Securities Fraud in REITs: A Case Study of CTO Realty Growth and Governance Risks

The real estate investment trust (REIT) sector, long a staple for income-focused investors, has faced growing scrutiny over governance risks and securities fraud allegations. CTO Realty Growth, Inc. (NYSE: CTO) has become a focal point of this debate, with a June 2025 report by Wolfpack Research and an ongoing investigation by the Schall Law Firm exposing systemic issues in financial disclosures and dividend sustainability. This case study underscores how opaque governance and misleading metrics can erode investor trust and destabilize REIT valuations.

The Wolfpack Report: A Blueprint for REIT Fraud

Wolfpack Research's report, “CTO: The B. Riley of REITs,” accuses CTO of a multi-year scheme to mislead investors. Key allegations include:
1. Dividend Sustainability Fraud: CTO allegedly paid out $38 million more in dividends than its cash flow from operations since 2021. To bridge this gap, the company increased its share count by 70% since late 2022, diluting existing shareholders. With only $8.4 million in cash as of March 2025 and quarterly dividends of $14 million, the report warns of an impending liquidity crisis.
2. Manipulated AFFO Metrics: CTO's use of non-GAAP Adjusted Funds From Operations (AFFO) excludes recurring capital expenditures (CapEx), inflating cash flow figures. This metric, tied to 70% of management's performance-based compensation, creates a conflict of interest, incentivizing executives to overpay for properties and mask deteriorating operational performance.
3. Sham Loan Deception: A $79.8 million loan tied to the Ashford Lane property was allegedly kept on the books despite a tenant's bankruptcy in 2023. This accounting maneuver inflated the company's balance sheet and misled investors about its financial health for over 18 months.

The report's release triggered a 5.4% drop in CTO's stock price, erasing $1.2 billion in market value. This volatility highlights the fragility of REIT valuations when governance risks are exposed.

Legal Exposure and the Role of Shareholder Litigation

The Schall Law Firm's investigation into CTO underscores the legal risks facing REITs with weak governance. The firm is representing shareholders who purchased CTO stock between February 2021 and June 2025, alleging violations of §§10(b) and 20(a) of the Securities Exchange Act of 1934. Key legal implications include:
- Class-Action Lawsuits: Shareholders may seek compensation for losses tied to alleged misrepresentations. The Schall Law Firm's call for investors to submit transaction records by October 7, 2025, signals a potential wave of litigation.
- SEC Scrutiny: The report's whistleblower testimony and financial modeling could prompt regulatory action, particularly around non-GAAP metric transparency. A restatement of CTO's financial results would further erode investor confidence.
- Credit Downgrades: With a net debt/EBITDA ratio of 6.6x and $603.8 million in debt, CTO faces heightened credit risk. A downgrade could increase borrowing costs and exacerbate liquidity challenges.

Governance Risks and REIT Valuations

The CTO case illustrates how governance flaws can distort REIT valuations. REITs are inherently sensitive to dividend sustainability, as their appeal hinges on consistent income generation. When management manipulates metrics like AFFO or engages in aggressive dilution, the perceived value of the dividend becomes a “value trap”—a stock that appears cheap but is underpinned by deteriorating fundamentals.

For investors, the lesson is clear: due diligence must extend beyond traditional financial metrics. Key red flags include:
- Non-GAAP Metric Usage: REITs that exclude recurring CapEx from AFFO or other metrics may be inflating cash flow.
- Dilution Trends: A sudden spike in share count can signal a liquidity crisis masked by dividend payouts.
- Portfolio Quality: Aging properties with declining foot traffic and rising vacancies are early indicators of operational distress.

Strategic Implications for Investors

The CTO saga offers critical insights for REIT investors:
1. Avoid Overreliance on Dividend Yields: High yields can mask underlying cash flow weaknesses. Investors should scrutinize the source of dividends and assess whether they are supported by operational performance.
2. Demand Transparency: REITs that obscure CapEx, debt, or tenant risks should be approached with caution. Wolfpack's report highlights how opaque disclosures can lead to catastrophic losses.
3. Monitor Legal and Regulatory Risks: Share price volatility often follows legal investigations. Investors should track developments in shareholder lawsuits and regulatory inquiries.

Conclusion: A Cautionary Tale for REIT Investors

CTO Realty Growth's legal and governance challenges serve as a cautionary tale for the REIT sector. The allegations of securities fraud, dividend manipulation, and accounting misrepresentations underscore the importance of rigorous due diligence. While REITs remain a valuable asset class for income generation, investors must remain vigilant against governance risks that can erode value.

For CTO, the path forward is fraught with uncertainty. Shareholders face asymmetric risks: the potential for a dividend cut or ratings downgrade far outweighs the limited upside of a short-term rebound. Until the allegations are resolved and the company's financial practices are independently audited, CTO should be treated as a high-risk investment.

In an era where non-GAAP metrics and opaque disclosures are increasingly scrutinized, the CTO case reinforces the need for transparency and accountability in REIT governance. Investors who prioritize these principles will be better positioned to navigate the sector's inherent risks and capitalize on its long-term potential.