IMPORTANT DISCLAIMER
Prophecy Asset Management Allegations: We remind readers that to date Brian Kahn has not been accused of OR charged with any crime.
I am/we are short RILY common and preferred securities. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article contains certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. This article reflects the author’s opinion at the time of publication. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.

How did B. Riley gain control of 84% of the voting shares of a company that it helped take private, force out the company’s CEO/Chairman with a sham unsecured loan, and then disavow having control of the company?  Did Marcum diligently assess B. Riley’s control over Franchise Group, or did it follow its lead from last year and allow B. Riley to continue violating basic GAAP rules?

  • B. Riley previously hid all its loans to Prophecy unindicted co-conspirator and B. Riley related party Brian Kahn from its SEC filings for the past several years, so we only recently were able to analyze their substance and form – we waited for the 1Q24 10-Q filing before completing this analysis of publicly available documents
  • Dating back to at least 2019, B. Riley has been secretly making loans to affiliates of Brian Kahn.  These loans appear to have eventually been rolled up into one single $200.5 million loan to “Vintage Capital Management” on August 21, 2023, a hedge fund entity owned by Brian Kahn that has been inactive for years.  Vintage appears to own no assets and have no operations.  Brian Kahn made a side pledge of around $227MM of his shares of Freedom VCM Holdings (“Franchise Group” or “Freedom VCM”) to collateralize the loan, effectively creating a synthetic securitization of his Franchise Group shares for B. Riley.
  • Kahn was previously Chairman/CEO of Freedom VCM but now no longer controls it – In December 2023, B. Riley paid him off in the form of yet another “loan” ($15 million through Franchise Group, representing ~20% of the distressed company’s cash on hand) so that he would give up governance rights (Exhibit A).  His control expired no later than January 22, 2024, the day he resigned as CEO and from the board.
  • B. Riley now either directly or indirectly controls ~84% of shares of Freedom VCM and is utilizing a sham VIE arrangement to avoid claiming ownership of Kahn’s pledged shares of Freedom VCM.
  • It appears Marcum fundamentally failed on numerous dimensions in its interim financial review last year (which we believe led to the premature audit partner change away from James LaRocca after only 1 year of audit service).  Marcum appears to be failing in its interim review yet again.
  • Based on a white paper from Marcum – B. Riley’s own auditor – B. Riley’s “loan” to Vintage Capital Management constitutes a collateralized financing entity (and not an operating entity, as B. Riley implies).
  • Brian Kahn is B. Riley’s related party (B. Riley discloses this) and therefore de facto agent. B. Riley claims Kahn’s Freedom VCM shares are in B. Riley’s possession.  Kahn therefore cannot sell, transfer, or encumber his interests in Freedom VCM (without B. Riley approval) under the Vintage loan agreement (by virtue of B. Riley’s “perfected” interest) – this fact alone proves that B. Riley holds the power in the Vintage VIE. 
  • Vintage, the underlying borrower, is a shell entity with no assets or known business activities that is run out of Brian Kahn’s home, and merely exists and functions to collect contractually mandated waterfall payments from Kahn’s Freedom VCM shares to B. Riley – B. Riley is therefore the primary beneficiary of the contractual arrangement between Vintage and B. Riley and holds all power in VIE its relationship with Vintage.  
  • Because the loan is now at 100% LTV+, B. Riley’s economic arrangement resembles a straight stock position in Freedom VCM rather than a “loan”.  B. Riley bears essentially all the economic exposure of the VIE relationship, with the stock upside coming from the 12% PIK interest (growing loan balance), and the stock downside coming from B. Riley bearing the entire loss on the shares. 
  • Bryant Riley has repeatedly claimed he would own all of FRG if he could – well now he does have 84% of voting shares under his control, yet he and his team of accountants are going out of their way to avoid claiming ownership – what gives?

Brian Kahn No Longer “Controls” Freedom VCM – So Who Does?

Brian Kahn stepped down as Chairman and CEO of Franchise Group / Freedom VCM Holdings (“Franchise Group” or “Freedom VCM”) on January 22, 2024.  He previously had super voting rights.  Kahn stepped down only after Franchise Group arranged to give Mr. Kahn a $15 million unsecured loan in December 2023 in exchange for Kahn giving up certain governance rights (see Exhibit A). 

Importantly, there are only two shareholders of size in the Freedom VCM capital structure– B. Riley (and its affiliates) and Kahn (see below).  At the time, the board consisted of Kahn, Bryant Riley, two employees of Franchise Group with minimal stock holdings, and an “independent” board member with no stock holdings. Therefore, the reality is that only Kahn and Riley had any ability to exert control on this board given the economic backdrop.

Therefore, with almost all the non-Kahn voting shares (representing over 50% excluding even Kahn’s pledged stock), B. Riley exerted control and arranged a payout to Mr. Kahn in December 2023 (see Exhibit A).  This control maneuver itself should have triggered consolidation.  B. Riley did not disclose this loan and governance shift in any of its SEC filings, and B. Riley also arranged for this loan to Kahn after being fully aware of Prophecy allegations – including that Mr. Kahn was behind on payments to a trustee for Prophecy victims.  B. Riley surely could have removed Kahn for cause given the allegations at hand, but instead opted to golden parachute him out of Franchise Group, a company that is financially struggling with term loan trading in the mid-70s as of the publication of this article. 

Neither law firm running purported independent investigations made any mention of this secret loan (but this does not surprise us, because Sullivan & Cromwell is defense counsel for B. Riley and should not have performed the investigation, and Winston & Strawn is also anything but independent, having represented B. Riley and promoted B. Riley interests dating back to at least 2019).  The $15 million being structured as an unsecured loan rather than direct payment also sets off significant tax evasion red flags given that Kahn has clearly demonstrated a propensity to not pay back debt.  A loan can be made without creating a taxable event versus a severance payment would create immediate taxable income.  His existing debt with B. Riley is a structure dating back to at least 2019 that has been rolled and extended repeatedly because Kahn cannot pay it back from cash on hand, so there is no way B. Riley could have expected this latest unsecured loan – junior to B. Riley’s existing $200.5 million loan – to be paid back.

B. Riley Has Up To 84% of Voting Shares of Freedom VCM Yet Does Not Consolidate It

With Kahn out of the way as Chairman and CEO, and with his super voting rights relinquished, the question becomes who is in control of Freedom VCM.  We believe the current capital structure of Freedom VCM is as follows:

Source: Freedom VCM Holdings Audit and B. Riley 10-K filing

B. Riley has never disclosed in its own financial statements that it manages 27% of Franchise Group units on behalf of clients.  However, Franchise Group disclosed this information (see Exhibit B).  The Form ADV (representing the fully consolidated B. Riley entity that manages the Freedom VCM client holdings) makes it clear B. Riley votes these shares on behalf of clients. 

Looking at the capital structure, B. Riley either directly or indirectly or implicitly has control over ~84% of the voting shares of Freedom VCM.  With Kahn no longer in control, B. Riley obviously controls this company and should consolidate the entire company onto its balance sheet (which is required for over 50% of voting control).  Last year, Marcum stood by fully aware that B. Riley was hiding a $200 million margin loan to Brian Kahn in the middle of a management buyout that it financed.  B. Rily failed to disclose many related party transactions in interim financial statements.  Marcum apparently did not identify (or detect) such related parties which is likely why James LaRocca did not audit the firm’s financial statement in FY2023 despite being in year 1 of his 5 year rotation on the B. Riley account.  B. Riley sold shares to the public at $55/sh in the summer of 2023 while withholding this information (with Marcum potentially aware that this information was withheld from the public).

It looks like Marcum is again obviously dropping the ball and letting B. Riley get away with fraudulent interim reporting on a significant audit matter.

Vintage Capital Management Does Not Hold Freedom VCM Shares and Has No Business Purpose

B. Riley previously failed to disclose loans to Brian Kahn and his affiliates and only did so after we published UCC filings confirming these loans in November 2023 (which may very well be one of most egregious examples of securities fraud we have ever seen).  B. Riley has now disclosed the loan out to Vintage Capital Management, LLC (“Vintage” or “VCM”) in the amount of around $215 million including PIK interest (representing ~$200 million at original face before write-downs, and $15mm of accrued PIK interest).  B. Riley claims that the loan is collateralized by shares of Freedom VCM Holdings “Freedom VCM”.  Notably, according to B. Riley, Vintage owns no stock in Freedom VCM.  The stock collateralizing the loan is entirely from Brian Kahn and his wife (which is consistent with the UCC filings, in which the only secured interest attachment is to Brian Kahn and his wife, not to Vintage). From the 10-K:

“On August 21, 2023, one of the Company’s subsidiaries and Vintage Capital Management, LLC (“VCM”), an affiliate of Brian Kahn, amended and restated a promissory note (the “Amended and Restated Note”), pursuant to which VCM owes the Company’s subsidiary the aggregate principal amount of $200,506 and bears interest at the rate of 12% per annum payable-in-kind with a maturity date of December 31, 2027. The Amended and Restated Note requires repayments prior to the maturity date from certain proceeds received by VCM, Mr. Kahn or his affiliates from, among other proceeds, distributions or dividends paid by Freedom VCM in amount equal to the greater of (i) 80% of the net after-tax proceeds, and (ii) 50% of gross proceeds. The obligations under the Amended and Restated Note are primarily secured by a first priority perfected security interest in Freedom VCM equity interests owned by Mr. Kahn, the CEO and a board member of Freedom VCM as of December 31, 2023, and his spouse with a value (based on the transaction price in the FRG take-private transaction) of $227,296 as of August 21, 2023.”

[Emphasis Added]

Therefore, when we consider VIE analysis that requires us to look at the “significant activities of the VIE”.  Vintage has not been registered with the SEC since 2017.  The website is no longer active.  The fund claims to operate from Kahn’s home since January 2022. The hedge fund does not appear to be active or have any capital as it is not even an Exempt Registered Adviser.  Its last SEC filing was to show divestiture of all FRG shares on August 21, 2023. Therefore, it appears to be a shell vehicle with no activities other than filtering payments to B. Riley and serving as a vehicle to attach a loan.  B. Riley openly admits in its 10-K and 10-Q that repayment of the loan is linked to the performance of Freedom VCM, not to the operating results of Vintage. 

Therefore, even from B. Riley’s own description, Vintage functions as a collateralized financing entity (“CFE”) structure – filtering payments from Freedom VCM to B. Riley based on a formula provided above.  While Kahn may be a principal of Vintage, he has no control over the specific securitization structure – he merely has obligations to the VIE (namely, to provide certain proceeds from Freedom VCM to Vintage so that Vintage can pay B. Riley).  And he has importantly signed over rights relating to his Freedom VCM Interests to B. Riley, restricting his ability to sell, transfer or encumber them.

The failure in B. Riley’s accounting is that it treats Vintage as an operating entity when in fact it should be treated as a “securitization entity” given its non-existent business activities and role as largely a conduit for payments.  This is a basic VIE analysis, and the fact B. Riley got this one past Marcum is remarkable given Marcum has written white papers on the matter.

Marcum, B. Riley’s auditor, produced a marketing white paper on CFE accounting (a catch-all phrase for securitization type VIE arrangements):

A CFE is defined as an asset-backed financing or securitization entity typically with no substantive business purpose other than to issue beneficial interests in the financial assets it holds.

In this specific example, the Vintage entity purely functions with no substantive business purpose other than to serve as a middle-man conduit remitting payments from Brian Kahn’s Freedom VCM shares to B. Riley.  Vintage is merely the signatory on a loan agreement and that is it.  In fact, it issued beneficiary interests in financial assets that it does not even hold.  So Vintage is truly a conduit, and this entire arrangement is merely a securitization of Brian Kahn’s Freedom VCM shares.

Freedom VCM is what creates the “variability” in the Vintage VIE structure.  B. Riley’s loan to Vintage – which is backed by collateral held outside of Vintage and linked to a formulaic payment scheme much like a CLO or CDO – is clearly a CFE.  It benefits from higher prices of Freedom VCM and hurts from lower prices for Freedom VCM.  And the primary beneficiary of the Vintage VIE is clearly B. Riley.

B. Riley is the Primary Beneficiary of the Vintage CFE

To determine the primary beneficiary of the CFE, Marcum says that the VIE should be consolidated by the entity that has “The power to direct the activities of a VIE that most significantly impacts the VIE’s economic performance. In most cases, the asset manager will have the power to direct the activities”.

Here, B. Riley is the asset manager (the underlying beneficiary and owned of the security instrument which in this case is described as a “loan security”).  Given that the activities Vintage is engaged in are essentially limited to remitting payments, control very obviously rests with B. Riley.

According to FASB guidance, the only activity likely to significantly impact the economic performance of certain securitization entities includes the management of troubled assets.

Therefore, B. Riley has the only relevant right here – they manage foreclosure on the underlying collateral.  B. Riley acknowledges this fact, stating that it expects the loan and accrued interest will be largely paid from cash distributions from Freedom VCM or foreclosure on the underlying collateral (p. 10).  The cash distributions are formulaic loan servicer activities of Vintage as part of the loan agreement, and foreclosure is an action that only B. Riley has the power to control, therefore putting B. Riley in control of the VIE entirely as its primary beneficiary.

Additionally, B. Riley enjoys both the upside and downside participation from its VIE arrangement with Vintage.  According to B. Riley, the loan merely allows for interest to be paid-in-kind (p8).  This means it is possible that the loan would not be paid in kind and instead in cash.  However, in the same SEC filings, B. Riley indicates that the loan will be paid in kind going forward (as if it is the only option – see p12).  Therefore B. Riley clearly decided to consent to participating in equity upside in Franchise Group through the PIK interest that causes the loan balance to grow over time, effectively giving B. Riley “participation” in the equity upside (and therefore did participate in the design of the VIE).  The 12% PIK interest implies the equity return that B. Riley can participate in (effectively B. Riley has sold a covered call on equity upside above 12%).  On the other hand, B. Riley clearly participates in all the equity downside of Freedom VCM – if Freedom VCM goes bankrupt, B. Riley would absorb the entire loss associated with Brian Kahn’s pledged shares. B. Riley clearly enjoys all the economic benefits and costs of Kahn’s shares through both upside and downside.

Therefore, in summary, B. Riley is clearly the primary beneficiary of the Vintage securitization arrangement, having the ultimate power to foreclose on the underlying asset which is the only activity that can be undertaken in this securitization entity.  It also participates in 12% equity upside annually, and all the possible equity downside.  The underlying equity should have been consolidated onto B. Riley’s holdings.  Marcum is yet again looking the other way at obvious accounting problems just as it did last year when it failed to force disclosure of B. Riley’s secret loans to Brian Kahn that were highly material.

Related Party Analysis Points to Even More Proof of Requirement to Consolidate

It is important to note that Brian Kahn is also a related party of B. Riley.  Here, B. Riley is enjoying almost all the benefits and risks of Kahn’s shares – up to 12% annual upside and all the downside – while parking them in Kahn’s name through a purported VIE arrangement.  The instrument B. Riley is invested in is effectively an equity instrument by the way it is behaving, and in its most recent 10-Q filing, B. Riley appears to have reclassified its approach the valuation of the Vintage loan, moving over $200 million of loan receivables into the “Market price of related security” bucket (p20).  No other loan on B. Riley’s balance sheet could cause this big of a move quarter-over-quarter, so it appears B. Riley is now marking the loan based on the equity value of Franchise Group (although we do wonder what how the price of Freedom VCM could be considered a “market price”). This shift is an implicit acknowledgment that the loan is in fact an equity-linked derivative security held by a related party and de facto agent (not a “loan”).  This requires consolidation.

This makes it even more likely that B. Riley is the primary beneficiary of the shares because B. Riley is part of Kahn’s related party group, and B. Riley severely restricts Kahn’s ability to transact with the Freedom VCM shares and must approve his transactions. B. Riley already has a ~32% direct equity interest and a 27% managed interest in Freedom VCM Holdings (well over 50% of voting control).  Kahn’s shares very obviously should be consolidated and counted as B. Riley’s.

Additionally, Kahn is without power (because as lender, B. Riley has approval rights over sale, transfer and encumbrance of Kahn’s shares), and even if Kahn does have limited power, he is a related party and under the related party tie breaker rule, B. Riley clearly wins the tie-breaker (by virtue of being the primary party enjoying the economics of the underlying VIE). B. Riley therefore holds the power. Any way you cut it, B. Riley is the primary beneficiary of the Vintage VIE.

Kahn’s shares very obviously should be consolidated and counted as B. Riley’s.

It Appears B. Riley Has Been Manipulating Marks to Dress Up the VIE

Notably, the loan to value evolution also tells a story of a firm that is trying to hide the ball with VIE math.  See the implied loan to values on the FRG-collateralized Vintage loan below:

Amazingly, at year-end 2023, when the Franchise Group term loan was trading at 81c on the dollar suggesting severe distress, B. Riley marked up the value of its Franchise Group collateral by an interesting number – +2%.  Likely not coincidentally, that markup led to the loan to value on the Vintage instrument to hit exactly 90%, suggesting that the VIE had about 10% equity.  This is significant and looks potentially fraudulent on its face.  In line with the year end audit, and with absolutely no basis in reason whatsoever, B. Riley moved up the value of its collateral in Freedom VCM to create the appearance that Vintage had the generally accepted minimal threshold equity at risk in the loan structure (10%).  This mark-up should have caught the attention of Marcum.  The markup appears to be indefensible given the term loan traded deeply distressed and Franchise Group had been double downgraded by the ratings agency by the end of the year, and its operating companies had materially underperformed underwriting expectations, providing absolutely no basis for increase in value.  Notably, for bulls that will point to Sylvan – that asset was not sold until 1Q24, so should not have been captured in the YE23 mark in any case.  In fact, it is telling that B. Riley ultimately wrote down its investment in Franchise Group in the quarter the Sylvan sale occurred.

Today, B. Riley’s Vintage “loan” has no excess equity (but somehow magically has ended up in a 100% LTV level based on the current mark and 109% LTV based on the original promissory note face value).  If B. Riley liked the investment case from here so much, why not voluntarily consolidate the entity onto its balance sheet?  Bryant Riley has repeatedly claimed he wanted to own the whole company – well he does have the ability (and likely obligation) to own the entire company because he is sitting on 84% of voting shares yet he is electing to use suspect and indefensible accounting to AVOID consolidation.  This is telling.

Conclusion

There is little doubt B. Riley should have consolidated Franchise Group by 4Q23 and 1Q24 at the very latest (after Brian Kahn ceded control).  B. Riley arranged for a payment to get Kahn to leave his role and give up control.  This left B. Riley with the economic equivalent of 84% of the voting shares of Franchise Group and no super-voting control alternative to B. Riley.  B. Riley orchestrated Kahn’s exit, exerting clear control.  B. Riley’s supposed loan is underwater, and even on a VIE basis, B. Riley is essentially participating in a standard equity instrument albeit parking it in a related party’s hands to avoid consolidation.  With just its clients shares alone it appears B. Riley needs to consolidate – once Kahn stock is taken into account the gamesmanship is glaringly obvious. This is exactly what the VIE accounting did not want to have happen.

“A reporting entity could avoid consolidation of a VIE by “parking” its interests with a third party and controlling that party’s actions by restricting its ability to sell, transfer, or encumber its interest.”

Brian Kahn is a related party and part of B. Riley’s group.  His pledged shares are encumbered by B. Riley, and B. Riley enjoys both the upside and downside of the shares as if they were equity.  Kahn clearly cannot transfer or sell the shares without approval from B. Riley.  In fact, Bryant Riley has bragged that the share certificates are even in possession of B. Riley.  Bryant Riley has repeatedly claimed that the loan is perfected and secured and that B. Riley has strong control over the collateral.  If true, this means that B. Riley likely restricts Brian Kahn’s ability to sell, transfer, or encumber his interest.  In fact, B. Riley has publicly stated that Prophecy claims against the collateral would be without merit because of the strength of B. Riley’s control over the collateral (this claim may very well be false, but B. Riley has postured this publicly so must now stand by it).  B. Riley therefore believes that it controls the collateral.

B. Riley clearly claimed that its loans with Brian Kahn were at arms’ length – it had to walk back that claim in the 10-K and has never made that claim again in an audited financial statement.  It also covered up the fact that Brian Kahn was a related party until Marcum apparently forced B. Riley’s hand.  In the latest iteration of lies from B. Riley, it is making up fanciful accounting stories to justify the lack of consolidation of Franchise Group.  But the analysis is straight forward.

There is no doubt that B. Riley is just parking stock in Kahn’s name to avoid consolidation.  It is also failing to disclose the 27% of voting shares it controls on behalf of clients – referring to this bucket as an obscure and misleading “Others” category in the analyst day deck (p62). 

Kahn has essentially no control over his Freedom VCM shares pledged to B. Riley, B. Riley is bestowed with both the upside and downside associated with these shares in a structure that resembles traditional equity.  This is obvious VIE accounting – B. Riley needs to consolidate the shares of Kahn as the primary beneficiary of the Vintage VIE arrangement with all the economic exposure.

We close with our opening question:

How did B. Riley gain control of 84% of the voting shares of a company that it helped take private, force out the company’s CEO/Chairman with a sham unsecured loan, and then disavow having control of the company?  What world are we living in that Marcum would sign off on this nonsense?

In summary, B. Riley got away with failing to disclose extremely material related party dealings throughout its 2023 interim filings, merger proxy for the Franchise Group deal, and prospectus for a secondary offering.  This led to B. Riley taking Franchise Group private while failing to disclose that it was sitting on a secret, undisclosed and underwater margin loan to Brian Kahn, the company’s then CEO (and purported leader of the buyout).  B. Riley seems to be highly motivated to avoid consolidation of Franchise Group though the improper use of the VIE; our question again is where is Marcum?

APPENDIX LINKS

Both documents below can be sourced from the Franchise Group FY23 Audited Financial Statements – which can be found in the American Freight FDD which can be downloaded here.

Exhibit A:

Exhibit B: