by Filing says 3 co-conspirators “caused Prophecy to spend investor funds on risky, highly illiquid investments, including investments into Kahn entities, for which Prophecy Asset Management performed little to no due diligence.”
The SEC filed suit against former Franchise Group CEO Brian Kahn yesterday afternoon for “a multi-year investment adviser fraud orchestrated” by Kahn and Prophecy Asset Management (PAM). The SEC puts the cost of this fraud to investors at $350 million, according to the filing.
The complaint for violations of federal securities laws centers on Prophecy, a hedge fund, and on a fraud scheme already admitted to by John Hughes, co-founder of PAM. The SEC alleges that Kahn and a third co-conspirator, Jeffrey Spotts, deceived investors by falsely claiming they were putting their money into an investment that minimized risk.This month, the Department of Justice announced that both Spotts and Hughes had been arraigned on charges of conspiracy to commit wire fraud and securities fraud. Hughes pleaded guilty to the charges in January 2024.
Several news outlets and lawsuits subsequently named Kahn as the third co-conspirator, and according to Bloomberg’s reporting, Kahn was a money manager for PAM with control of 86% of Prophecy’s funds at the time the money went missing. Previously, Kahn has denied knowledge of or involvement in the fraud. He has not yet responded to the SEC’s lawsuit.
According to the SEC’s filing, the three co-conspirators “caused Prophecy to spend investor funds on risky, highly illiquid investments, including investments into Kahn entities, for which PAM performed little to no due diligence.”
The SEC further claims that to conceal the hundreds of millions of dollars in losses, the co-conspirators fabricated documents demonstrating that Kahn had adequate collateral and engaged in a “series of sham transactions to inflate the apparent value of Prophecy’s assets,” according to the lawsuit.
Going viral
Just as Covid became a reality in March 2020, so did the losses at PAM, with actual losses totaling $350 million, according to the SEC. PAM’s auditor resigned, and PAM simply shut down.
The SEC charged Hughes with securities fraud in November 2023, and he was criminally charged, as well. His sentencing was recently delayed until March next year.
The damage done to PAM and its investors by Kahn, who participated in the fraud as a “sub-advisor” to PAM, according to the SEC, was sustained and substantial. These losses exceeded the cash collateral Kahn contributed by $55 million in November 2018, $216 million in November 2019 and $328 million in March 2020, according to the filing. PAM, Spotts and Hughes were aware of these losses, yet they allowed Kahn to keep trading, the SEC alleges.
“PAM, Spotts and Hughes knew, or were reckless in not knowing, that, by January 2020, Kahn’s use of leverage resulted in cumulative losses of approximately $270,000,000, which was more than 74% of the reported assets under management,” according to point No. 79 of the filing.
PAM principals used what amounted to smoke and mirrors to hide the losses, according to the SEC, including no fewer than four payments to Kahn-owned entities with no assets or operations, payments that were immediately returned to PAM but that were masked as collateral contributions from Kahn.
Sham transaction?
For example, in a November 2017 series of transactions, PAM wired $5 million to Kahn’s empty or “paper” company, AGS Enterprises, which then wired the same amount to a second Kahn entity, Samjor Family, which then “immediately” wired the money back to Prophecy to be recorded as a cash collateral contribution, according to the detailed descriptions in the SEC filing. This was the general sequence repeated several times and with several “paper” entities or subsidiaries.
The SEC further claims that Kahn forged the signature of a former colleague as the signer of a loan agreement for a loan that was never extended: “Kahn’s former colleague had no knowledge of this transaction,” the filing states.
As the losses continued to mount, the efforts to obfuscate them became more complex, the SEC’s filing describes, including the use of FRG subsidiary Buddy’s Newco to show PAM as an owner of $125 million of Buddy’s stock that could be used as collateral to secure Kahn’s 2018 trading losses.
“In reality,” the SEC claims, “Buddy’s Newco LLC Series A Preferred Shares were never issued to Prophecy or anybody else because the shares never existed. The entire agreement and transaction was a sham” created by the co-conspirators.
Backdating
The creation of imaginary Buddy’s stock was repeated in 2019, and again it used the backdating of documents to try to persuade PAM’s auditor that the shares were real, the SEC further describes. PAM failed to disclose to investors the millions in non-cash collateral assets it was purportedly accepting, only that PAM “may” accept non-cash collateral, the filing states.
As part of yet another series of sham transactions, according to the SEC’s descriptions, Kahn forged the signature of his then 13-year-old son, using that son’s first and middle name, to conceal Kahn’s role in “clearing the books” for PAM relating to its dealings with a company called Broad Reach.
“Broad Reach turned out to be a Ponzi-like, fraudulent scheme,” the filing claims.
Making seven claims for relief, the SEC asks the U.S. District Court in Trenton, New Jersey, to restrain and enjoin PAM, Spotts and Kahn from violating a raft of cited statutes, to force the defendants to “disgorge all ill-gotten gains or unjust enrichment” and to pay civil penalties, and it asks the court to bar Spotts and Kahn from serving as an officer or a director of a public company, according to the filing.
AF Newco lawsuit
FRG once comprised American Freight, Buddy’s Home Furnishings, Pet Supplies Plus and The Vitamin Shoppe. All that remains is Buddy’s.
Last week, the new owners of Franchise Group, led by Octagon Credit Investors and Garnett Station Partners, filed suit in bankruptcy court against AF Newco, accusing the buyer of American Freight assets of breach of contract, threats to delete critical corporate records and misleading the court about ties to Brian Kahn.
The complaint paints a picture of a company engaging in obstruction, delay and even attempted coercion. The allegations, if upheld, could expose AF Newco to damages, court orders and reputational harm.
AF Newco was approved as the buyer of 31 American Freight stores in January for $1.12 million, or an average of $36,000 per location. At that bankruptcy court hearing, testifying on behalf of AF Newco was Michael Piper, the group’s “managing member” and once CFO at Liberty Tax, where he reported to Kahn.
The SEC lawsuit does not map the many intersections of the fortunes of Prophecy, B. Riley Financial and FRG through Kahn’s many companies and subsidiaries, including Vintage Capital Management, Vintage Tributum and Vintage Panther, among others.
