Securities Litigation and REITs: Navigating Risk in a Shifting Legal Landscape

The recent class-action lawsuit against CTO Realty Growth, Inc. (NYSE: CTO) has reignited scrutiny over the interplay between securities litigation and real estate investment trust (REIT) performance. As investors grapple with the fallout from allegations of financial misrepresentation, the case underscores a broader trend: litigation is no longer a peripheral risk but a central factor in REIT valuation and strategy. For investors, understanding this dynamic is critical to mitigating exposure and capitalizing on opportunities in a market increasingly shaped by legal and governance challenges.

The CTO Case: A Microcosm of Systemic Risks

The lawsuit, O'Connor, Jr. v. CTO Realty Growth, Inc., alleges that the company manipulated key financial metrics—such as Adjusted Funds from Operations (AFFO)—to mask a $38 million dividend shortfall and conceal the collapse of a major tenant at its Ashford Lane property. These practices, exposed by a June 2025 report from Wolfpack Research, triggered a 5.42% drop in CTO's stock price, closing at $17.10 per share. The case highlights how opaque accounting practices and aggressive dividend strategies can erode investor trust, particularly in REITs, which rely heavily on consistent cash flows and transparent governance.

The CTO saga is emblematic of a growing pattern. According to data from Nareit's 2025 Law, Accounting & Finance Conference, core securities class actions (SCAs) increased by 14% in 2024 compared to historical averages. Christian Hartman of Arch Insurance noted that the average market capitalization loss during class periods has expanded, signaling that litigation risks are not only more frequent but also more financially damaging. For REITs, which often operate on thin margins and rely on debt financing, such volatility can exacerbate liquidity crises and force costly restructuring.

Legal Shifts and Their Market Implications

The U.S. Supreme Court's 2018 Cyan Inc. v. Beaver County Employees Retirement Fund ruling has further amplified these risks. By allowing securities class actions to be filed in state courts—where plaintiffs often have an advantage—Cyan has led to a surge in litigation and higher directors' and officers' (D&O) insurance premiums. For example, a REIT with a $100 million+ D&O policy saw its annual premium jump from $340,000 to $500,000 post-Cyan, with deductibles rising from $1.5 million to $2.5 million. These costs are ultimately borne by shareholders, compounding the financial toll of litigation.

Moreover, litigation can trigger a cascade of secondary effects. A study of Chinese A-share companies found that corporate lawsuits increase the likelihood of controlling shareholders exiting, driven by heightened uncertainty, stock price volatility, and financing costs. For REITs, which are capital-intensive and sensitive to market sentiment, such exits can destabilize operations and reduce long-term value.

Risk Assessment: What Investors Should Watch

For investors, the CTO case and broader trends highlight three key risk factors:
1. Transparency in Financial Reporting: REITs that manipulate metrics like AFFO or use non-standard accounting practices are more vulnerable to litigation. Investors should scrutinize footnotes in 10-K filings and assess whether a REIT's definitions align with industry norms.
2. Governance Structure: Weak board oversight and lack of independent directors increase the risk of misconduct. REITs with robust governance frameworks—such as audit committees with financial expertise—are better positioned to avoid legal pitfalls.
3. Dilution Practices: Aggressive share issuance to cover dividend shortfalls, as alleged in the CTO case, can erode shareholder value. Investors should monitor a REIT's capital structure and evaluate whether dilution is justified by growth or merely a stopgap measure.

Strategic Adjustments for a Litigation-Prone Era

Given these risks, investors must adapt their strategies:
- Diversification: Avoid overexposure to REITs in sectors with high litigation risk, such as commercial real estate or those reliant on non-traditional financing.
- Due Diligence: Engage third-party research firms to audit a REIT's financial health, particularly if it faces short-seller scrutiny. Wolfpack Research's report on CTO, for instance, leveraged whistleblower insights to uncover systemic issues.
- Litigation Monitoring: Track legal developments using tools like the SEC's EDGAR database or litigation risk scores from platforms like S&P Global. Early detection of lawsuits can allow investors to exit positions before market corrections.

The Road Ahead for CTO and REITs

While the CTO lawsuit remains unresolved, its outcome could set a precedent for how courts handle REIT-specific litigation. If the court rules in favor of plaintiffs, it may pressure REITs to adopt stricter disclosure standards and governance reforms. Conversely, a dismissal could embolden companies to prioritize short-term gains over transparency.

For investors, the lesson is clear: litigation is no longer an abstract risk but a tangible threat to returns. By integrating legal and governance analysis into their due diligence, investors can better navigate the uncertainties of the REIT sector and position themselves to capitalize on opportunities in a post-litigation landscape.

In an era where legal scrutiny is intensifying, the most resilient REITs will be those that prioritize transparency, accountability, and long-term value creation. For investors, the challenge lies in distinguishing these leaders from the rest—and acting decisively when red flags emerge.