Activist investor Carl Icahn, one of the world's richest men, is suing CMBS special servicing firm Rialto Capital Advisors alleging that it delayed the sale of a distressed property, and in doing so, defrauded investors out of millions of dollars.

Icahn’s funds backed Prizm Outlets, a Nevada mall close to the California border. In 2017, the half-vacant mall was struggling to pay its $67M in CMBS debt, when Rialto came in as the special servicer. Icahn sued Rialto for allegedly dragging out the loan servicing process and conducting appraisals that deprived bondholders, such as Icahn, the chance to take control of the property, The Real Deal reports.

In April 2018, Rialto appraised Prizm Outlets for $25.5M — approximately $50M below its loan balance. That appraisal should have delivered control of the property to Class E bondholders, Icahn argued, but instead Rialto allegedly schemed to keep the mall in special servicing — for which it collected millions in fees — by inflating its value in subsequent appraisals.

Another appraisal a year later arrived at a value of $28.8M, but based its calculations on the assumption that the property was fully leased instead of its actual half-vacant status, the lawsuit alleges. A 10-year lease signed with an experiential retailer in 2019 was used to bump up the property's value, but the suit claims HeadzUp received $650K from Rialto to sign the lease and never actually paid rent.

Class E bondholders were finally given control of the property in March 2020, but by that point the property’s value, like that of all retail properties, had fallen drastically. Kohan Retail Investment Group, which buys distressed malls, purchased Prizm Outlets for $400K in spring 2021, TRD reported. CMBS bondholders lost everything they invested.

By the time of the sale, Rialto had incurred $12.85M between fees, expenses at the property and advances, the suit claims. Bondholders recognized a loss of $62.2M — all of the outstanding principal left on the loan, according to TRD.

CMBS servicers have come under scrutiny in recent years for similar practices as the allegations against Rialto.

In 2020, one mortgage adviser filed a lawsuit with the Securities and Exchange Commission alleging that 14 lenders and CMBS servicers inflated the net operating income of properties in their care. It allowed servicers to obtain higher loan amounts for the properties and retain control of them, extending the period during which they can collect fees on the property.

“Borrowers should thank Icahn, as this case will be quoted in many foreclosure cases and may even bring change to the industry,” Shlomo Chopp, an adviser on distressed real estate transactions, told TRD. “It brings to light issues that judges have dismissed for the past 10-plus years.”