(Bloomberg) - US authorities are investigating B. Riley Financial Inc.’s deals with a key client who was linked to a securities fraud, and the use of his assets to help the investment bank obtain a loan from Nomura Holdings Inc., according to people familiar with the matter.
The US Securities & Exchange Commission carried out interviews in recent months about B. Riley and its relationship with Brian Kahn, the people said, requesting anonymity as details aren’t public. Kahn is an unidentified co-conspirator in a US Department of Justice criminal case prompted by the 2020 demise of the Prophecy Asset Management hedge fund, Bloomberg News previously reported.
Officials have been scrutinizing how Kahn led a buyout of a retail business called Franchise Group Inc. in a deal arranged last year by B. Riley. Nomura partly financed the transaction, with some of Kahn’s assets pledged as collateral, according to the people and documents reviewed by Bloomberg.
Concern about B. Riley’s relationship with Kahn has helped send the Los Angeles-based firm’s shares tumbling, along with losses and writedowns on some of its investments, and the stock has attracted large bets by so-called short-sellers wagering on further declines. The brewing controversy also touches on Nomura, one of B. Riley’s biggest lenders, which has been seeking to repair its own reputation for risk management after losing almost $3 billion in 2021 amid the collapse of Archegos Capital Management.
The stock fell as much as 10% Monday, and was down 2.5% at 9:47 a.m. in New York. By one measure, B. Riley is among the most shorted shares in the global financial services sector, according to a Jan. 16 report from S&P Global Market Intelligence.
A spokesperson for the SEC declined to comment. The probe is in its early stages. Scrutiny by the agency doesn’t necessarily mean anyone has engaged in any wrongdoing or that legal action will result, and Nomura isn’t the focus of the probe.
“We have not received anything from the SEC on this matter and to the extent the SEC makes an inquiry, we would fully cooperate as we have done in the past on all regulatory inquiries,” a spokesperson for B. Riley said in an emailed statement.
Short Sellers
“We would welcome an investigation into the outrageous tactics the short sellers have pursued to destroy B. Riley, including the coordinated options trading with zero disclosure obligations,” the statement said. “The short sellers continue to harass, intimidate, and insult employees and everyone associated with B. Riley, resorting to lies and crude remarks so they can personally profit.”
A Nomura representative said the bank declined to comment.
B. Riley told shareholders on Nov. 9 in its quarterly filing with the SEC that the firm has enough cash and other sources of liquidity to meet its needs. Kahn and his attorney didn’t respond to messages.
Read More: B. Riley Faces Investors After Deals, Profits and Stock Go Sour
“At no time during my former business relationship with Prophecy did I know that Prophecy or its principals were allegedly defrauding their investors, nor did I conspire in any fraud,” Kahn said in a November statement. “Like many other investors, my relationship with Prophecy was costly, including economically, and I ceased doing business with Prophecy several years ago. In no way, shape or form has this previous relationship impacted Franchise Group.”
Investigators from the SEC’s Los Angeles office have also sought information about bebe stores inc., a women’s clothing chain that B. Riley controls and that also had dealings with Kahn, one of the people said.
Representatives for bebe stores didn’t respond to a request for comment.
B. Riley, founded by Chief Executive Officer Bryant Riley, traces its roots to 1997 as a boutique stock-picking firm focused on smaller companies. It now offers a birth-to-death business model for smaller publicly traded clients, including stock and bond offerings.
Franchise Group
Kahn is a longstanding client of B. Riley’s who has been involved with multiple businesses. Last August, the bank helped him lead a management buyout of Franchise Group, or FRG, a retail company based in Delaware, Ohio.
Nomura led a $600 million lending syndicate for B. Riley to help finance Kahn’s takeover, putting in place the three-way relationship that now exists among the parties, according to loan documents reviewed by Bloomberg News. The Japanese bank committed $240 million, more than any other lender, one of the people said.
B. Riley put up about $1.5 billion of various assets as collateral for the loan, the documents show. Some $220 million included shares of FRG, while $200 million is a loan B. Riley made to Kahn that is itself secured by more FRG stock, according to the documents.
Prophecy Management
Several months after the FRG deal closed, a Kahn associate named John Hughes pleaded guilty to conspiring to defraud investors out of $294 million through Prophecy Asset Management, a now-defunct investment fund.
One of Hughes’s co-conspirators was “the CEO and president of a multibillion-dollar company that owned and managed large and diversified retail franchises,” according to the charging document prosecutors filed in New Jersey federal court. That conspirator was Kahn, according to a person familiar with the matter, Bloomberg previously reported.
The SEC also sued Hughes in a complaint that details massive trading losses by Individual 2. The agency’s depiction of Individual 2’s alleged actions matches the description of Kahn in the Hughes criminal case.
It also aligns with a 2020 civil lawsuit filed in New York by a group of Prophecy investors who named Kahn and others as defendants. They alleged Kahn helped to swindle them out of tens of millions of dollars and used more than $100 million to amass a controlling stake for himself in FRG. Kahn has not been charged and denies any wrongdoing.
The case, filed in federal court in New York, was referred to arbitration and dismissed in 2022. It’s not clear from court records whether there was a settlement or whether Kahn paid any money.
The allegations against Kahn rippled through B. Riley’s relationship with Nomura and FRG’s credit rating. Loan documents show that at Nomura, a team of external advisers encouraged the Tokyo-based bank to write down the value of the loan to B. Riley, citing the allegations against Kahn and warning that the collateral for the debt may be tainted by fraud.
Nomura decided not to take action, citing the overall strength of the loan, according to the documents and one of the people.
However, S&P Global Ratings downgraded FRG’s credit rating, which was already deep in junk territory, to B minus on Nov. 10, warning that its high leverage and “weak operating performance” could make its heavy debt burden unsustainable. S&P described the allegations against Kahn as an “unresolved” situation that could distract the company.
(Updates with share reaction and short interest in the fifth paragraph)
By Donal Griffin and David Voreacos
With assistance from Jill R. Shah, Austin Weinstein and Subrat Patnaik
