Questions burn for shareholders after RCAP’s demise

Nicholas Schorsch and his partners a year and a half ago grossed nearly $100 million by selling shares of RCS Capital Corp., the soon-to-be defunct brokerage holding company he founded and that announced last Monday it would file a pre-arranged bankruptcy reorganization later this month.

Meanwhile, RCAP shareholders, including plenty of Cetera Financial Group advisers who bought $22 million in common shares of RCAP under a stock purchase program in 2014, have wound up with bupkis.

Cetera, a brokerage network of 9,500 financial advisers, is currently the largest asset remaining inside RCAP.work of 9,500 financial advisers, is currently the largest asset remaining inside RCAP.

(Related read: How Nicholas Schorsch lost his mojo)

BITTER FEELINGS

To be fair, Mr. Schorsch and his partners have also taken a severe financial hit with the collapse of RCAP. Their 30 million shares of common stock in the company have been wiped out. A year ago, those same shares would have been worth close to $330 million. And he recently put back $37 million of his own money to keep RCAP afloat, to no avail.

One Cetera adviser was left with a bitter taste last week after RCAP announced it had reached an agreement with a majority of its lenders to enter bankruptcy, which will eliminate the common and preferred equity of the company.

“If you’re asking me as a stockholder, I feel lied to, used and taken advantage of,” said the Cetera adviser, who bought RCAP shares under the stock warrant program. “I’m taking my life’s work and starting over again,” said the adviser, who asked not to be identified but said that he had invested a six-figure amount in RCAP shares.

How did this happen? How could a seemingly robust and vibrant company fall apart so quickly and wind up heading to bankruptcy?

RCAP insiders and associates of Mr. Schorsch would likely point to a series of events that lined up to cool the sale of nontraded real estate investment trusts. Most significant, they would argue, has been the Financial Industry Regulatory Authority Inc.’s new customer statement rule that will bring more transparency to the pricing of nontraded REITs. Also, the Department of Labor’s push to a fiduciary standard has been a blow. As it stands in its most recent proposal, that DOL rule would eliminate illiquid investments such as nontraded REITs from retail retirement accounts.

Realty Capital Securities, the wholesale brokerage inside RCAP that sold the REITs, also had a series of severe and embarrassing setbacks.

For example, in November the Massachusetts Securities Division charged Realty Capital with proxy fraud. Realty Capital settled the allegations weeks later for $3 million and said it was closing up shop.

Through a spokesman, Mr. Schorsch declined to comment for this column.

Let’s back up a few years, to 2012 and 2013, when Mr. Schorsch, at the time the executive chairman of RCAP and the CEO of AR Capital, was riding high. A handful of nontraded REITS he controlled and ran as CEO were merging and posting heady returns.

Investors were happy, and their financial advisers were ecstatic. After one Schorsch-controlled REIT merged or was acquired, financial advisers often rolled investor money from that REIT into the next line of Schorsch-sponsored deals, collecting fat commissions all along the way.

PUT INVESTORS FIRST

At the time, Mr. Schorsch routinely preached the necessity and importance of putting investors first when it came to nontraded REITs. In interviews, he insisted, stressed and emphasized that he and his partners would only get paid after investors who owned AR Capital REITs.

The history of RCAP, a brokerage holding company and not a REIT, shows the opposite. While plenty made money trading the stock, there were also plenty of losers. One investor, the hedge fund Luxor Capital, bought at least $250 million of RCAP preferred shares and convertible notes that are now at risk of being worthless. 

Mr. Schorsch and his partners, including William Kahane, sold some of their RCAP shares in 2014, during the peak of Mr. Schorsch’s blaze of celebrity.

Realty Capital Securities had just posted a record year in 2013 with $8.6 billion in sales of nontraded REITs, the bread and butter investment product that laid the foundation for Mr. Schorsch’s empire and personal wealth.

RCAP then went on a borrowing binge, facilitated by the same group of lenders who are slated to own Cetera after RCAP’s bankruptcy concludes. RCAP in April 2014 had just completed the acquisition of Cetera, spending $1.1 billion in mostly borrowed cash building out the network.

According to a filing with the Securities and Exchange Commission, Mr. Schorsch and his partners sold five million shares of class A common stock in a private offering in June 2014, grossing $95.2 million. (Without knowing their original investment, it is impossible to say what their profit was.)

At the time, RCAP shares were trading at about $20, and the company had a market capitalization close to $1.84 billion.

In the summer of 2014, RCAP was also selling shares to advisers. Some of those advisers thought it was a way to invest in themselves. Turns out, they were wrong.