A year ago, Orso Partners co-founder Nate Koppikar told investors in his hedge fund that he was shorting an investment bank, which he didn’t name, that “almost failed during the GFC and has been on a slow march to death in recent years.” There are “few clients of this bank that have any legitimate business purpose, or any reason to exist outside of scamming retail investors,” he asserted.
But Koppikar could not have predicted that less than10 months later, a U.S. Department of Justice investigation would be connected with one of that bank’s most important clients — a man who has been confirmed by Bloomberg as “conspirator #2” in a recent plea deal with the co-founder of a hedge fund who was charged with fraud.
The bank is B. Riley Financial, and the client is Brian Kahn, CEO of Franchise Resource Group.
On Nov. 2, Prophecy Asset Management co-founder and chief compliance officer John Hughes pleaded guilty to conspiracy to commit securities fraud from 2015 to 2020. He admitted that he and two co-conspirators had engaged in a variety of financial crimes, including forgery, passing off fake collateral, misappropriating money, engaging in phony round-trip transactions and deceiving auditors.
“Conspirator #2” in the scheme is reportedly Kahn, who also runs the Vintage Capital Management hedge fund, which the Securities and Exchange Commission has claimed was involved in the fraud at Prophecy. The SEC said Prophecy invested most of its assets with Vintage and Kahn — whom it calls “Individual 2.”
The DOJ accused Hughes of a $294 million securities fraud conspiracy, which he admitted was tied to trading losses of more than that amount in the hedge fund run by conspirator #2. Hughes acknowledged that he engaged in a “secret round-trip transaction that siphoned off cash” and “gave it to Co-conspirator-2, who then fraudulently used it as collateral in order to obtain more investment money from the funds.” Hughes is now cooperating with prosecutors, according to the transcript of his plea.
Kahn has not been indicted, but the affair threatens to entangle him as well as the Franchise Group and B. Riley, which has maintained a close relationship with Kahn and has acknowledged helping him finance his hedge fund activities over two decades. Recently, B. Riley said it had lent Kahn and his entities $200 million.
Both Kahn and B. Riley are trying to distance themselves from the Prophecy case. In a statement released soon after the Hughes’ plea deal, Kahn said “at no time in my former relationship with Prophecy did I know that Prophecy or its principals were allegedly defrauding their investors nor did I conspire in any fraud.” He added, “I ceased doing business with Prophecy several years ago,” and said the relationship with Prophecy did not “impact” Franchise Group. (An attorney for Kahn did not respond to a request for further comment.
B. Riley has claimed it knew nothing of the fraud at Prophecy or Kahn’s alleged role in it until Hughes’ plea deal became public in November.
“I’ve known Brian for many years and have had no direct experience with what has been alleged,” Bryant Riley, the eponymous bank’s chairman and co-CEO, said during the firm’s third-quarter earnings call. “We learned of this matter late last week like many others, and we continue to closely monitor relevant developments.” Riley added that the bank has a “great partnership” with Kahn.
Short sellers aren’t convinced. In addition to Koppikar, last February, Wolfpack Research founder Dan David published a short research piece on the same bank, calling it “a lender of last resort for the dregs of the public market.” The small bank focuses on penny stock companies and high-yield financed recapitalizations.
David argued that B. Riley had “overleveraged to buy speculative assets during the financial mania of 2020-2021” and “lent money to companies that have degenerated into zombies.” He added that to finance its business, B. Riley sold $2 billion of junk bonds to retail investors in its wealth management division.
“The high‐net‐worth channel is financing the bank’s bonds that in turn are used to buy high risk assets,” Koppikar told Institutional Investor.
David says he’s been calling for B. Riley to go bankrupt since his first report last February and that the Kahn connection is just icing on the cake. “When they indict Kahn, the only thing Kahn’s got to give them is Bryant Riley. So that would be a cataclysmic event, if and when the indictment does come down on Kahn,” he told II.
(Blake Coppotelli, the assistant US Attorney for New Jersey who prosecuted Hughes, did not return a request for comment on the possibility of additional indictments.)
More recently, noted short seller Marc Cohodes jumped into the short after getting a call from Koppikar following the Hughes plea agreement. “I’m just going to make it really simple for you,” Koppikar says he told Cohodes that. B. Riley had just acquired a company whose CEO, he believes, is guilty of fraud.
Koppikar was referring to B. Riley’s role in taking Franchise Group private last August in a deal valued at $2.8 billion with a group consisting of B. Riley and Kahn. While Kahn controls the company, B. Riley owns 31 percent of its equity and is also its lender.
In a year in which short sellers by and large lost money, B. Riley had the greatest percentage of shares shorted on the open market and was also one of the most profitable short trades. Some 53 percent of its shares were sold short as of mid-December, according to S3 Partners. Awash in troubles with other investments that have soured, the bank also recently posted a $75.8 million third-quarter loss, and its shares have fallen more than 60 percent since peaking in late July.
But the bank is pushing back.
“The short thesis is wrong – plain and simple,” B. Riley spokesman Scott Bisang says. “It relies on an alleged quid pro quo that didn’t happen and ignores obvious facts that undermine the entire argument. The short sellers have jumped from one incorrect theory to another in an attempt to push the acceptable limits of financial research to profit at the expense of B. Riley’s employees and clients.”
Meanwhile, Cohodes and short seller James Gibson, founder of hedge fund Castalian Partners, have recently sent several letters to B. Riley’s auditor Marcum as well as to Deloitte, the auditor for the Franchise Group.
According to one letter, which is addressed to James LaRocca, B. Riley’s auditor at Marcum, “B. Riley has accumulated large financial exposure on its balance sheet to the Kahn Enterprise via hundreds of millions of dollars in purported equity investments, business and personal loans, and other agreements with companies and entities controlled or beneficially owned by the Kahn Enterprise.”
The letter focused on the recent leveraged buyout of the Franchise Group, saying it has left B. Riley “with hundreds of millions in balance sheet exposure consisting of its equity stake, loans backed by the franchise group’s receivables, and undisclosed loans to the Kahn Enterprise purportedly backed by Franchise Group stock.”
Cohodes and Gibson also wrote that “a recent downgrade by S&P suggests the Franchise Group business is now deteriorating rapidly, receivables are ballooning, and that free cash flow has fallen to the point that interest coverage is very thin.”
The two told II that their attorney has sent similar letters to the DOJ, the SEC, Financial Industry Regulatory Authority, Financial Crimes Enforcement Network and the Public Company Accounting Oversight Board.
Marcum and Deloitte executives to whom the letters were addressed did not respond to a request for comment.
“We have crazy conspiracy theories, and the honest truth is they almost never are true,” says Koppikar, who went public with his short thesis on B. Riley around the time the stock peaked in late July, writing as “The Friendly Bear,” which is also his X (formerly Twitter) handle. “There’s some shades of truth to them, but they’re not as crazy as you expect.” But when B. Riley put up a slide at a December “investor day” saying it had lent $200 million to Kahn, Koppikar says, “I fell out of my chair. It was way crazier than I expected.” In 2021, the bank had a net loss around $220 million.
At that event, the firm said the loan to Vintage is a PIK (noncash interest bearing) and collateralized by Kahn’s holdings of Franchise Group stock. Cohodes and Gibson called the loan “extremely troubling” in an email to the firm’s auditor that II has seen.
The short sellers say that prior to the mention of these loans at investor day, they could find no mention of the existence of the Vintage loan in any of the firm’s disclosures about the Franchise Group.
At that event, Bryant Riley again defended B. Riley’s association with Kahn and Vintage, calling it a “profitable relationship for the firm.”
According to Bisang, “a core facet of our business strategy is our ability to utilize both our in-house expertise as well as our balance sheet to support our clients, and in turn deliver value to our shareholders.”
Both Bryant Riley and B. Riley President and CEO Kenneth Young were on Franchise Resource Group’s board until 2020. They left shortly after Deloitte resigned as the auditor of Prophecy on March 18, 2020 — after the accounting firm said it had detected alleged fraud, Koppikar notes.
“It seems implausible that Riley and Young were not aware of these developments,” he says.
Indeed, a shareholder lawsuit predated the DOJ and SEC charges, laying out some of the issues that emerged in Hughes’ plea deal. Hedge fund Lyonross Partners sued Prophecy, which used Kahn’s hedge fund as a subadviser for investments from Lyonross. That lawsuit, filed May 9, 2022, claimed that Kahn used the money he was getting from Prophecy to build up his controlling stake in the Franchise Group.
The SEC’s case against Hughes mentions a separate allegedly fraudulent transaction — a $36 million unsecured loan from Prophecy to Vintage Capital “to provide rescue financing to a company in which Vintage was heavily invested.” The SEC said this loan was later concealed using a series of sham transactions and was never paid back.
Despite all the red flags, staying short the stock of a company with such high short interest is dangerous, the short sellers acknowledge. “We wouldn’t get involved with a stock with this kind of short interest, but it’s disgraceful that no one has actually shut this down yet,” Koppikar says. “It’s not a company that claims to be sending rockets to space or making the next renewable energy solar cell project.”
B. Riley, he notes, is a registered broker-dealer. “They’re registered by FINRA, by the SEC. This is a regulated entity. They are subject to some KYC [know your customer] and AML [anti-money-laundering] laws. They have had nonstop business relationships and money exchanging hands with a guy who has been accused of things that I have never seen before in a government charging document.”
“Why do I stay short these kinds of stocks?” Koppikar asks. “Because when you’re short bad guys, you never know what’s going to do them in. But one morning you come to work and something like Kahn happens.”
