Archive for 2019
Is The Definition Of Accredited Investor Ripe For Change?
October 26, 2019
The definition of accredited investor, which the SEC is tackling this year, is causing a fair amount of debate.
At issue is the fact that under federal securities laws only persons who are accredited investors may participate in certain types of securities offerings.
As it now stands, to be deemed an accredited investor, a person needs to earn income of more than $200,000 ($300,000 with a spouse) in each of the prior two years and reasonably expect to earn the same for the current year. Alternatively, the person needs to have a net worth of $1 million or more (alone or with a spouse), excluding the value of a primary residence.
The goal of these rules, of course, is investor protection. In theory, the rules are supposed to ensure investors are sophisticated enough to invest in riskier investments and, on top of that, have adequate cushioning against the risk of financial loss.
The trouble, critics say, is that the rules aren’t doing a very good job of achieving these objectives. There’s widespread agreement that the current definition is flawed. Where it gets trickier is in deciding how it should be fixed.
There are some who say the current bar is too high, others who say it’s too low. Some contend that the wealth-based test should be scrapped altogether in favor of a sophistication test. Others promote a sliding scale approach to investing in riskier offerings. This would allow all investors to participate, but in increments that are proportional to their wealth—similar to what happens in the crowdfunding arena today. Some industry players support a combination of measures, a sophistication test in connection with a sliding scale, to maximize investor protection and still open the playing field for others who can’t participate today based on their income or net worth.
The varying opinions are likely to be debated by the SEC as it reviews the accredited investor definition, which it’s required to do every four years by a provision in the Dodd-Frank Act. The SEC is taking the opportunity to do a broad-based review of the regulatory framework for investing in alternative assets; the accredited investor definition is just one of the areas on its docket to examine. The comment period for this review ended on August 30th.
At this point, what the SEC actually decides to do about the accredited investor definition is anybody’s guess. The thrust of these conversations is likely to focus on what constitutes an appropriate degree of protection, which is where many of the disagreements—and alternative suggestions on how to best accomplish this— come into play.
VETTING THE VARIOUS OPINIONS
On one hand, consumer advocates want to maintain the highest degree of investor protection possible. The concern is that consumers generally don’t have enough prowess or information to safely invest in unregistered offerings, which can carry more risk than registered investments.
“We don’t want the definition to be any weaker than it is now because that would do the vast majority of consumers a disservice,” says Brian Young, public policy manager at the National Consumers League. “With these exempt products, there are a lot of unknown variables and there’s a lot more vulnerability,” he says.
One suggestion that’s being proposed is to raise the wealth and income levels to adjust for inflation. It’s a step in the right direction because it would further limit who is eligible to be considered an accredited investor, says Barbara Roper, director of investor protection for the Consumer Federation of America. “The levels haven’t kept pace with inflation since they were set,” she says.
This alone, however, wouldn’t be sufficient to protect investors, consumer advocates say, since there are plenty of wealthy people who have little to no investment prowess.
“Just changing it to correct for inflation doesn’t change it to correct for sophistication and still places investors at risk,” says Ed Mierzwinski, who oversees U.S. PIRG’s federal consumer program, helping to lead national efforts to improve consumer credit reporting laws, identity theft protections, product safety regulations and more.
On this point consumer advocates and industry professionals seem to agree: that limits based on income or net worth aren’t all that useful.
Roper of the Consumer Federation of America gives the example of a 64-year-old who has $200k in income or $1 million of assets in his or her retirement accounts. This doesn’t mean he or she is financially literate, let alone sophisticated enough to take part in certain types of riskier alternative investments, she says. “That would be an inappropriate investment recommendation if it were made by your broker or investment advisor,” she says.
Some industry professionals also find fault with the wealth test, but, unlike consumer advocates, they’d like to see more investors allowed to participate, not fewer. It’s not right, they contend, that a wide range of highly educated people are prevented from investing in certain offerings because of arbitrary limits on net worth and income.
Many promising investment opportunities are not even being offered to a huge majority of American investors, based on the standards that exist today, according to Nat Hoopes, executive director of the Marketplace Lending Association, an industry trade organization.
“By harmonizing and simplifying complex rules and adjusting the current accredited investor standards, my hope is that the SEC will find that they can permit many more Americans to gain access to a wider range of well regulated investment opportunities, without leaving those citizens exposed to fraud or abuse. Done right, changes from the SEC in this area will help to promote more equality of opportunity in our economy, without adding new red tape,” he says.
Brew Johnson, co-founder and chief executive of PeerStreet, an online platform for investing in real estate debt, says it’s “crazy” that people who are highly educated—such as MBAs, accountants, attorneys and other businesspersons can’t invest in certain offerings simply because they don’t have the income or wealth levels. He takes issue with the fact that he didn’t qualify to invest on his own platform when it was first getting off the ground. Some of his employees today also don’t qualify to invest in the platform they are helping to build, which is troubling, he says.
“You don’t want people to make terrible decisions. But the idea that the average person is too dumb to make decisions with their money…is offensive,” Johnson says. Today, there’s much more readily available information and transparency—a significant change from when the rules were first put in place—when only the largest investors had access to the types of information necessary to make critical investment decisions, he says.
Johnson doesn’t take issue with the goal of protecting investors from getting into things they don’t understand. Rather, he says, “I don’t believe wealth is a determiner of sophistication.”
ALTERNATIVE PROPOSALS TO A WEALTH-BASED TEST
That’s where another idea being floated by members of the Marketplace Lending Association and others may come in. The thought is to create a new way to measure an investor’s level of sophistication and ability to withstand loss. An example of this could be some kind of test to identify investors who are deemed to have sufficient investment prowess, despite falling below the SEC’s threshold based on wealth or net worth, to participate in certain types of offerings.
It’s an option that, if adopted, could open up the playing field to additional investors—while still trying to accomplish the SEC’s goal of investor protection, industry participants say.
Ryan Metcalf, head of U.S. Regulatory Affairs at Funding Circle, says the Financial Industry Regulatory Authority Inc. (FINRA) could develop a test to be administered online when an investor who doesn’t meet the wealth or income bar wants to invest. This would allow quick-decisions to be made. People who want to invest a few thousand dollars shouldn’t have to do it in person; this would be too onerous, he says.
There could even be different tests based on what investors are seeking to invest in, says Mark Atalla, owner and managing director at private lending firm Carlyle Capital.
For a private placement in a mortgage fund, there could be questions related to the risks involved there, whereas for a private placement in a start-up technology company, there could be other types of questions pertaining to risk. The goal would be to ensure the investor has a sufficient level of understanding about the particular products they are considering.
Otherwise, Atalla says, there’s too much room for people to lose on a large scale. “These are people’s livelihoods you’re responsible for at the end of the day,” he says. “I think it’s important for investors to understand what they are really doing.”
Some industry professionals say there may be too many practical limitations for this type of an assessment to work. Certainly details would have to be worked out including what the scope of the test or tests should be. Decisions would also have to be made about who would be in charge of creating and administering a test or tests and how and where they would be administrated, among other things.
In theory, if someone can pass a test to show he or she is knowledgeable about investing, the person should be able to invest, says PeerStreet’s Johnson, adding that there’s something to be said about people accepting personal responsibility for their decisions, provided they have been given adequate information from which to make informed, knowledgeable decisions. “The devil is in the details of what [this type of test] would look like,” he says.
Another idea being floated—that could stand on its own or be implemented together with a sophistication test—is to allow all investors to invest on a scale that’s similar to the crowdfunding exemption. Under rules adopted by the SEC in 2015, the general public now has the opportunity to participate in the early capital raising activities of start-up and early-stage companies and businesses by way of crowdfunding. Because of the risks involved with this type of investing, however, investors are limited in how they can invest during any 12-month period in these transactions. The limitation depends on the person’s net worth and annual income.
Some industry watchers say the sliding scale idea is a viable one because it would allow more investors a chance to participate in more risky offerings, while providing a safety net for loss.
This type of model has the potential to offer investors a reasonable amount of protection, says Vincent Petrescu, chief executive of truCrowd, Inc., an equity crowdfunding portal that connects startups and emerging businesses with non-accredited and accredited investors. “If you have less money, you are allowed to invest less, but you still can play your hand,” he says.
Johnson of PeerStreet also supports this approach because it allows investors who otherwise wouldn’t have access a chance to broaden their exposure to areas that could potentially allow them to increase their wealth.
Certainly, questions about this approach persist as well. What should the investment limits be? Would it depend on the type of investment? Would investors need to self-certify as they do in crowdfunding, or would their information need to be verified by a third party? These questions and more are also likely to be probed more deeply during an SEC review.
The Marketplace Lending Association would also like employees of private funds to qualify as accredited investors for investments in their employers funds. The trade group contends that a private fund’s employees likely have sufficient access to the information necessary to make informed decisions about investments in their employer’s funds.
The suggestion would be for the SEC to consider adding a new category of the definition to include “knowledgeable employees” of “covered companies” as those terms are defined in Rule 3c-5 of the Investment Company Act.
Industry watchers are hopeful to have some clarity on these issues within the coming months, so stay tuned.
“The SEC’s mandate is to protect investors, which sometimes is needed,” says Petrescu of truCrowd, the equity crowdfunding portal. “There needs to be checks and balances,” he says.
Attorney Pleads Guilty In 1 Global Capital Securities Fraud Mess
October 25, 2019
Jan Douglas Atlas, a Florida attorney that was arrested last month for his role in the 1 Global Capital debacle, entered a plea of guilty on Wednesday to 1 count of securities fraud. 74-year-old Atlas also agreed to be disbarred.
The charges stem from his willingness to sign an opinion letter that claimed investment opportunities being offered by 1 Global were not securities when he knew that they actually were.
1 Global collapsed last year amid investigations by the SEC and US Attorney’s office and the discovery of a massive discrepancy in the company’s accounting records. Atlas is the 2nd person to be criminally convicted. 1 Global’s chairman consented to judgment with the SEC but has not been criminally charged. Court records indicate he has already satisfied the vast majority of the SEC’s judgment.
The set of facts established by prosecutors and Atlas in his guilty plea suggest that additional individuals could still be criminally charged.
OnDeck Repurchased 3.2M Shares, Reports $8.7M Q3 Profit
October 24, 2019
OnDeck announced this morning that it has repurchased 3.2M of its own shares for $11M since making its buyback announcement on July 29th. The company intends to repurchase another $39M worth.
OnDeck was profitable in Q3, reporting a net income of $8.7M on originations of $629M. Although that was an increase over the previous quarter, the year-over-year decline was said to be a reflection of “tightening underwriting criteria and market dynamics.”
The average term loan was for $56,000 with an average maturity of 13 months. The company’s line of credit program is growing and now accounts for 21% of the company’s total loans and finance receivables at quarter-end, up 15% from last year.
“OnDeck expects the current operating environment to extend into 2020 with increased profitability,” their quarterly report said.
LendIt China 2019 is Canceled
October 23, 2019
LendIt Fintech has officially announced that there will be no conference in China this year after 3 long years in the country. A blog post written by LendIt Fintech co-founder Peter Renton explained that calamitous events engulfing the peer-to-peer lending industry there, namely the abundance of fraud, and the government’s waning tolerance, has led them to believe that no lending companies will be interested in speaking, sponsoring or even attending this year.
“We will regroup in 2020 and hopefully will be able to bring our unique event back to China,” Renton wrote.
The decision only applies to their Lang Di Fintech China event. Their US event is scheduled to take place in New York this year on May 13-14 at the Javits Center. That event will be immediately followed by deBanked’s Broker Fair 2020 at the brand new Convene at Brookfield Place on 225 Liberty Street in New York on May 17-18.
The FTC Wants To Police Small Business Finance
October 22, 2019
On May 23, the Federal Trade Commission launched an investigation into unfair or deceptive practices in the small business financing industry, including by merchant cash advance providers.
The agency is looking into, among other things, whether both financial technology companies and merchant cash advance firms are making misrepresentations in their marketing and advertising to small businesses, whether they employ brokers and lead-generators who make false and misleading claims, and whether they engage in legal chicanery and misconduct in structuring contracts and debt-servicing.
Evan Zullow, senior attorney at the FTC’s consumer protection division, told deBanked that the FTC is, moreover, investigating whether fintechs and MCAs employ “problematic,” “egregious” and “abusive” tactics in collecting debts. He cited such bullying actions as “making false threats of the consequences of not paying a debt,” as well as pressuring debtors with warnings that they could face jail time, that authorities would be notified of their “criminal” behavior, contacting third-parties like employers, colleagues, or family members, and even issuing physical threats.
“Broadly,” Zullow said in a telephone interview, “our work and authority reaches the full life cycle of the financing arrangement.” He added: “We’re looking closely at the conduct (of firms) in this industry and, if there’s unlawful conduct, we’ll take law enforcement action.”
Zullow declined to identify any targets of the FTC inquiry. “I can’t comment on nonpublic investigative work,” he said.
The FTC investigation is one of several regulatory, legislative and law enforcement actions facing the merchant cash advance industry, which was triggered by a Bloomberg exposé last winter alleging sharp practices by some MCA firms.
The Bloomberg series told of high-cost financings, of MCA firms’ draining debtors’ bank accounts, and of controversial collections practices in which debtors signed contracts that included “confessions of judgment.”
The FTC long ago outlawed the use of COJs in consumer loan contracts and several states have banned their use in commercial transactions. In September, Governor Andrew Cuomo signed legislation prohibiting the use of COJs in New York State courts for out-of-state residents. And there is a bipartisan bill pending in the U.S. Senate authored by Florida Republican Marco Rubio and Ohio Democrat Sherrod Brown to outlaw COJs nationwide.
Mark Dabertin, a senior attorney at Pepper Hamilton, described the FTC’s investigation of small business financing as a “significant development.” But he also said that the agency’s “expansive reading of the FTC Act arguably presents the bigger news.” Writing in a legal memorandum to clients, Dabertin added: “It opens the door to introducing federal consumer protection laws into all manner of business-to-business conduct.”
FTC attorney Zullow told deBanked, “We don’t think it’s new or that we’re in uncharted waters.”
The FTC inquiry into alternative small business financing is not the only investigation into the MCA industry. Citing unnamed sources, The Washington Post reported in June that the Manhattan district attorney is pursuing a criminal investigation of “a group of cash advance executives” and that the New York State attorney general’s office is conducting a separate civil probe.
The FTC’s investigation follows hard on the heels of a May 8 forum on small business financing. Labeled “Strictly Business,” the proceedings commenced with a brief address by FTC Commissioner Rohit Chopra, who paid homage to the vital role that small business plays in the U.S. economy. “Hard work and the creativity of entrepreneurs and new small businesses helped us grow,” he said.
But he expressed concern that entrepreneurship and small business formation in the U.S. was in decline. According to census data analyzed by the Kaufmann Foundation and the Brookings Institution, the commissioner noted, the number of new companies as a share of U.S. businesses has declined by 44 percent from 1978 to 2012.
“It’s getting harder and harder for entrepreneurs to launch new businesses,” Chopra declared. “Since the 1980s, new business formation began its long steady decline. A decade ago births of new firms started to be eclipsed by deaths of firms.”
Chopra singled out one-sided, unjust contracts as a particularly concerning phenomenon. “One of the most powerful weapons wielded by firms over new businesses is the take-it-or-leave-it contract,” he said, adding: “Contracts are ways that we put promises on paper. When it comes to commerce, arm’s length dealing codified through contracts is a prerequisite for prosperity. “But when a market structure requires small businesses to be dependent on a small set of dominant firms — or firms that don’t engage in scrupulous business practices — these incumbents can impose contract terms that cement dominance, extract rents, and make it harder for new businesses to emerge and thrive.”
As the panel discussions unfolded, representatives of the financial technology industry (Kabbage, Square Capital and the Electronic Transactions Association) as well as executives in the merchant cash advance industry (Kapitus, Everest Business Financing, and United Capital Source) sought to emphasize the beneficial role that alternative commercial financiers were playing in fostering the growth of small businesses by filling a void left by banks.
The fintechs went first. In general, they stressed the speed and convenience of their loans and lines of credit, and the pioneering innovations in technology that allowed them to do deeper dives into companies seeking credit, and to tailor their products to the borrower’s needs. Panelists cited the “SMART Box” devised by Kabbage and OnDeck as examples of transparency. (Accompanying those companies’ loan offers, the SMART Box is modeled on the uniform terms contained in credit card offerings, which are mandated by the Truth in Lending Act. TILA does not pertain to commercial debt transactions.)
Sam Taussig, head of global policy at Kabbage, explained that his company typically provides loans to borrowers with five to seven employees — “truly Main Street American small businesses” — that are seeking out “project-based financing” or “working capital.”
“The average small business according to our research only has about 27 days of cash flow on hand,” Taussig told the fintech panel, FTC moderators and audience members. “So if you as a small business owner need to seize an opportunity to expand your revenue or (have) a one-off event — such as the freezer in your ice cream store breaks — it’s very difficult to access that capital quickly to get back to business or grow your business.”
Taussig contrasted the purpose of a commercial loan with consumer loans taken out to consolidate existing debt or purchase a consumer product that’s “a depreciating asset.” Fintechs, which typically supply lightning-quick loans to entrepreneurs to purchase equipment, meet payrolls, or build inventory, should be judged by a different standard.
A florist needs to purchase roses and carnations for Mother’s Day, an ice-cream store must replenish inventory over the summer, an Irish pub has to stock up on beer and add bartenders at St. Patrick’s Day.
The session was a snapshot of not just the fintech industry but of the state of small business. Lewis Goodwin, the head of banking services at Square Capital, noted that small businesses account for 48% of the U.S. workforce. Yet, he said, Square’s surveys show that 70% of them “are not able to get what they want” when they seek financing.
Square, he said, has made 700,000 loans for $4.5 billion in just the past few years, the platform’s average loan is between $6,000 and $7,000, and it never charges borrowers more than 15% of a business’s daily receipts. The No. 1 alternative for small businesses in need of capital is “friends and family,” Goodwin said, “and that’s a tough bank to go back to.”
Panelist Gwendy Brown, vice-president of research and policy at the Opportunity Fund, a non-profit microfinance organization, provided the fintechs with their most rocky moment when she declared that small businesses turning up at her fund were typically paying an annual percentage rate of 94 percent for fintech loans. And while most small business owners were knowledgeable about their businesses — the florists “know flowers in and out,” for example — they are often bewildered by the “landscape” of financial product offerings.
“Sophistication as a business owner,” Brown said, “does not necessarily equate into sophistication in being able to assess finance options.”
Panelist Claire Kramer Mills, vice-president of the Federal Reserve Bank of New York, reported that the country’s banks have made a dramatic exit from small business lending over the past ten years. A graphic would show that bank loans of more than $1 million have risen dramatically over the past decade but, she said, “When you look at the small loans, they’ve remained relatively flat and are not back to pre-crisis levels.”
Mills also said that 50% of small businesses in the Federal Reserve’s surveys “tell us that they have a funding shortfall of some sort or another. It’s more stark when you look at women-owned business, black or African-American owned businesses, and Latino-owned businesses.”
On the merchant cash advance panel there was less opportunity to dazzle the regulators and audience members with accounts of state-of-the-art technology and the ability to aggregate mountains of data to make online loans in as few as seven minutes, as Kabbage’s Taussig noted the fintech is wont to do.
Instead, industry panelists endeavored to explain to an audience — which included skeptical regulators, journalists, lawyers and critics — the precarious, high-risk nature of an MCA or factoring product, how it differs from a loan, and the upside to a merchant opting for a cash advance. (To their credit, one attendee told deBanked, the audience also included members of the MCA industry interested in compliance with federal law.)
A merchant cash advance is “a purchase of future receipts,” Kate Fisher, an attorney at Hudson Cook in Baltimore, explained. “The business promises to deliver a percentage of its revenue only to the extent as that revenue is created. If sales go down,” she explained, “then the business has a contractual right to pay less. If sales go up, the business may have to pay more.”
As for the major difference between a loan and a merchant cash advance: the borrower promises to repay the lender for the loan, Fisher noted, but for a cash advance “there’s no absolute obligation to repay.”
Scott Crockett, chief executive at Everest Business Funding, related two anecdotes, both involving cash advances to seasonal businesses. In the first instance, a summer resort in Georgia relied on Everest’s cash advances to tide it over during the off-season.
When the resort owner didn’t call back after two seasonal advances, Crockett said, Everest wanted to know the reason. The answer? The resort had been sold to Marriott Corporation. Thanking Everest, Crockett said, the former resort-owners reported that without the MCA, he would likely have sold off a share of his business to a private equity fund or an investor.
By providing a cash advance Everest acted “more like a temporary equity partner,” Crockett remarked.
In the second instance, a restaurant in the Florida Keys that relied on a cash advance from Everest to get through the slow summer season was destroyed by Hurricane Irma. “Thank God no one was hurt,” Crockett said, “but the business owner didn’t owe us anything. We had purchased future revenues that never materialized.”
The outsized risk borne by the MCA industry is not confined entirely to the firm making the advance, asserted Jared Weitz, chief executive at United Capital Service, a consultancy and broker based in Great Neck, N.Y. It also extends to the broker. Weitz reported that a big difference between the MCA industry and other funding sources, such as a bank loan backed by the Small Business Administration, is that ”you are responsible to give that commission back if that merchant does not perform or goes into an actual default up to 90 days in.
“I think that’s important,” Weitz added, “because on (both) the broker side and on the funding side, we really are taking a ride with the merchant to make sure that the business succeeds.”
FTC’s panel moderators prodded the MCA firms to describe a typical factor rate. Jesse Carlson, senior vice-president and general counsel at Kapitus, asserted that the factor rate can vary, but did not provide a rate.
“Our average financing is approximately $50,000, it’s approximately 11-12 months,” he said. “On a $50,000 funding we would be purchasing $65,000 of future revenue of that business.”
The FTC moderator asked how that financing arrangement compared with a “typical” annual percentage rate for a small business financing loan and whether businesses “understand the difference.”
Carlson replied: “There is no interest rate and there is no APR. There is no set repayment period, so there is no term.” He added: “We provide (the) total cost in a very clear disclosure on the first page of all of our contracts.”
Ami Kassar, founder and chief executive of Multifunding, a loan broker that does 70% of its work with the Small Business Administration, emerged as the panelist most critical of the MCA industry. If a small business owner takes an advance of $50,000, Kassar said, the advance is “often quoted as a factor rate of 20%. The merchant thinks about that as a 20% rate. But on a six-month payback, it’s closer to 60-65%.”
He asserted that small businesses would do better to borrow the same amount of money using an SBA loan, pay 8 1/4 percent and take 10 years to pay back. It would take more effort and the wait might be longer, but “the impact on their cash flow is dramatic” — $600 per month versus $600 a day, he said — “compared to some of these other solutions.”
Kassar warned about “enticing” offers from MCA firms on the Internet, particularly for a business owner in a bind. “If you jump on that train and take a short-term amortization, oftentimes the cash flow pressure that creates forces you into a cycle of short-term renewals. As your situation gets tougher and tougher, you get into situations of stacking and stacking.”
On a final panel on, among other matters, whether there is uniformity in the commercial funding business, panelists described a massive muddle of financial products.
Barbara Lipman: project manager in the division of community affairs with the Federal Reserve Board of Governors, said that the central bank rounded up small businesses to do some mystery shopping. The cohort — small businesses that employ fewer than 20 employees and had less than $2 million in revenues — pretended to shop for credit online.
As they sought out information about costs and terms and what the application process was like, she said, “They’re telling us that it’s very difficult to find even some basic information. Some of the lenders are very explicit about costs and fees. Others however require a visitor to go to the website to enter business and personal information before finding even the basics about the products.” That experience, Lipman said, was “problematic.”
She also said that, once they were identified as prospective borrowers on the Internet, the Fed’s shoppers were barraged with a ceaseless spate of online credit offers.
John Arensmeyer, chief executive at Small Business Majority, an advocacy organization, called for greater consistency and transparency in the marketplace. “We hear all the time, ‘Gee, why do we need to worry about this? These are business people,’” he said. “The reality is that unless a business is large enough to have a controller or head of accounting, they are no more sophisticated than the average consumer.
“Even about the question of whether a merchant cash advance is a loan or not,” Arensmeyer added. “To the average small business owner everything is a loan. These legal distinctions are meaningless. It’s pretty much the Wild West.”
In the aftermath of the forum, the question now is: What is the FTC likely to do?
Zullow, the FTC attorney, referred deBanked to several recent cases — including actions against Avant and SoFi — in which the agency sanctioned online lenders that engaged in unfair or deceptive practices, or misrepresented their products to consumers.
These included a $3.85 million settlement in April, 2019, with Avant, an online lending company. The FTC had charged that the fintech had made “unauthorized charges on consumers’ accounts” and “unlawfully required consumers to consent to automatic payments from their bank accounts,” the agency said in a statement.
In the settlement with SoFi, the FTC alleged that the online lender, “made prominent false statements about loan refinancing savings in television, print, and internet advertisements.” Under the final order, “SoFi is prohibited from misrepresenting to consumers how much money consumers will save,” according to an FTC press release.
But these are traditional actions against consumer lenders. A more relevant FTC action, says Pepper Hamilton attorney Dabertin, was the FTC’s “Operation Main Street,” a major enforcement action taken in July, 2018 when the agency joined forces with a dozen law enforcement partners to bring civil and criminal charges against 24 alleged scam artists charged with bilking U.S. small businesses for more than $290 million.
In the multi-pronged campaign, which Zullow also cited, the FTC collaborated with two U.S. attorneys’ offices, the attorneys general of eight states, the U.S. Postal Inspection Service, and the Better Business Bureau. According to the FTC, the strike force took action against six types of fraudulent schemes, including:
- Unordered merchandise scams in which the defendants charged consumers for toner, light bulbs, cleaner and other office supplies that they never ordered;
- Imposter scams in which the defendants use deceptive tactics, such as claiming an affiliation with a government or private entity, to trick consumers into paying for corporate materials, filings, registrations, or fees;
- Scams involving unsolicited faxes or robocalls offering business loans and vacation packages.
If there remains any question about whether the FTC believes itself constrained from acting on behalf of small businesses as well as consumers, consider the closing remarks at the May forum made by Andrew Smith, director of the agency’s bureau of consumer protection.
“(O)ur organic statute, the FTC Act, allows us to address unfair and deceptive practices even with respect to businesses,” Smith declared, “And I want to make clear that we believe strongly in the importance of small businesses to the economy, the importance of loans and financing to the economy.
Smith asserted that the agency could be casting a wide net. “The FTC Act gives us broad authority to stop deceptive and unfair practices by nonbank lenders, marketers, brokers, ISOs, servicers, lead generators and collectors.”
As fintechs and MCAs, in particular, await forthcoming actions by the commission, their membership should take pains to comport themselves ethically and responsibly, counsels Hudson Cook attorney Fisher. “I don’t think businesses should be nervous,” she says, “but they should be motivated to improve compliance with the law.”
She recommends that companies make certain that they have a robust vendor-management policy in place, and that they review contracts with ISOs. Companies should also ensure that they have the ability to audit ISOs and monitor any complaints. “Take them seriously and respond,” Fisher says.
Companies would also do well to review advertising on their websites to ascertain that claims are not deceptive, and see to it that customer service and collections are “done in a way that is fair and not deceptive,” she says, adding of the FTC investigation: “This is a wake-up call.”
How Business Financing Has Changed
October 22, 2019
The first thing small business owners think about when deciding to take on funding to grow their business is the ten-year, 3% bank loan that was the standard ten to twenty years ago. The application and approval process was much slower, and if a borrower didn’t fit the mold that mainstream lenders were looking for, approval was difficult. Today, the business loan landscape has changed, and alternative financing methods have captured much of the market. Small business owners who can’t get approved by the banks have access to the funding they need to grow and expand their businesses.
The technology that these alternative lenders use has made small business lending more accessible. Applications are online, underwriting techniques are fine-tuned and often times quicker, and borrowers get personalized offers and service.
More money is going out and more business owners are getting approved.
Changes in loan accessibility
Increased loan accessibility has resulted in more loans, but what does this mean for small business owners? And what are the risks to small business funders?
While alternative lending has opened up more doors for small business owners, as both the industry as a whole and individual lenders move faster, so increases the risk of people taking advantage of the system. Twenty years ago, fewer lenders meant that business owners had fewer options, but on the flip side, it meant that lenders didn’t need to worry as much about dishonest borrowing practices.
Increased competition pushes more lenders to approve more loans faster than ever. After all, if one lender won’t, another may, and the competition is just a Google search away. Unfortunately, this has also resulted in more opportunities for both borrowers and salespeople to take advantage of the system, and one of the largest risks to small business funders and small business owners alike is loan stacking.
What is loan stacking?
Loan stacking is used to refer to borrowers who take out multiple loans from multiple sources within a short window of time without thinking of their business’s long term health, due to the speed and efficiency that the funding occurs in, most business owners do not think twice as it becomes easy to obtain funding. Typically this situation occurs when a borrower can’t get approved for the total amount of money they need, or when a borrower is promised better rates at a future date by accepting the first offer from an overeager salesperson. The biggest red flag for all small business owners is when a promise is made without it being put in writing. If the funder or lender is not willing to put future promises on paper then steer clear of any future funding dealings.
Who is the culprit?
While some small business owners that cannot qualify for the full amount of cash they need may instead obtain multiple smaller loans to satisfy their requirements, others have more malicious intentions. Some borrowers take on funding for their business intending to use those funds for non-business related expenses. Whether it’s to go on vacation, pay down debt, or make a large purchase, this type of loan stacker may not fully understand the consequences of taking on more debt than their business can comfortably handle. During the funding verification calls, prior to funding, any mention of outside use for the funding can have a lasting effect on future funding relations.
An owner whose business is about to go under is another common offender. These borrowers make the decision to accept multiple funded deals, knowing that their business is at the end of its life, take the cash, close their bank accounts, and often declare bankruptcy, leaving the lender with no way to collect.
Finally, a small business owner may choose to lie to the lender about the purpose of the loan, thus convincing the lender to approve them for additional funding. A business loan to help with a larger long term project, like opening a new location that will bring increase revenue. But, when a borrower lies to a lender to get additional funding and thereby stacks loans on top of loans, this can become an issue.
While the borrower is often the offender, this isn’t always the case. Some brokers and salespeople prey on potential borrowers by employing aggressive and unethical sales tactics. “Baiting the borrower with a promise of a better rate down the line, but more importantly offering terms of approval that are unrealistic is a recipe for disaster. It is perfectly fine for any funder or lender to customize approvals to gain long term business relations, but to purposely or viciously offer unrealistic terms in the future, creates a need for a “Small Business Funding Code of Ethics”. Long term funding relationships are created with trust, transparency, and willingness to meet halfway. With the right Code of Ethics in place, the entire Small Business Funding industry can shine above all other financing,” explains Paul Pitcher, managing Partner at First Down Funding and SharpShooter Funding. Often these borrowers have just taken on a loan, probably for less than they had originally wanted, and the prospect of additional funds is quite appealing. The problem is that this often leaves the borrower overstretched, putting all parties at risk.
Understand the risks & signs
Business owners who stack loans are not only affecting the lenders they obtain funding from but are putting both their personal and business finances at risk. “Every business owner must analyze their 30, 60, and 90-day cash flow in order to better serve the purpose and total cost of capital for all rounds of funding” explains Pitcher.
Chances are if a lender doesn’t approve a business owner for the full amount they wanted, it’s because their finances can’t handle more and the lender did not want to put the business in a difficult position. After all, it is in the best interest of the lender for the small business to succeed.
In many cases, a business owner could be personally liable for their debt. However, aggressive brokers looking to quickly cash in on loans commissions put lenders at risk as well. Therefore, funders need to be wary of both deceptive business owners and lenders.
Prevention
When it comes to prevention, most lenders benefit from a three-pronged approach; a strong underwriting system, helpful consumer education, and open communication with the competition. “The most important part of funding deals day-to-day is the strength and volume of business and personal references. When the inner circle of the business owner vouches for them positively, 99% of the time, the deal can fund cleanly and perform,” explains Pitcher.
A strong underwriting system and a solid set of procedures can help lenders make sure they don’t unknowingly enter into a cycle of loan stacking. Experience plays an important role, but if you have a strong understanding of what you’re looking for and perform the appropriate amount of due diligence, you should be able to prevent the majority of loan stacking. Nevertheless, most small business funders already have such systems in place and yet loan stacking is continuously growing problem.
An informed applicant becomes a great borrower. Dealing with a frustrated business owner who can’t get approved for the full amount they want, is never fun. But, educating them about why they can only qualify for a certain amount is a key component in preventing loan stacking and ensuring a borrower isn’t taken advantage of. “The first impression a funder gets from an owner, a hand-signed and dated application, and the organizational skills needed to send over prepared financials and bank statements, can say a whole lot about the business owner’s interests, intentions, and overall health. The more rushed we feel, the less likely we will want to work with that said business,” explains Pitcher.
Finally, chatting with your competition might not seem like a great idea, but maintaining open lines of communication with those in your industry can help spot loan stacking schemes before they get out of hand. Trade shows and other industry events are a good place to network and meet other industry stakeholders.
Closing
Running a small business takes time, persistence, passion, and money. This is why small business owners need funders to be on their side of the court.
Educating and providing borrowers with useful information at the right time can help reduce the risk of loan stacking and helps to maintain healthy accounts.
Federal Judge Rules New York’s “Win” Against OCC’s Fintech Charter Nullifies The Fintech Charter Concept Entirely
October 21, 2019
The Office of the Comptroller of The Currency took a gamble with a federal judge in a lawsuit brought by the New York Department of Financial Services (DFS) and lost. On Monday, Judge Victor Marrero ruled that the OCC must “set aside” its special purpose (fintech) national bank charters entirely, not just for those with a nexus to New York.
The outcome is a byproduct of a ruling issued on May 2nd where the OCC had sought to dismiss the challenge from the onset. DFS was somewhat victorious then in that the case was allowed to proceed, be litigated, and eventually tried. But the OCC felt the case was lost before it had begun because “the Court [had already] ruled on the issue of the law at the heart of the case: whether, under the National Bank Act, OCC has the authority to issue special purpose national bank charters to financial technology companies that do not accept deposits.”
The Court made it clear, that “OCC does not have the authority because the relevant language in the National Bank Act unambiguously defines ‘the business of banking to include deposit-taking.”
As a result, OCC negotiated with DFS to reach an agreed upon final judgment in DFS’s favor. The only remaining question was to what level of defeat the OCC would concede. OCC argued a judgment should preclude only New York companies from applying for a fintech charter while the DFS argued it should apply beyond New York’s borders to all 50 states.
On Monday, the judge went with DFS’s version, pointing out that ordinarily prevailing on an Administrative Procedure Act claim, as OCC had indeed consented to judgment on, would mean that the agency’s order would be vacated, not that the plaintiff would win some special relief.
It is hereby ordered, adjudged and decreed that:
OCC’s regulation 5 C.F.R. 5.20(e)(1)(i), is set aside with respect to all fintech applicants seeking a national bank charter that do not accept deposits.
DFS Superintendent Linda A. Lacewell issued an official comment on the ruling:
This decision makes the financial well-being of consumers from New York and around the country a priority. It reflects the rational conclusion that DFS and other state banking regulators have the expertise to provide the strict supervisory oversight and enforcement of anti-money laundering and consumer protection statutes and regulations that non-depository financial service providers are required to follow. The decision stops OCC’s attempt to usurp state authority by establishing a federal fintech regulatory framework at the expense of consumers. Going forward, DFS will continue to be a fierce advocate for consumers in New York and nationwide.
Consultative Selling in Small Business Finance
October 16, 2019
It’s nearly impossible to teach fiscal responsibility to most consumers, according to researchers at universities and nonprofit agencies. But alternative small-business funders and brokers often manage to steer clients toward financial prudence, and imparting pecuniary knowledge can become part of a consultative approach to selling.
Still, nobody says it’s easy to convince the public or merchants to handle cash, credit and debt wisely and responsibly. Consider the consumer research cited by Mariel Beasley, principal at the Center for Advanced Hindsight at Duke University and co-director of the Common Cents Lab, which works to improve the financial behavior of low- and moderate-income households.
“For the last 30 years in the U.S. there has been a huge emphasis on increasing financial education, financial literacy,” Beasley says. But it hasn’t really worked. “Content-based financial education classes only accounted for .1 percent variation in financial behavior,” she continues. “We like to joke that it’s not zero but it’s very, very close.” And that’s the average. Online and classroom financial education influences lower-income people even less.
The problem stems from trying to teach financial responsibility too late in life, says Noah Grayson, president and founder of Norwalk, Conn.-based South End Capital. He advocates introducing young people to finance at the same time they’re learning history, algebra and other standard subjects in school.
Yet Grayson and others contend that it’s never too late for motivated entrepreneurs to pick up the basics. Even novice small-business owners tend to possess a little more financial acumen than the average person, they say. That makes entrepreneurs easier to teach than the general public but still in need of coaching in the basics of handling money.
Take the example of a shopkeeper who grabs an offer of $50,000 with no idea how he’ll use the funds to grow the business or how he’ll pay the money back, suggests Cheryl Tibbs, general manager of One Stop Commercial Capital, Douglasville, Ga. “The easy access to credit blinds a lot of merchants,” she notes.
Entrepreneurs often make bad decisions simply because they don’t have a background in business, according to Jared Weitz, CEO of New York based United Capital Source. “Many of the people who come to us are trying their hardest,” he observes.
Weitz offers the example of his own close relative who’s a veterinarian. That profession attracts some of the brainiest high-school valedictorians but doesn’t mean they know business. “He’s the best doctor ever and he’s not a great businessman because he doesn’t think about those things first. What he thinks about is helping people. That’s why he got into his profession.”
Entrepreneurs often devote themselves to a vision that isn’t businesses-oriented. “They start a business because they have a great idea or a great product, and that’s what excites them,” Grayson says. “They jump in with both feet and don’t think much about the business side.” The business side isn’t as much fun.
Merchants also attend to so many aspects of an enterprise—everything from sales, production and distribution to hiring, payroll and training—that they can’t afford to devote too much time to any single facet, notes Joe Fiorella, principal at Kansas City, Mo.-based Central Funding. Business owners respond to what’s most urgent, not necessarily what’s most important.
For whatever reason, some business owners spiral downward into financial ruin, bouncing checks, stacking merchant cash advances and continually seeking yet another merchant cash advance to bail them out of a precarious situation, says Jeremy Brown, chairman of Bethesda, Md.-based Rapid Advance.
Weitz advises sitting down with those clients and coming to an understanding of the situation. In some cases, enough cash might be coming in but the incoming autopayments aren’t timed to cover the outgoing autopayments, he says by way of example.
Informing clients of such problems makes a demonstrable difference. “We can see that it works because we have clients renewing with us,” says Weitz. “We’re able to swim them upstream to different products” as their finances gradually improve, he says.
The products in that stream begin with relatively higher-cost vehicles like merchant cash advances and proceed to other less-expensive instruments with better terms, says Brown. Those include term loans, Small Business Administration loans, equipment leasing, receivables factoring and, ultimately the goal for any well-capitalized small business—a relationship with the local bank.
Failing to consider those options and instead simply abetting stackers to make a quick buck can give the industry a “black eye,” and it benefits none of the parties involved, Tibbs observes. But merchants deserve as much blame as funders and brokers, she maintains.
Prospective clients who stack MCAs, don’t care about their credit rating and simply want to staunch their financial bleeding probably account for 35 percent to 40 percent of the applicants Tibbs encounters, she says.
Just the same, alt-funders continue to urge clients to hire accountants, consult attorneys, employ helpful software, shore up credit ratings, keep tabs on cash flow, calculate margins, improve distribution chains and outline plans for growth. It’s what helps the industry rise above the “get-money quick” image that it’s outgrowing, Weitz, says. Many funders and brokers consider providing financial advice an essential aspect of consultative selling. It’s an approach that begins with making sure applicants understand the debt they’re taking on, the terms of the payback and how their businesses will benefit from the influx of capital. It continues with a commitment to helping clients not just with funding but also with other types of business consultation.
“It’s not so much selling as building a rapport with clients—serving as a strategic advisor or financial resource for them, identifying their needs and directing them to the right loan product to meet those needs,” says Grayson. “They should feel they can call you about anything specific to their business, not just their loan requests.” He also cautions against providing information the client will not absorb or will find offensive.
Justin Bakes, CEO of Boston-based Forward Financing also advocates consultative selling. “It’s all about questions and getting information on what’s driving the business owner,” he says. “It’s a process.”
Consultative sales hinges on knowing the customer, agrees Jason Solomon, Forward Financing vice president of sales. “Businesses are never similar in the mind of the business owner,” he notes. “To effectively structure a program best-suited to the merchant’s long-time business needs and set a proper path forward to better and better financial products, you need to know who the business owner is and what his long term goals are.”
“It’s taking an approach of actually being a consultant as opposed to a $7 an hour order taker,” Tibbs says of consultative selling. “I like to teach new reps to think of it as if you were a doctor. Doctors ask questions to arrive at a final diagnosis. So if you’re asking your prospective customer questions about their business, about their cash flow, about their intentions of how they’re planning to get back on track.”
Learning about the clients’ business helps brokers recommend the least-expensive funding instrument, Tibbs says. “I really hate to see someone with a 700 credit score come in to get a merchant cash advance,” she maintains. The consultative approach requires knowing the funding products, knowing how to listen to the customer and combining those two elements to make an informed decision on which product to recommend, she notes.
Consultative sales can greatly benefit clients, Weitz maintains. If a pizzeria proprietor asks for an expensive $50,000 cash advance to buy a new oven, a responsible broker may find the applicant qualifies for an equipment loan with single-digit interest and monthly payments over a five-year period that puts less pressure on daily cash flow.
It’s also about pointing out errors. Brokers and funders see common mistakes when they look at tax returns and financial records, says Brown. “The biggest issue is that small-business owners—because they work so hard— make a profit of X amount of money and then take that out of the business,” he notes. Instead, he advises reinvesting a portion of those funds so that they can build equity in the business and avoid the need to seek outside capital at high rates.
Another common error occurs when entrepreneurs take a short-term approach to their businesses instead of making longer-term plans, Brown says. That longer-term vision includes learning what it takes to improve their businesses enough to qualify for lower-cost financing.
Sometimes, small merchants also make the mistake of blending their personal finances and their business dealings. Some do it out of necessity because they’re launching an enterprise on their personal credit cards, and others act of ignorance. “They don’t necessarily know they’re doing something wrong,” Grayson observes. “There are tax ramifications.”
Some just don’t look at their businesses objectively. Take the example of a company that approached Central Funding for capital to buy inventory in Asia. Fiorella studied the numbers and then informed the merchant that it wasn’t a money problem—it was a margins problem. “You could sell three times what you’re wanting to buy, and you still won’t get to where you want to be,” he reports telling the potential customer.
Consultative selling also means establishing a long-term relationship. Forward Financing uses technology to keep in contact with clients regularly, not just when clients need capital, Bakes notes. That cultivates long-lasting relationships and shows the company cares. As the relationship matures it becomes easier to maintain because the customers want to talk to the company. “They’re running to pick up the phone.”
The conversations that don’t hinge on funding usually center on Forward Financing learning more about the customer’s business, says Solomon. That include the client’s needs and how they’ve used the capital they’ve received.
“We have our own internal cadence and guidelines for when we reach out and how often and what happens,” says Solomon. Customer relationship management technology provides triggers when it’s time for the sales team or the account-servicing team to contact clients by phone or email.
Do small-business owners take advice on their finances? Some need a steady infusion of capital at increasingly higher cost and simply won’t heed the best tips, says Solomon. “It’s certainly a mix,” he says. “Not everybody is going to listen.”
Paradoxically, the business owners most open to advice already have the best-run companies, says Fiorella. Those who are closed to counseling often need it the most, he declares.
Moreover, not everybody is taking the consultative approach. “New brokers are so excited to get a commission check they throw the consultative approach out the window,” Tibbs says.
Yet many alt-funders bring consultative experience from other professions into their work with providing funds to small business. Tibbs, for example, previously helped home buyers find the best mortgage.
Consultative selling came naturally to Central Funding because the company started as a business and analytics consultancy called Blue Sea Services and then transformed itself into an alternative funding firm, says Fiorella. Central Funding reviews clients’ financial statements and operations between rounds of funding, he notes.
Consultations with borrowers reach an especially deep level at PledgeCap, a Long Island-based asset-based lender, because clients who default have to forfeit the valuables they put up as collateral—anything from a yacht to a bulldozer—says Gene Ayzenberg, PledgeCap’s chief operating officer. Conversations cover the value of the assets and the risk of losing them as well as the reasons for seeking capital, he notes.
No matter how salespeople arrive at their belief in the consultative approach, they last much longer in the business than their competitors who are merely seeking a quick payoff, Tibbs says. Others contend that it’s clearly the best way to operate these days.
“The consultative approach is the only one that works,” says Weitz. “Today, everything is about the customer experience. People are making more-educated, better informed decisions.” What’s more, with the consultative approach clients just keep getting smarter, he adds.
The days of the hard sell have ended, Grayson agrees. Customers have access to information on the internet, and brokers and funders can prosper by helping customers, he says. “Our compensation doesn’t vary much depending upon which product we put a client in so we can dig deeper into what will fit the client without thinking about what the economic benefit will be to us.”
Even though the public has become familiar with alternative financing in general, most haven’t learned the nuances. That’s where consultative selling can help by outlining the differing products now available for businesses with nearly any type of credit-worthiness. “It’s for everybody,” Weitz says of today’s alternative small business funding, “not just a bank turn-down.”
