Securities and Exchange Commission v. AR Capital, LLC

Background

The SEC sued AR Capital, LLC, Nicholas S. Schorsch, and Brian S. Block over alleged misconduct connected to mergers involving Vereit, Inc. and two other real estate investment trusts. According to the allegations summarized by the court, the defendants changed the method used to calculate incentive fees, causing AR Capital to receive approximately 2,922,445 more Vereit partnership units than it was entitled to. The SEC also alleged that related asset-purchase agreements caused Vereit to pay more than the transferred furniture, fixtures, and equipment were worth.

The defendants consented to final judgments without admitting or denying the allegations. The judgments required cash disgorgement, prejudgment interest, and civil penalties, and required AR Capital to return 2,922,445 Vereit partnership units. The units were returned and canceled. The cash payments and penalties were placed in a Fair Fund totaling $34,063,856, consisting of $12,313,856 in disgorgement and prejudgment interest and $21,750,000 in civil penalties.

Proposed Distribution Plan

The SEC proposed distributing the Fair Fund on a pro rata basis to investors who purchased or acquired Vereit common stock from February 28, 2013, the date the first merger closed, through October 28, 2014, and held the shares through the close of trading on October 28, 2014. The plan excludes specified parties, including the defendants and Vereit. It provides for claims review, notice, documentation requirements, a minimum preliminary payment of $10, and distribution payments based on each eligible claimant’s share of the total eligible shares.

Vereit objected to the portion of the Fair Fund consisting of disgorged funds. It argued that it was the true victim and should receive the money, including because it could trace the funds to money allegedly taken through the asset-purchase agreements. Vereit also challenged the eligibility dates and argued that the plan should account for differences in the amounts investors allegedly lost rather than distribute the funds pro rata.

Court’s Analysis

The court reviewed the plan to determine whether it was fair and reasonable. It rejected Vereit’s argument that the Supreme Court’s decision in United States v. Liu required the money to be paid to Vereit. The court concluded that Liu permits disgorgement as a remedy and does not require the SEC to distribute disgorged funds to a company rather than directly to investors, so long as the plan returns the funds to victims in a fair and reasonable manner.

The court concluded that Vereit’s shareholders were independent victims because the alleged misrepresentations were made directly to them and the defendants owed them an independent fiduciary duty. The court also rejected Vereit’s tracing argument, explaining that tracing could produce unfair results by giving priority to some claimants based on which funds happened to be used. The court noted that Vereit had already received value through the return and cancellation of the partnership units, while some investors—particularly investors who had sold their Vereit shares—would receive no reimbursement if the money went to Vereit.

The court also found the eligibility dates reasonable. It accepted the SEC’s explanation that February 28, 2013, marked the beginning of the period because investors who bought earlier could not bring a securities-fraud claim against Vereit, and that October 28, 2014, was a reasonable ending date because it followed the first announcement of fraud and a substantial stock-price decline. The court approved the pro rata method because the funds had been commingled and the investors were sufficiently similarly situated.

Disposition

The court overruled Vereit’s objections and granted the SEC’s motion to approve the plan. It approved the Distribution Plan in its entirety and ordered that the plan govern administration and distribution of the Fair Fund. The ruling did not alter the prior consent judgments against the defendants.