B. Riley, L.A. financial services firm, and its deal gone bad

Oct. 2, 2024 3 AM PT

The Westwood area company became one of the nation’s leading investment banks for small and midsize firms. Now some are questioning whether it can survive.
B. Riley’s fortunes changed dramatically after its biggest deal went bad, leading to huge losses, the crash of its stock price — and a Securities and Exchange Commission investigation.
Bryant Riley is taking aggressive steps to save his embattled empire, including an offer to take the company private.

In the dark moments of the early pandemic, Bryant Riley was riding high.

The Los Angeles investment banker had in the prior decade merged his stock firm with asset disposition specialist Great American Group, which flourished as online sales surged and thousands of stores closed.

“We believe we have built a platform to not only withstand volatile markets but also to benefit amid destruction,” the founder of B. Riley Financial told analysts.

The confidence wasn’t misplaced. By 2021, profits at the company exploded.

A man in front of a wall with the words "B. Riley" on it.

The Westwood area firm had become one of the nation’s leading investment banks for small and midsize companies — handling initial public offerings, reverse mergers and providing research on some 400 firms, among other services.

Now, some are questioning whether the 27-year-old company with more than 2,000 employees can survive.

What led to the dramatic reversal of fortune? Its biggest deal ever went bad, leading to huge losses, the crash of its stock price — and a Securities and Exchange Commission investigation.

The company’s challenges, some investors say, serve as a cautionary tale on the perils of placing too big a bet on a single deal.

Riley has acknowledged the SEC probe stems from his firm’s dealing with Brian Kahn, who led a $2.8-billion management-led buyout of Franchise Group, the owner of retailers including Vitamin Shoppe and Pet Supplies Plus.

Kahn is a longtime Riley business associate who has been linked to the 2020 collapse of a hedge fund that federal prosecutors allege defrauded investors out of $294 million.

Kahn denies any wrongdoing, and Riley denies any knowledge of any fraud. But the scandal threatens to swamp his firm, which took on debt and lent Kahn $200 million to build and take the Delaware, Ohio, company private.

The SEC investigation has spooked investors and made the L.A. firm the most highly shorted stock on the market, according to research firm S3 Partners. Shares that approached $90 three years ago are now trading below $6.

Amid the scrutiny, B. Riley in August marked down its investment in Franchise Group by up to $370 million and expects to record a loss of up to $475 million in the second quarter.

Riley, 57, is taking aggressive steps to save his embattled empire.

“I am confident we are going to get through this bad transaction and come out of it,” he told The Times last week at his office overlooking the 405 Freeway in his first interview since the controversy. “I feel a lot of responsibility.”

Riley has suspended a rich dividend that paid him millions annually. He’s renegotiated debt. He’s trying to sell off businesses. And he’s even made an offer to take his company private.

But not everyone is convinced it will be enough.

“B. Riley is so broke right now,” said Nate Koppikar, a prominent short seller who has bet on the firm’s stock price continuing to decline. “I don’t know how they could possibly survive this.”

Teenage trader

Riley, who was born in Rockville, Md., was obsessed with stocks at an early age.

He gave his father $100 from his paper-route earnings to buy shares when he was just 14 or 15, he recalled in a Los Angeles Business Journal interview.

“The best thing that happened is I bought losers and figured out very quickly you better know what you are buying,” he said.

At Lehigh University in Pennsylvania, the future entrepreneur made and sold T-shirts with his fraternity brother Tom Kelleher, both now co-chief executives of B. Riley.

‘We’re gonna make a lot of money for our shareholders.’

— Bryant Riley

After graduating in 1989 with a finance degree, Riley knocked around the industry before starting in 1997 what was called B. Riley & Co. with his wife and Kelleher.

The fledgling firm provided research to institutional investors, focusing on small local and California companies ignored by large banks.

“We wanted to follow local companies where you could go see the whites of the CEO’s eyes,” he told the Business Journal.

The firm had fewer than 100 employees five years after it started, but in 2014 made an unusual deal that would supercharge its growth: It went public through a merger with Great American Group, known for liquidating chains such as Mervyn’s during the 2008 financial crisis.

A pedestrian on a corner with buildings behind them.

What followed were a dizzying series of deals that created today’s B. Riley. He acquired wealth managers, small-cap investment banks and brokerages, and myriad other businesses.

He bought a series of legacy communications companies, starting in 2016 with internet service provider United Online. And he scooped up brands of faded apparel companies, including girls clothing brand Justice, now sold in Walmart.

It was a motley assortment of businesses that Riley acknowledges was hard for Wall Street to understand.

“Our guiding principle has always been to find unique investment ideas that can generate outsized returns,” he said, during one call with analysts.

Riley has been rewarded for his success. He earned $5.6 million last year and received roughly $27 million in dividends. He also owns homes worth $9.7 million in Pacific Palisades and $21.7 million at an exclusive Montana resort, according to real estate records.

Meeting an ambitious dealmaker

Riley’s ties to Kahn, the Franchise Group founder, date back to his first year in business.

Riley said he met him in 1997 after Kahn had founded his own small firm, called Kahn Capital Management. Kahn was a client to whom B. Riley offered stock research, in the hope that it would lead to stock trades the firm could fill.

Working out of a one-room office, Riley said, he would overhear his salesman talking to investors, including Kahn.

“I’d get on that phone with that client, so that’s how I got to know Brian. He was trafficking in small-cap stocks too.”

Kahn, 50, from Boca Raton, Fla., had attended Harvard, where he was a defensive back on the football team in 1995. He started at Boston asset manager Fidelity before striking out on his own.

‘I don’t know how they could possibly survive this.’

— Nate Koppikar

Riley said he had little contact with Kahn for a decade or more after those early years, aside from executing a few trades or running into him at a conference.

Kahn had started an investment fund in Orlando, Fla., called Vintage Capital Management. Kahn proved himself ambitious, taking a stake in 2012 in Buddy’s Home Furnishings, the nation’s third-largest chain of rent-to-own furniture, appliances, electronics and other consumer goods.

In 2014, he made a $2.3-billion bid for the rent-to-own industry’s largest chain, Aaron’s. When that didn’t work out, Kahn became interested in acquiring Rent-A-Center, the industry’s second-largest chain.

A colleague of Kahn reached out to Riley to pitch him on the idea of participating in the deal.

Riley said he looked it over and decided he wanted in, helping raise money for a $15-per-share offer, while putting in his own firm’s capital for an equity stake.

Rent-A-Center accepted a $1.37-billion buyout offer from Vintage in June 2018. But as an antitrust review dragged on, Rent-A-Center alleged that Vintage had failed to extend the deal’s expiration date and demanded a $126.5-million breakup fee.

Kahn disputed that, but a Delaware Chancery Court judge in March 2019 decided in Rent-A-Center’s favor. Riley said in an interview that the deal would have generated hundreds of millions of dollars in returns had it gone through.

A shopping spree

In 2018, Riley said Kahn came to him with an idea to buy into Liberty Tax, a franchise tax preparer based in Virginia Beach, Va. that is a smaller competitor to H&R Block. The idea was to buy other franchisers that would later be sold off for a profit, much like a private equity business.

Riley liked the idea, believing Liberty’s stock was undervalued. “I’m like, ‘This is really interesting. We’re going to roll up some other franchise businesses and we want to be part of it,’” he said.

Vintage and B. Riley took stakes in Liberty Tax, which acquired Buddy’s. The merged company changed its name to Franchise Group and started buying companies, including Sylvan Learning.

“They are all remarkably similar because they all generate a lot of free cash flow,” Kahn said of the acquisitions at a 2022 conference.

Given his company’s more than 10% stake, Riley took a board seat.

With more than 3,000 locations, Franchise Group took off during the pandemic, earning $364 million in 2021. But, like other retailers, it was squeezed as consumers eventually drew down their COVID stimulus checks and interest rates rose.

The Cypress + EcoSmart backpack is on display at the Targus in Las Vegas.

Pet Grooming station inside the Pet Supplies Plus store, Boston, Massachusetts.

Exterior of a The Vitamin Shoppe store in Fresno.

The Cypress + EcoSmart backpack is on display at the Targus in Las Vegas. Pet Grooming station inside the Pet Supplies Plus store, Boston, Massachusetts. Exterior of a The Vitamin Shoppe store in Fresno. (Associated Press; Getty Images; Google street view)

‘I am confident we are going to get through this bad transaction and come out of it.’

— Bryant Riley

Riley discussed with Kahn a potential acquisition of Franchise Group, but decided instead to assist Kahn in taking the company private, according to a regulatory filing. Riley said he thought the company’s shares were undervalued.

Kahn led a $2.8-billion management buyout in August 2023, with B. Riley providing $600 million in financing through debt it had taken out from Japanese bank Nomura and other lenders. It also raised equity from other investors and took its own 31% stake.

Additionally, B. Riley lent Vintage $201 million, which was largely secured with shares of Franchise Group, according to a regulatory filing. Riley said about half of the loan was made to Kahn as he was establishing Franchise Group and buying up shares, with the rest stemming from the buyout.

Suddenly, Riley had a huge amount invested in a single deal.

Fraud investigation

While Kahn was busy assembling Franchise Group with help from Riley, he was also involved in another business: Prophecy Asset Management, a hedge fund with offices in New York and South Carolina.

The fund was set up to provide investors with solid but safe returns, with assets spread out among “sub-advisors” whose investments were tracked and who were required to reimburse the fund for initial losses.

In March 2020, however, the fund collapsed because of heavy losses. A lawsuit filed under seal alleged Kahn, as a sub-advisor, had controlled as much as 86% of the fund’s $363 million in assets and that much of the money was used to acquire shares and take a controlling position in Franchise Group.

The lawsuit was dismissed and unsealed two years later. Kahn denied wrongdoing but settled for about $70 million in arbitration, Bloomberg News reported.

Kahn and his attorney did not respond to requests for comment.

The fund’s collapse and investor losses of $294 million sparked a criminal investigation by the Department of Justice. John Hughes, the fund’s co-founder, pleaded guilty Nov. 2 to conspiracy to commit securities fraud.

Hughes was charged by federal prosecutors with hiding massive trading losses with two unindicted co-conspirators, including one described as the “CEO and President of a multi-billion dollar company that owned and managed large and diversified retail franchises.”

That same day, the Securities and Exchange Commission filed civil charges in the case against Hughes, alleging that Vintage played a role in the alleged fraud, though it is not named as a defendant. Kahn has not been charged.

After Hughes entered his plea, Kahn issued a statement to Bloomberg saying that “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.”

A man stands in an office, with people seated at desks with computers behind him.

That day, during his firm’s third-quarter conference call, Riley expressed faith in Kahn’s profession of innocence. “That’s good enough for me,” Riley said. “I believe we are going to make a lot of money for our shareholders.”

Riley, who has not been accused of any involvement in the fraud, also defended the investment in Franchise Group.

But the earnings announcement disclosed that B. Riley had marked down the value of its equities portfolio, contributing to a $75.8-million quarterly loss.

S&P Global also dropped Franchise Group’s debt ratings further to junk status.

“These investments they’ve made are bad, but [Franchise Group] is the Titanic,” said Marc Cohodes, a short seller who declined to disclose the size of his position in B. Riley.

Riley said he personally knows nothing about what happened at Prophecy, and regrets making such a forceful statement defending Kahn.

“It’s my nature if I know you and I’ve known you for a long time, and I’ve seen you do nothing but ethical stuff — I just didn’t believe it,” said Riley, who added that while he was friendly with Kahn, he never considered him more than a business associate.

Take-private offer

In January, Kahn resigned as chief executive of Franchise Group.

The following month, B. Riley announced that an investigation led by outside counsel had concluded its founder and others at the company had no involvement with or knowledge of any wrongdoing at Prophecy.

Events came to a head in August when B. Riley announced a markdown up to $370 million of its Franchise Group investment and the Vintage loan. It also suspended its quarterly dividend, and Riley disclosed his firm had received subpoenas from the SEC, which was investigating his firm’s dealings with Kahn.

Riley said at the time he was confident regulators would find the firm “had no involvement with or any knowledge of alleged misconduct concerning Brian Kahn or his affiliates.”

News of the investigation pummeled the stock, which hit a low of $4.51, causing the Nasdaq to halt trading several times.

Franchise Group “did not work out the way we had hoped it would work out, and it’s been devastating to our stock price,” he said.

Riley, who owns 24% of the common stock, later made an offer to take the company private at $7 a share.

B. Riley recently disclosed that it was in discussions to sell a 53% stake in Great American Group and all its retail apparel brands for more than $400 million to help reduce its debt, which totals about $1.9 billion.

Riley acknowledged he was too optimistic about Franchise Group, but noted many retailers have suffered similar challenges. And he said B. Riley has profitable businesses such as advisory services.

“There’s great people here. There’s a great business,” he said. “We made a large investment, but I don’t think we bet the house.”

Koppikar, the short seller, traces B. Riley’s problems to its founder’s dreams of expanding well beyond its core operations.

“He went from being sort of a nice small banking, restructuring and liquidation operation into a hodgepodge of empire building,” he said.