In August, B. Riley Financial Inc., which provides services from investment banking to wealth management, said it invested $216.5 million as part of the $2.8 billion management-led acquisition of Franchise Group Inc.
Now the CEO of the Franchise Group, Brian Kahn, is under scrutiny, following a report that Kahn has links to a hedge fund manager who pleaded guilty to fraud.
And some B. Riley brokers and financial advisors face uncomfortable conversations with clients. Many of those advisers were acquired as part of B. Riley’s purchase last year of National Securities Corp. and collected money for part of the financing of the redemption.
“About $30 million to $40 million raised for the Franchise Group was from retail brokers,” said one industry source, who asked not to be identified. “The brokers are beside themselves, especially the independent brokers, the national securities.”
Other institutional, financial and strategic investors invested approximately $280 million of additional equity capital in the new Franchise Group along with significant takeover equity contributions from the company’s management, according to an August B. Riley press release. The management-led consortium acquired all outstanding and issued common and preferred stock of Franchise Group, which controls franchise businesses such as Pet Supplies Plus, Wag N’ Wash and The Vitamin Shoppe.
B. Riley said on Nov. 8 that it was forced to write down the value of its stock portfolio, resulting in a net loss of $75.8 million in the third quarter, compared with a profit of $45.8 million a year earlier, according to Reuters report. . The following day, S&P Global Ratings downgraded Franchise Group’s credit rating to “B-” from “B” with a negative outlook, after the company reported a decline in revenue and a net loss in the third quarter.
“Our investigation is first focused on B. Riley,” said Reed Kathrein, a plaintiff’s attorney and partner at Hagens Berman Sobol Shapiro. “The issue is whether B. Riley knew what Kahn was doing.”
Spokesmen for B. Riley and Franchise Group did not return calls Thursday for comment.
According to Reuters, S&P also said it was monitoring legal developments related to Franchise Group’s Kahn. Bloomberg reported this month that Kahn is one of two co-conspirators named by John Hughes, co-founder of hedge fund Prophecy Asset Management, who pleaded guilty this month to securities fraud, according to the Reuters report. It is not clear if Kahn also faces charges.
Kahn told Reuters earlier that he was not involved in any fraud. “At no time during my former business relationship with Prophecy did I know that Prophecy or its principals allegedly defrauded its investors, nor did I conspire to commit any fraud,” Kahn said in a statement to the news organization.
Bryant Riley, president and co-CEO of B. Riley, gave his full-throated approval of the company’s investment in Franchise Group during an earnings call with analysts on November 9.
“I think there’s noise there, so I want to address it and be crystal clear,” Riley said. “We would have bought everything from Franchise Group. We’re a huge fan of that business, and it’s a really simple analysis. They have a great constant (earnings before interest, taxes, depreciation and amortization) in Vitamin Shoppes.”
Meanwhile, the share price of B. Riley, which trades on the Nasdaq, has been on a stormy rise this week. On Nov. 7, the day before the company’s earnings announcement that revealed the drop in revenue, its stock closed at $34.78. On Thursday, B. Riley shares closed trading at $22.04, down 36.6% over six days.
