.

Contrary to those promises, however, and "from the very beginning of its history as a public company," ARCP lacked an adequate system of controls over its financial reporting, according to the complaint. Vanguard says the company's financial statements were "riddled with errors," which masked its faltering performance and made it appear "exceptional."

ARCP specifically touted its "adjusted funds from operations," or AFFO, and reported a record-high AFFO of $147 million in the first quarter of 2014: 330 percent greater than reported for the same period in 2013, according to the complaint.

"ARCP's false financial reporting culminated with a miscalculation of its AFFO that incorporated adjustments to AFFO for interests that did not belong to ARCP at all," the complaint states. "This improper calculation allowed ARCP to inflate its AFFO materially, and gave the company access to additional capital to continue its acquisition spree."

Vereit predecessor ARCP "hid its fraud from investors until Oct. 29, 2014," when it "stunned the market" by disclosing an audit report which "determined that the company 'intentionally' misreported and [had] 'intentionally not corrected' certain AFFO calculations and that prior statements by the company 'should no longer be relied upon,'" according to the lawsuit.

The company, then known as ARCP, restated its prior financial statements for seven consecutive reporting periods, and fired its founder, top officers and most of its board of directors, the plaintiffs claim.

ARCP's stock price then "plummeted" by 36 percent, costing investors "billions of dollars."

Schorsch resigned on Dec. 15, 2014. Four co-defendants officers also stepped down between October and December 2014.

In October 2014, ARCP admitted that it falsified its operating performance. In March 2015, the company restated and filed amendments to its 2013 Annual Report on Form 10-K and its first and second quarter financial reports on Form 10-Q.

Vereit's audit committee and outside auditor said the company's previous financial reports "should no longer be relied upon" because they included "dozens of accounting tricks intended to inflate AFFO or to line executives' pockets, or both," the lawsuit states.

Vereit, via New York-based public relations agency Rubenstein, declined to comment on the lawsuit Wednesday.

Plaintiffs' counsel did not immediately respond to requests for comment.

The plaintiffs seek an injunction and punitive damages for violations of the Arizona Consumer Fraud Act, the Securities Act of 1933 and the Securities Exchange Act of 1934.

They are represented by Keith Beauchamp with Coppersmith Brockelman, of Phoenix, and Jonathan Sherman with Boies, Schiller & Flexner, of Washington, D.C.

The individual defendants, who are all former employees of ARCP, include ARCP founder and longtime CEO Schorsch; former ARCP president, from December 2013, David Kay; former ARCP CFO and executive vice president Brian Block; former ARCP Senior Vice President and Chief Accounting Officer Lisa Pavelka McAlister; and former COO and President Lisa Beeson.

No current employees of Vereit were named in the lawsuit.

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