Investment advisory firm B. Riley Financial (RILY 0.78%) is facing some uncomfortable questions about its links to an ongoing fraud investigation, and investors are getting nervous. Shares of B. Riley are trading down 22% as of 11 a.m. ET Monday as the market tries to make sense of the reports.
Fraud headlines are taking their toll
B. Riley provides financial services including asset management services, equity research, and direct investments to corporate, institutional, and high-net-worth-individual clients. It is one particular investment, its involvement in the August buyout of Franchise Group, that has investors on edge.
The company invested $216.5 million in the $2.8 billion management-led buyout of Franchise, which owns a portfolio of retail businesses including Pet Supplies Plus, The Vitamin Shoppe, Badcock Home Furniture, and Sylvan Learning.
Last week, John Hughes, a co-founder of Prophecy Asset Management, which is not related to B. Riley, pled guilty in a $294 million fraud case. Hughes said he worked with two co-conspirators, including the CEO of a multibillion-dollar retail franchise company. That CEO has not been named, but Bloomberg reported that it is Franchise CEO Brian Kahn.
Kahn has denied involvement, and the news story notes that it is not clear whether he is facing any charges.
Is B. Riley a buy after its severe fall?
Last week, B. Riley management told investors that it "continue[s] to closely monitor relevant developments" but remains confident in its Franchise holding.
"We would have bought all of Franchise Group. We are a huge fan of that business," CEO Bryant Riley said. "I want to just be clear. I believe we are going to make a lot of money for our shareholders and Franchise Group."
That may prove to be true, but investors hate uncertainty, and federal fraud investigations are nothing if not thorough. The market's reaction suggests that Riley's reassurances are, at least for now, falling on deaf ears.
Shares of B. Riley have lost about half their value this month. If this all blows over without any further headlines, or if Franchise Group performs to expectations, that drop is likely to be reversed, and investors stand to make a significant return from buying in today.
But those buying in also have to understand there is still downside risk from here if the investigation continues, or if Franchise ends up not being the investment it appeared to be just a few months ago. Investors need to tread carefully here.
