$4.5M raised on trust alone: SEC alleges affinity fraud in merchant lending

The SEC says an Illinois man with no industry experience exploited the trust of his own religious community to run a $4.5 million investment operation built on false track records, undisclosed fees, and misleading performance reports.

In a complaint filed September 28 in the Northern District of Illinois, the Securities and Exchange Commission alleges the founder and sole controller of two related merchant cash advance entities raised funds from at least 23 investors between November 2021 and January 2023. The investors came almost exclusively from Orthodox Jewish communities in Illinois, New York, and New Jersey, drawn in through personal connections and word of mouth. The complaint states investors trusted the defendant "due to their social or community connections with him."

A merchant cash advance is a short-term financing arrangement in which a company gives a small business an upfront sum and collects repayment from a portion of that business's future revenue. The defendant told investors their money would be pooled to fund these advances, with net profits split 50/50 after a 6% management fee - all paid only from merchant repayments.

The pitch included claimed returns of "36%-65% on any given deal" and assurances of a proven track record. The SEC says both were false. The defendant had no merchant cash advance experience when he launched the business, the complaint alleges. The entities had completed their first advance just one month before the December 2021 investor presentation that boasted those returns - and none had generated any profit.

Behind the scenes, the SEC alleges, the defendant was collecting undisclosed origination fees - typically 10% per deal - directly from investor funds before passing the rest to merchants. Written investor agreements said nothing about the fee. At least five investors were told orally that the entities would only earn money from merchant collections. Those origination fees totaled approximately $1.1 million, according to the complaint.

The portfolio itself was "never profitable," the SEC says, collecting "less than 60% of the total amount owed." Only about 30 of 184 merchant cash advances were fully repaid. But investors did not know that. The complaint alleges the defendant maintained an online portal and sent reports showing projected returns - sometimes between 25% and 60% - without disclosing the figures were projections, not actual results.

The SEC also alleges the defendant entered into at least five renewal transactions with merchants who were already behind on payments, making it look like original advances had been repaid. In one case, a merchant that had missed roughly 15 of its last 20 scheduled payments received a $300,000 renewal. Investors were charged approximately $190,000 in fees across these renewals. All five merchants later defaulted.

The complaint describes a pattern of fund diversion. Approximately $400,000 from the entities' bank account went to personal spending - "such as for jewelry and cash payments" - and to related accounts, the SEC alleges. Another approximately $320,000 in merchant repayments was routed to a separate entity the defendant owned that the complaint says "has no business operations" but was used "to purchase a home, to buy automobiles, and to pay gambling debts." An additional approximately $282,000 in commission refunds owed to investors was also directed to that entity.

The operation stopped making new advances in January 2023. The defendant "stopped returning investor calls," the complaint states. Investors later learned the business was insolvent when contacted by an attorney representing the defendants.

Investors have received less than $1.7 million back. Only one of the at least 23 investors has recovered more than their original contribution. The rest lost between approximately $15,000 and $670,000 each.

The SEC charges violations of federal antifraud statutes - Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act. The agency seeks permanent injunctions, disgorgement with prejudgment interest, civil penalties, and a bar from securities offerings.

These are allegations in a complaint filed by the SEC, and no court has ruled on the claims.