Fashion Investor and Retail Lender B. Riley Under SEC Probe

Concerns raised at B. Riley Financial Inc. over certain dealings could mean trouble for some fashion firms and retailers.

Well-known in the distressed and special situations field, the investment bank takes on advisory roles in recapitalizations, debtor-in-possession financing, and exit facilities when companies are set to put their tour of bankruptcy court behind them. The company also is an investor in the fashion and retail sectors through its investment arm.

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Now B. Riley has bigger headaches as short sellers ponder the investment bank’s future.

On Monday, B. Riley’s stock price tumbled by more than 50 percent following a profit warning and the suspension of its dividend. The company’s second-quarter report estimated a net loss for the quarter ended June 30 in the range of $435 million to $475 million due to a write-down on its investment in Franchise Group (FRG) of between $330 million to $370 million and a Vintage Capital loan receivable. The loan’s primarily collateralized by equity interests in FRG. B. Riley acquired the FRG stake last year as part of a management-led buyout. According to a Bloomberg company profile, Vintage is an asset management firm founded and managed by Brian R. Kahn, who was the former CEO of FRG.

Bryant Riley, B. Riley’s chairman and co-CEO, during a call to Wall Street referenced issues related to alleged misconduct by Kahn, which resulted in the company and himself receiving subpoenas in July from the Securities and Exchange Commission (SEC). Kahn was the former hedge fund manager at the now collapsed Prophecy Asset Management.

“These primarily related to the company’s dealings with Brian Kahn. We are responding to the subpoenas [and] are fully cooperating with the SEC,” Riley said.

A Bloomberg story indicated that the SEC probe is widening to include whether B. Riley had sufficiently disclosed the investment risks in some of its assets.

A B. Riley spokeswoman on Tuesday declined comment regarding the reported widening SEC probe. Instead, she referenced the company’s prior disclosures of two separate investigations, one “an internal review with the assistance of Sullivan & Cromwell LLP as outside counsel, and a separate independent investigation with the assistance of Winston & Strawn LLP as independent legal counsel.” She also said that the both investigations concluded that the “company and its executives, including Mr. Riley, had no involvement with, or knowledge of, any alleged misconduct concerning Mr. Kahn or any of his affiliates.”

“We are confident that the SEC will reach the same conclusion,” Riley told investors during the company call.

Concerns have surfaced regarding Kahn’s role in the 2020 collapse of Prophecy. Neither Kahn nor B. Riley have been charged with any wrongdoing. And each one has maintained in published reports that they’ve done nothing wrong. Moreover, there are no ties between B. Riley and Prophecy. B. Riley’s CEO tried to assuage investor concerns during the company call by noting it has “significant cash on the balance sheet.” He also said a “review of the Great American business is advancing,” and that B. Riley was “going back to our roots and refocusing on a core financial services business.”

Bryant Riley founded the company in 1997 as a stock-picking firm. It later acquired a boutique investment firm and years after that merged in 2014 with asset appraisal and asset disposition specialist Great American Group to form B. Riley Financial. The company went on to acquire several other business—including restructuring advisory firm GlassRatner Advisory & Capital Group in 2018—as it expanded operations.

Short sellers are concerned that as the SEC probe widens, that will open doors to areas where regulators will want to dig even deeper. And one area is expected to be a wider exploration into the business ties between Kahn and B. Riley.

Kahn is believed to have been investing money for Prophecy while building up FRG. Prophecy’s former president and chief compliance officer John Hughes pled guilty to one count of conspiracy to commit securities fraud last November. Hughes admitted to defrauding $294 million from clients, according to the U.S. Attorney’s Office in N.J. There is still a pending SEC complaint against Hughes based on the same set of facts. According to the SEC, its civil case alleges violations of anti-fraud provisions of federal securities laws.

Short sellers are focused on a reference in court documents in the criminal case against Hughes regarding alleged co-conspirators. While not identified by name, prosecutors described one as Prophecy’s CEO and the other as Prophecy’s investment manager who, around 2019, “also was the CEO and president of a multi-billion dollar company that owned and managed large and diversified retail franchises.” The latter was described in the separate SEC complaint as individual 2 residing in Florida, who controlled entities that traded Prophecy’s capital. Bloomberg’s profile listed an address in Orlando, Fla., for Vintage. It didn’t take long for short sellers to focus their speculation on Kahn, given that he was wearing two hats.

In July, FRG investors sued Kahn and B. Riley in a Delaware Chancery Court. The purported class-action suit alleged that the FRG buyout deal undervalued their shares and that B. Riley helped Kahn cheat investors, among other claims. With all the probes and legal action in the background, short sellers believe that the intense scrutiny and pressure eventually could result in a B. Riley collapse.

Meanwhile, Kohl’s Corp. might want to count its blessings that its then board rejected FRG’s acquisition offer, given that now both Franchise and its parent B. Riley Financial are in the hot seat.

Activists had been pushing Kohl’s to shake things up, including the sale of the company. In June 2022, the department store retailer was in exclusive talks with Franchise Group to hammer out a $7.74 billion deal at $60 a share. But the retail environment was starting to show signs of a slowdown and on July 1, 2022, the Kohl’s board ended talks following Franchise’s revised—and lower—$6.84 billion offer at $53 a share.

In retail circles, FRG was known for a portfolio that included The Vitamin Shoppe, Badcock Furniture, and Buddy’s Home Furnishings, among other holdings. Badcock was sold to Conn’s last December, with the help of a $100 million loan from B. Riley. Last month saw speculation that Conn’s Inc. was contemplating a Chapter 11 filing. The home retailer on July 24 filed a Chapter 11 petition to orderly wind-down operations, which resulted in the shut-down of the Conn’s banner as well as that of the W.S. Badcock nameplate. A separate B. Riley affiliate, B. Riley Retail Solutions LLC, is handling the store closing sales.

Riley said during the conference call that the investment bank will “continue to benefit from the steady cash flow generated by our communications and brands portfolios.” Those brands include a fashion portfolio launched in November 2019 when B. Riley invested $116.5 million to become the 80 percent majority owner—Bluestar Alliance retained a 20 percent interest—of six fashion brands that include Catherine Malandrino, Joan Vass, Limited Too, and Nanette Lepore. In July 2023, B. Riley added Scotch & Soda’s U.S. operations to its equity holdings, in partnership with Bluestar’s acquisition of the Scotch & Soda brand. Other brand deals the two are parties to include Hurley in 2019 and Justice a year later.

Bebe, the women’s specialty chain turned online-only operation became an affiliate of B. Riley, its lender, in January 2018. The investment bank took a 29 percent stake through the conversion of a $16.9 million loan into 2.82 million shares of common stock at $6 a share, as well as the acquisition of an additional 250,000 shares. That stake became part of the B. Riley Principal Investments portfolio. B. Riley invested another $18.5 million in Bebe in September 2023 through the acquisition of an additional 3.7 million shares, at $5 a share. It acquired the stake from Bebe founder Manny Mashouf, giving the investment firm a 76 percent interest in the fashion brand.

The B. Riley name also has had a steady presence in the retail space over the years. Its asset disposition group, in a joint venture with Tiger Capital Group, handled the closure of Payless Shoe Source stores when it liquidated in 2019. And it has acted as financial advisor to retailers that include Ruby Tuesday and Bed Bath & Beyond, both in 2021.

B. Riley was also the investment banker to RTW retailwinds in its Chapter 11 case that resulted in the company’s sale of the e-commerce business and related IP to Saadia Group in 2020. Those assets included the fashion operations under the banners New York & Co. and Fashion to Figure. Saadia went on to acquire the  bankrupt Lord & Taylor and Le Tote assets, as well as Aquatalia. Saadia is also no stranger to the court system. Rumblings of trouble at Saadia surfaced earlier this year. In March, Saadia’s lender White Oak Commercial Finance obtained a preliminary injunction against Saadia over certain assets after it defaulted on a $45.3 million loan agreement. Operations, including Lord & Taylor, were shut down. The lender is working on selling all remaining inventory and other assets, a source said.

The investment bank has an extensive reach in the fashion and retail sectors, both as investor and advisor. The company’s CEO said transactional activity is increasing for both capital raising and M&A, while the restructuring business is also seeing increased activity. But how all the legal matters surrounding Kahn and B. Riley eventually will shake out remains uncertain. Yet one thing is clear: Moody’s Investors Service last month downgraded FRG’s corporate rate to “Caa1” from “B3.” That indicates credit analysts’ belief of a very high risk of default. If that were to happen, the impact likely would not bode well for either B. Riley or the fashion brands in its investment portfolio.