Wayward Merchants

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This story appeared in deBanked’s Mar/Apr 2018 magazine issue. To receive copies in print, SUBSCRIBE FREE

Wayward merchants and outright criminals are continuing to bilk the alternative small-business funding industry out of cash at a dizzying pace. In fact, an estimated 23 percent of the problematic clients that funders reported to an industry database in 2017 appeared to have committed fraud, up from approximately 17 percent in the previous year. That’s according to Scott Williams, managing member of Florida-based Financial Advantage Group LLC, who along with Cody Burgess founded the DataMerch database in 2015. Some 11,000 small businesses now appear in the database because they’ve allegedly failed to honor their commitments to funders, Williams says.

Whether fraudulent or not, defaults remain plentiful enough to keep attorneys busy in funders’ legal departments and at outside law firms funders hire. “I do a lot of collections work on behalf of my cash-advance clients, sending out letters to try to get people to pay,” says Paul Rianda, a California-based attorney. When letters and phone calls don’t succeed, it’s time to file a lawsuit, he says.

Lawsuits become necessary more often than not by the time a funder hires an outside attorney, according to Jamie Polon, a partner at the Great Neck, N.Y.- based law firm of Mavrides Moyal Packman Sadkin LLP and manager of its Creditors’ Rights Group. “Typically, my clients have tried everything to resolve the situation amicably before coming to me,” he observes.

That pursuit of debtors isn’t getting any easier. These days, it’s not just the debtor and the debtor’s attorney that funders and their attorneys must confront. Collections have become more difficult with the recent rise of so-called debt settlement companies that promise to help merchants avoid satisfying their obligations in full, notes Katherine Fisher, who’s a partner in the Maryland office of the law firm of Hudson Cook LLP.

robber oil paintingMeanwhile, a consensus among attorneys, consultants and the funders themselves holds that the nature of the fraudulent attacks is changing. On one side of the equation, crooks are hatching increasingly sophisticated schemes to defraud funders, notes Catherine Brennan, who’s also a partner in the Maryland office of Hudson Cook LLP. On the other side, underwriters and software developers are becoming more skilled at detecting and thwarting fraud, she maintains.

Digitalization is fueling those changes, says Jeremy Brown, chairman of Bethesda, Md.-based RapidAdvance. “As the business overall becomes more and more automated and moves more online – with less personal contact with merchants – you have to develop different tools to deal with fraud,” he says.

A few years ago, the industry was buzzing about fake bank statements available on craigslist, Brown recalls. Criminals who didn’t even own businesses used the phony statements to borrow against nonexistent bank accounts, and merchants used the fake documents to inflate their numbers.

Altered or invented bank statements remain one of the industry’s biggest challenges, but now they’ve gone digital. About 85 percent of the cases of fraud submitted to the DataMerch database involve falsified bank documents, nearly all of them manipulated digitally, Williams notes.

Merchants alter their statements to overstate their balances, increase the amount of their monthly deposits, erase overdrafts, or hide automatic payments they’re already making on loans or advances, Williams says. Most use software that helps them reformat and tamper with PDF files that begin as legitimate bank statements, he observes.

To combat false statements, alt funders are demanding online access to applicants’ actual bank accounts. Some funders ask for prospective clients’ usernames and passwords to examine bank records, but applicants often consider such requests an invasion of their privacy, sources agree.

That’s why RapidAdvance has joined the ranks of companies that use electronic tools like DecisionLogic, GIACT or Yodlee to verify a bank balance or the owner of the account and perform test ACH transfers – all without needing to persuade anyone to surrender personally identifiable information, Brown says.


Other third-party systems can use an IP address to view the computing device and computer network that a prospective customer is using to apply for credit, Brown says. RapidAdvance has received applications that those tools have traced to known criminal networks. The systems even know when crooks are masking the identity of the networks they’re using to attempt fraud, he observes.

RapidAdvance has also developed its own software to head off fraud. One program developed in-house cross references every customer who’s contacted the company, even those who haven’t taken out a loan or merchant cash advance. “People who want to defraud you will come back with a different business name on the same bank account,” Brown says. “It’s a quick way to see if this is somebody we don’t want to do business with.”

Sometimes businesses use differing federal tax ID numbers to pull off a hoax, according to Williams at DataMerch. That’s why his company’s database lists all of the ID numbers for a business.

All of those electronic safeguards have come into play only recently, Brown maintains. “We didn’t think about any of this five years ago – certainly not 10 years ago,” he says. In those days, funders were satisfied with just an application and a copy of a driver’s license, he remembers.


Since then, some sage advice has been proven true. When RapidAdvance was founded in 2005, the company had a mentor with experience at Capital One, Brown says. One piece of wisdom the company guru imparted was this: “Watch out when the criminals figure out your business model.” That’s when an industry becomes a target of organized fraud.

As that prediction of fraud has become reality, it hasn’t necessarily gotten any easier to pinpoint the percentage of deals proposed with bad intent. That’s because underwriters and electronic aids prevent most fraudulent potential deals from coming to fruition, Brown notes. The company looks at the loss rates for the deals that it funds, not the deals it turns down.

Brown guesses that as many as 10 percent of applications are tainted by fraudulent intention. “It’s meaningful enough that if you miss a couple of accounts with significant dollar amounts,” he says, “then it can have a pretty negative impact on your bottom line.”

Some perpetrators of fraud merely pretend to operate a small business, and funders can discover their scams if there’s time to make site visits, Rianda notes. Other clients begin as genuine entrepreneurs who then run into hard times and want to keep their doors open at all costs, sources agree.

underwriterApplicants sometimes provide false landlord information, something that RapidAdvance checks out on larger loans, Brown notes. Underwriters who call to verify the tenant-landlord relationship have to rely upon common sense to ferret out anything “fishy,” he advises.

Underwriters should ask enough questions in those phone calls to determine whether the supposed landlord really knows the property and the tenant, which could include queries concerning rent per square foot, length of time in business and when the lease terminates, Brown suggests. All of that should match what the applicant has indicated previously.

Lack of a telephone landline may or may not provide a clue that an imposter is posing as a landlord, Brown continues. Be aware of a supposed landlord’s verbal stumbles, realize something’s possibly amiss if a dubious landlord lacks of an online presence, note whether too many calls to the alleged landlord go into voicemail and be suspicious if a phone exchange with a purported landlord simply “feels” residential instead of commercial, he cautions.

Reasonable explanations could exist for any of those concerns, but when in doubt about the validity of a tenant-landlord relationship it pays to request a copy of the lease or other type of verifications, according to Brown. Then there are the cases when the underwriter is talking to the actual landlord, but the applicant has convinced the landlord to lie. It could happen because the landlord might hope to recoup some back rent from a merchant who’s obviously on the verge of closing up shop.

Occasionally, formerly legitimate merchants turn rogue. They take out a loan, immediately withdraw the funds from the bank, stop repaying the loan, close the business and then walk or run away, notes Williams. “We view that as a fraudulent merchant because their mindset all along was qualifying for this loan and not paying it back,” he says.

Collecting on a delinquent account becomes problematic once a business closes its doors, Rianda notes. As long as the merchant remains in business, funders can still hope to collect reduced payments and thus eventually get back most or all of what’s owed, he maintains.

In another scam sometimes merchants whose bank accounts are set up to make automatic transfers to creditors simply change banks to halt the payments, Brown says. That move could either signal desperation or indicate the intent to defraud was there from the start, he says.

Merchants with cash advances that split card revenue could change transaction processors, install an additional card terminal that’s not programmed for the split or offer discounts for paying with cash, but those scams are becoming less prevalent as the industry shifts to ACH, Brown says. Industrywide, only 5 percent to 10 percent of payments are collected through card splits these days, but about 20 percent of RapidAdvance’s payments are made that way.

Merchants occasionally blame their refusal to pay on partners who have absconded with the funds or on spouses who weren’t authorized to apply for a loan or advance, Brown reports. Although that claim might be bogus, such cases do occur, notes Williams of DataMerch. People who own a minority share of a business sometimes manipulate K-1 records to present themselves as majority owners who are empowered to take out a loan, Williams says.

In a phenomenon called “stacking,” merchants take out multiple loans or advances and thus burden themselves with more obligations than they can meet. Whether or not that constitutes fraud remains debatable, Rianda observes. Stacking has increased with greater availability of capital and because some funders purposely pursue such deals, he contends.

Some contracts now contain covenants that bar stacking, notes Brennan of Hudson Cook. As companies come of age in the alt-funding business, they are beginning to employ staff members to detect and guard against practices like stacking, she says.

Moreover, underwriting is improving in general, according to Polon “The vetting is getting better because the industry is getting more mature,” he says. “The underwriting teams have gotten very good at looking at certain data points to see something is wrong with the application – they know when something doesn’t smell right.” They’re better at checking with references, investigating landlords, examining financials and requesting backup documentation, he contends.

Despite more-systematic approaches to foiling the criminal element and protecting against misfortunate merchants, one-of-a-kind attempts at fraud also still drive funders crazy, Brown says. His company found that a merchant once conspired with the broker who brought RapidAdvance the deal. The merchant and the broker set up a dummy business, transferred the funds to it and then withdrew the cash. “The guy came back to us and said, ‘I lost all the money because the broker took it,’” he recounts. “Why is that our problem?” was the RapidAdvance response.

Although such schemes appear rare, some funders are developing methods of auditing their ISOs to prevent problems, notes Brennan. They can search for patterns of irregularities as an early-warning system, she says. It’s also important to terminate relationships with errant brokers and share information about them, she advises, adding that competition has sometimes made funders reluctant to sever ties with brokers.


policeAlthough fraud’s clearly a crime, the police rarely choose to involve themselves with it, Brown says. His company has had cases where it lost what it considered large dollar amounts – say $50,000 – and had evidence he felt clearly indicated fraud but the company couldn’t attract the attention of law enforcement, he notes.

Rianda finds working with law enforcement “hit or miss,” whether it’s a matter of defaulting on loans or committing other crimes. In one of his cases an employee forged invoices to steal $100,000 and the police didn’t care. In another, someone collected $3,000 in credit card refunds and went to jail. If the authorities do intervene, they may seek jail time and sometimes compel crooks to make restitution, he notes.

“Engaging law enforcement is generally not appropriate for collections,” according to Fisher from Hudson Cook. However, notifying police agencies of fraud that occurs at the inception of a deal can sometimes be appropriate, says Fisher’s colleague Brennan, particularly when organized gangs of fraudsters are at work.

At the same time, sheriffs and marshals can help collect judgments, Polon says. He works with attorneys, sheriffs and marshals all over the country to enforce judgments he has obtained in New York State, he says. That can include garnishing wages, levying a bank account or clearing a lien before a debtor can sell or refinance property, he notes.

When Rianda files a lawsuit against an individual or company in default, the defendant fails to appear in court about 90 percent of the time, he says. A court judgment against a delinquent debtor serves as a more effective tool for collections than does a letter an attorney sends before litigation begins, Rianda notes.

But even with a judgment in hand, attorneys and their clients have to pursue the debtor, often in another state and sometimes over a long period of time, Rianda continues. “The good news is that in California a judgment is good for 10 years and renewable for 10,” he adds.

So guarding against fraud comes down to matching wits with criminals across the country and around the world. “It makes it hard to do business, but that’s the reality,” Brown concludes. Still, there’s always hope. To combat fraud, funders should work together, Brennan advises. “It’s an industrywide problem … so the industry as a whole has a collective interest in rooting out fraud.”

Last modified: April 20, 2019

Category: Business Lending, merchant cash advance

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