As reported by The DI Wire, the planned roll-up of a number of non-traded REITs sponsored by AR Global, the successor business to AR Capital, has caused a stir in the industry since it was disclosed by two unnamed sources at the end of April. Since then, a number of insiders have spoken out about the controversial deal that would consolidate seven REITs with nearly $10.5 billion in assets under two companies, American Finance Trust and Global Net Lease (NYSE: GNL).
Dr. Robert Froehlich, an ex-independent director of two AR Global-sponsored non-traded REITs, resigned after calling foul and publicly disclosing conflicts of interests with the proposed transaction and with Nicholas Radesca serving the chief financial officer of two REITs engaged in the merger discussions. He also warned his replacement of “shoddy corporate governance procedures” and potential investor lawsuits. Last week, a federal lawsuit was filed on behalf of an American Realty Capital – Retail Centers of America shareholder to block the proxy vote and roll-up.
Most recently, investment banking firm Robert A. Stanger & Co. issued a special report titled “Clear and Present Danger” which blasts the roll-up and various proxies that could lead to the loss of shareholder protections and rights during the ongoing strategic review process. Stanger is urging the REIT boards to eliminate the proxies until the strategic direction of each REIT has been determined and disclosed to investors.
With Stanger’s permission, we have published the report in its entirety below.
Clear and Present Danger
Over this past Memorial Day weekend, we at Stanger spent some time reading Clear and Present Danger—no, not the Tom Clancy novel that was turned into a thrilling movie starring Harrison Ford. We were reading seven proxy statements issued by seven non-traded REITs sponsored by AR Global (formerly known as American Realty Capital, or ARC for short).
ARC has been under siege during the past two years for alleged accounting improprieties at American Realty Capital Properties (now known as VEREIT) and proxy fraud allegations at Realty Capital Securities, the now bankrupt managing broker dealer for ARC’s non-traded REIT programs. Regulatory investigations into these entities and their officers are reportedly on-going.
Now comes a series of proxy statements from the ARC sponsored REITs that would give pause even to Jack Ryan, Clancy’s courageous CIA protagonist. Although the proxies are not the work of Colombian drug cartels or extremists in the Irish Republic Army, they could be viewed as constituting a clear and present “danger” to investors in those REITs.
Why? Because through these proxies certain of the ARC-sponsored REITs would remove many important protections built into their respective charters at the very time when each of these REITs is reportedly reviewing strategic alternatives but has not yet informed investors of the strategic path which will be taken. The alternatives under consideration reportedly include a consolidation or roll-up transaction into entities which are externally advised by AR Global under a long-term (twenty-year) advisory agreement.
It has been reported that two separate transactions are under consideration by the ARC sponsored REITs. The first transaction (the “AFIN Roll-Up”) reportedly involves the consolidation of four REITs, none of which are publicly traded (ARC Healthcare III, ARC Retail Centers of America, Healthcare Trust and Realty Finance Trust) into American Finance Trust (“AFIN”), another ARC-sponsored non-traded REIT. The second transaction reportedly involves the consolidation of ARC Global Trust II, a non-traded REIT, into Global Net Lease, a publicly traded company (ticker symbol: GNL).
The aspect of these two consolidations which would keep Jack Ryan and the other analysts inside Langley Headquarters busy is that the two “consolidators” which would be the surviving entities in these roll-up transactions (AFIN and GNL) are each externally advised by AR Global under a twenty-year management contract, whereas all the other reported participants in these consolidation transactions have one -year management contracts with their AR Global affiliated advisor.
The potential “danger” here relates to two things. First, the nature of the charter provisions which are being altered, and second, the “two step” process apparently being choreographed wherein investors are first asked to make substantial charter changes which affect their rights and protections and later will be told of the transactions which would potentially be affected by those charter changes.
Reducing Investor Protections
Each of these non-traded REITs, when sold to the investing public through Realty Capital Securities as managing broker dealer, contained numerous provisions built into their charters and required by regulators that protected investors. However, the charter changes proposed in certain of the proxies would remove, limit or otherwise alter many of these protections. In particular, if approved, the charter changes would:
i) allow for the issuance of stock with disproportionate voting rights;
ii) expand those corporate actions which can be taken without shareholder consent;
iii) reduce shareholder information rights;
iv) potentially enable entrenchment of board members and limit changes to the composition of the board;
v) expand the types of investments (and therefore risks) that the REIT can expose investors to;
vi) reduce protections against the extension of the REITs existence;
vii) eliminate protections against advisory agreements with terms exceeding 60 days;
viii) reduce protections against changes to the advisory agreement that are adverse to the interest of the stockholders, including protections regarding a limit on fees paid to the advisor; and
ix) eliminate investor protections in roll-up transactions.
Although certain charter changes at times may be appropriate to prepare a non-traded REIT for a specific strategic transaction, such as listing on a national exchange, the changes investors in certain of these REITs are being asked to approve are more expansive than typically seen and are being sought without any strategic context for investors. Which brings us to…
The Two Step
Reducing or eliminating investor protections at any time is a cause for careful scrutiny and potential concern. But asking investors to abridge their own protections and rights at a time when there is an on-going review of strategic alternatives is virtually unprecedented based on our experience as investment bankers in the non-traded REIT industry.
Investors in these REITs have not yet been informed of the strategic direction of the company, the transaction which the company will pursue, or the explicit reasons why the charter changes proposed are in the investors’ best interests given the context of a specific strategic transaction which will be pursued.
What is particularly striking is the proposed elimination of investor protections in connection with the type of consolidation transactions reportedly being considered. These protections are required in the charters of all public, non-traded REITs by “roll-up rules” which have been variously issued by the Financial Industry Regulatory Authority (FINRA), the North American Securities Administrators Association (NASAA) and the state of California.
Among the protections afforded by these roll-up rules and which investors are being asked in certain of these proxies to eliminate are:
• The requirement that investors voting against the roll -up transaction be provided with the option to receive either cash equal to the investor’s pro rata share of the appraised value of the net assets of the REIT or a security substantially similar to the one they held prior to the roll-up;
• The requirement that the roll-up cannot result in a reduction in the democracy rights of the investors or otherwise limit the investors’ pre-rollup voting rights;
• The requirement that the roll-up not include any provisions which would impede the accumulation of shares of the roll-up entity by any purchaser (i.e. not prevent takeover attempts); and
• The requirement that the costs of a rejected roll-up transaction be borne by the sponsor and not by the REIT’s investors.
I suspect Jack Ryan would, upon reading these proxies, immediately call in Special Ops forces to interdict the mailing of the proxies and prevent the a-priori elimination of the charter provisions which provide investor protections in the very type of roll-up transaction reportedly being considered by these REITs but which have not yet been disclosed to investors as the strategic path the boards have chosen to take.
In Clancy’s book there are fallen soldiers as Ryan fights for the right. And, in real life, there has been at least one “casualty” as AR Global and its affiliates have been marching down this path – the recent and very public resignation of a board member who served on the boards of both Realty Finance Trust and Healthcare Trust. (Interestingly, these seven REITs have a combined total of 18 independent director positions which are presently filled by only 11 different individuals—a significant overlap of independent directors among these REITs which could raise questions regarding potential conflicts of interest in connection with a consolidation transaction among these REITs.)
And, a larger battle has been launched by the proxies as a class action lawsuit has recently been filed (which will lead to litigation expenses for certain REITs ultimately borne by investors).
We at Stanger would encourage the boards of these REITs to have the next casualty not be another one of their members, but rather be this two-step proxy process itself. Eliminate the clear and present “danger” by withdrawing the proxy until the strategic direction of each REIT has been determined and disclosed to investors. Then, ask investors to approve alteration of only those charter provisions which clearly inhibit the ability of the REIT to pursue the best interests of its investors.