Broker-dealer’s parent gets its stock out of hock from a pawn shop

With financing as tight as ever for independent broker-dealers these days, one holding company, which owns an independent firm, took the unusual step of turning to a network of pawn shops to clean up its balance sheet.

Capital Financial Holdings Inc. last fall signed a stock purchase agreement and promissory note with PawnMart Inc., a chain of 29 pawn shops in Georgia and Charlotte, N.C., according to Capital Financial Holdings' most recent quarterly report from November.

Capital Financial Holdings, the parent of independent broker-dealer Capital Financial Services, originally sold the $950,000 convertible note to PawnMart in 2006.

The transaction last fall involved a buyback of 3,050,000 shares of outstanding Capital Financial Holdings preferred stock from PawnMart. In exchange, PawnMart received a promissory note in the amount of $1.3 million, which valued the company stock at about 43 cents a share.

“We wanted to start buying [the stock] back a bit at a time, and it was cleaner to [do that] as a note with principal and interest,” said John Carlson, chief executive and president of Capital Financial Holdings and chief compliance officer of the broker-dealer.

There is a strong link between Capital Financial Holdings and PawnMart. Jeffrey Cummer, the chairman of Capital Financial Holdings, is also the chief executive of Xponential Inc., which operates PawnMart.

When Capital Financial Holdings entered into the agreement with PawnMart in 2006, it was called Integrity Mutual Funds and used the money for a number of initiatives, including the expansion of its broker-dealer, Capital Financial Services, Mr. Carlson said.

In 2009, the company sold the mutual funds and changed its name to Capital Financial Holdings.

Capital Financial Services, a Minot, N.D.-based independent broker-dealer with 300 representatives, is the main business unit of Capital Financial Holdings.

The note carries a 7% interest rate, and Capital Financial Holdings will pay 24 monthly installments of $66,801.

Capital Financial Holdings is publicly traded and listed on the over-the-counter bulletin board under the symbol CPFH. As of last Thursday afternoon, it was trading at around at 61/2 cents a share.

To be sure, financing for all stripes of broker-dealers is tightening these days. Ticonderoga Securities LLC, a boutique investment banking, sales and trading firm, was set to close last week after an attempt to boost capital fell through, according to Bloomberg News.

Parent companies of independent broker-dealers GunnAllen Financial Inc. and QA3 Financial Inc. were forced in 2010 and 2011, respectively, into bankruptcy protection. Both ran out of money to pay for rising legal fees and settlements with clients due to a series of failed private investments.

Capital Financial Holdings said in the November report that its cash on hand declined over the past year. As of Sept. 30, the company held $1.2 million in cash and cash equivalents, as compared with $2.2 million at the end of 2010, according to the November filing.

The company also said in that report that it has no lines of credit available. Mr. Carlson was quick to note that the cash on hand is lower because $950,000 went to buy back stock from PawnMart. He added that the firm has no lines of credit because it has not applied for any.

MEDCAP, PROVIDENT

Capital Financial Services was one of the leading sellers during the past decade of two series of private placements that failed and were later accused of being fraudulent by the Securities and Exchange Commission.

Capital Financial reps sold $100 million of Medical Capital Holdings Inc. notes and $60 million of Provident Royalties LLC preferred shares.

Capital Financial Services generated about $19 million in fees and commissions in 2010, according to its filings with the SEC.

The broker-dealer industry has been clobbered by the recession and its aftermath, with brokers routinely complaining about investor fear of the volatile stock market, which has led to lower trading volume and lower commissions. Small and mid-size broker-dealers, meanwhile, also face increased costs due to new initiatives by securities regulators that eat into firms' profit margins.

In August, the Financial Industry Regulatory Authority Inc. and Capital Financial reached a $200,000 settlement over the sale of the failed private deals.

According to a Finra letter of acceptance, waiver and consent, Capital Financial Services “failed to have reasonable grounds to believe that private placements offered by Medical Capital Holdings Inc. and Provident Royalties LLC, pursuant to Regulation D, were suitable for any customer.”

The firm also “failed to conduct adequate due diligence” on the two series of offerings and to put in place a supervisory system to achieve compliance when selling the private placements, according to the Finra letter.

And in the aftermath of the Finra private-placement findings, the SEC ordered Capital Financial Services on Dec. 16 to hire an independent consultant within 60 days and to cooperate fully with that consultant's findings, according to the firm's profile on Finra BrokerCheck.

Mr. Carlson said that the firm was well on its way to completing that requirement.

Xponential operates PawnMart and also holds a significant minority stake in Capital Financial Holdings. According to its website, Xponential owns 1.66 million shares, or 12.13%, of the common stock of Capital Financial Holdings.

That position is separate from the preferred shares that the company bought back in the PawnMart transaction, according to the Xponential website.

Xponential chief financial officer Robert Schleizer didn't return calls seeking comment.

The PawnMart transaction was announced weeks before another broker-dealer, B.B. Graham & Co. Inc. of Orange, Calif., said it was willing to enter into a transaction to buy certain assets of Capital Financial after a due diligence review and other consideration. B.B. Graham president Bruce Graham owns 5.4% of Capital Financial Holdings shares, according to SEC filings, while William L. Graham owns 1.3%.

It isn't clear whether William Graham is employed by B.B. Graham. Bruce Graham didn't return phone calls seeking comment.

Mr. Carlson said that he has “no idea” where the interest of Mr. Graham will lead and that “nine times out of 10,” such potential transactions fizzle.

“Most of the time, it doesn't work out,” Mr. Carlson said.

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