Allegations of shirking fiduciary duties in exchange for self-gain have swirled around real estate mogul Barry Portnoy for years, but only now have the alleged fiduciary crimes against Portnoy and his son been thrust into the spotlight.
Portnoy and his son, Adam, are in the midst of a legal tug-of-war with activist shareholders of the Newton-based CommonWealth REIT that want to oust the father-son team from running the real estate investment trust’s day to day operations. The Portnoys’ Reit Management and Research (RMR) firm conducts CommonWealth’s day to day operations according to fee-based management contracts with CommonWealth.
The two were allowed to go through with a 34.5 million-share equity offering last week that closed for $627 million, about $19 per share, despite objections from major shareholders that the investors were cherry-picked by underwriters as friendly investors that would help prevent change in the company and keep the Portnoys and other trustees in power. Plus there’s the fact that major current shareholders say they offered $27 per share for the stocks prior to the sale. Officials from CommonWealth did not return calls seeking comment.
That led the Delaware County Employees Retirement Fund, along with Keith Meister’s Related Cos., to file separate suits to stop the sale. But a federal judge in Boston denied their pleas.
The sale of the shares put about 30 percent of the overall equity of CommonWealth in the hands of investors loyal to the Portnoys, essentially preventing change in the company in perpetuity since stockholder action requires a two-thirds vote, said Nicholas Chimicles, a lawyer for the Delaware fund.
So now those activist investors are right back where they started, with the firm still solidly controlled by the Portnoys. And if the accusations of investor cherry-picking are correct, by all appearances, the father and son will be able to run the firm however they see fit.
That includes spinning off properties owned by CommonWealth to REITs controlled by the Portnoys and reaping the management fees for themselves, according to court filings from the activist shareholders. In the first quarter of 2012, the Portnoys allegedly sold off 251 of CommonWealth’s office and industrial properties to Select Income REIT (SIR). Many of those properties were occupied by a single tenant, far easier to manage than a property with, say, 15 tenants. The properties were also mostly free of debt, and when those assets were removed from CommonWealth’s portfolio, the total portfolio jumped to about 60 percent leveraged, said Kimberly Smith, a lawyer with the Delaware team.
‘What Are You Going To Do To Your Cash Flow?’
That SIR portfolio was generating about 58 percent of all of CommonWealth’s cash available for distribution, according to the plaintiffs’ calculation.
“What are you going to do to your cash flow when you remove all those properties? You’re going to hurt it,” Smith told Banker & Tradesman.
Then, in 2009, the Portnoys spun off 29 government-leased office properties to an entity called Government Properties Income Trust. Created in 2009, the trust has no employees, is overseen by a board of trustees, and its day to day operations are run by RMR – just like CommonWealth and the many other sister companies the Portnoys have established. The Portnoys have since raised capital and assigned more debt to those 29 properties, with which they can buy even more properties and earn even more management fees.
According to calculations from plaintiffs Corvex and Related, which own 9.8 percent of CommonWealth, over the last three years, CommonWealth has paid out $209 million in management fees to RMR, while CommonWealth’s market cap has declined by $647 million. RMR and the board of trustees collectively own just 630,000 shares of CommonWealth, 0.8 percent of the company, and so have little incentive to help CommonWealth succeed, Related alleges.
After all those spinoffs, it was no surprise to analysts when, in August, the company announced it could not pay the expected 10 percent dividend yield, and in September cut the dividend in half. When the firm started pushing the 34.5 million-share equity offering earlier this year, analysts from Stifel, Nicolaus & Co. tacked a “sell” recommendation onto the company’s shares.
“You have to be getting a very significant discount … on the price you’re willing to [buy CommonWealth] stock because of management’s tendency to destroy value,” said one analyst with the company that was not authorized to speak on the record.
Not to be excluded is the allegation that the Portnoys are shorting CommonWealth on the sales prices for the properties they are purchasing from the REIT for their own entities.
To do this the Portnoys form a new REIT, and CommonWealth sells properties to the new entity in exchange for ownership in the new REIT. However, the plaintiffs are also alleging the Portnoys are not paying fair market value for the properties they’re exchanging, said Thomas Shapiro, an attorney with Shapiro Haber & Urmy.
“We are asking for greater corporate governance to make sure this doesn’t happen again,” Smith told Banker & Tradesman. “We want to stop [the Portnoys] from spinning off other properties, and put in place independent trustees for the company. This has been self-dealing run amok.”
This Has Happened Before
As was mentioned earlier in this article, this is not the first time allegations of fiduciary breaches and fraudulent activity have been heaved at Barry Portnoy. In 2008, a Delaware court dismissed a case brought against Portnoy by a shareholder of TravelCenters of America (TA), a publicly traded Delaware LLC that operates truck stops. Portnoy was a director of that company as well.
Plaintiff Alan Kahn filed a derivative suit on behalf of TA that alleged TA’s directors breached their fiduciary duties – sound familiar? – by approving the “Petro Lease Transaction.” That deal allowed TA to purchase Petro Stopping Centers LP, another truck stop operator, and TA leased its facilities from defendant Hospitality Properties Trust (HPT) – one of Portnoy’s many spinoff companies. The plaintiff alleged that the deal benefitted Portnoy’s RMR management firm, which managed TA and HPT, at TA’s expense because the transaction required TA to pay above-market rent for the space.
In this case, Portnoy, a TA director, was not a shareholder of TA, but was a director of HPT, and a key shareholder in RMR. According to a white paper on the case by Odia Kagan, an attorney with Pepper Hamilton LLP in Philadelphia, Penn., many of the directors that participated in the decision to execute the deal were allegedly beholden to Portnoy, due to positions they held in RMR and other entities in which Portnoy was involved.
However, the case was dismissed because of ambiguities in the LLC agreement that defined the scope of a TA director’s fiduciary duties.
Email: jcronin@thewarrengroup.com
