Populism Comes to Wall Street

(Bloomberg Businessweek) -- Milind Mehere keeps plenty of copies of Hillbilly Elegy, J.D. Vance’s best-selling memoir about poverty in the Rust Belt, on hand for visitors to his Midtown Manhattan office. Mehere talks about how ordinary people are shut out of opportunities to build wealth. “If we don’t change fundamentally how we save, invest, and actually make money as a society, there will be anarchy in 20 or 30 years,” he says.

The implicit pitch? That YieldStreet Inc., his online investment company, can help democratize high finance. It’s selling alternative investments normally reserved for billionaires and hedge funds. For now, his crowdfunding startup caters to the mass affluent—individuals who are so-called accredited investors, meaning they have $1 million in net worth or make at least $200,000 a year. A successful New Jersey doctor or dentist, perhaps.

Founded in 2015 by Mehere and two other Wall Street entrepreneurs, YieldStreet has allowed investors to put more than half a billion dollars into exotic debt securities. More than 80,000 people have signed up to receive its offering notices. Since inception, the investments have an expected internal rate of return of almost 13 percent and to date haven’t lost any principal. In the same period, the S&P 500 appreciated an annualized 9.3 percent. With many individual investors eager to juice their returns, some YieldStreet offerings sell out in seconds.

Populism Comes to Wall Street

Mehere has big plans to market the same kinds of investments to a bigger audience—if regulators go along. There are signs they will. U.S. Securities and Exchange Commission Chairman Jay Clayton said in August that he was considering relaxing the accredited-investor rule. Mehere says YieldStreet has its legal team looking at a fund structure in which nonaccredited investors may participate.

This all makes some people nervous, because what YieldStreet sells is unusual. Many of its offerings involve litigation finance, in which investors front money to law firms or plaintiffs hoping for a big settlement. More recently the company has moved into marine finance, allowing investors to participate in loans for cargo vessels that transport dry-bulk goods such as coal or grain. Or they could jump into a deal in which vessels are acquired and sold for scrap. Each offering is backed by collateral, but sometimes that’s a litigant’s contractual obligation to pay investors back—if there is a settlement—or the scrap value of a ship.

How many individual investors are prepared to navigate such fare? Even many accredited investors might not be in a position to lose their entire investment, as YieldStreet warns could happen. Because the net worth and annual earnings criteria have never been inflation-adjusted since they were set in 1982, a wide swath of America—more than 12 million households—is qualified to own YieldStreet securities. “The percentage of accredited investors for whom they are appropriate is quite small,” says Barbara Roper, director of investor protection at the Consumer Federation of America. “They like to make it sound like it’s populist,” she adds, “but this doesn’t belong anywhere in the portfolio of the typical retail investor.”

The company, with more than 50 employees, says its offerings are originated by industry veterans who bring deals to YieldStreet, but in many cases the originator was one of the founders’ other companies. Of 109 offerings on its website, 61 were sourced by firms operated by founders. Of those, 44 were drawn from the existing inventory of LawCash, one of the firms. In an SEC filing, YieldStreet says the founders’ dual roles create a conflict of interest “due to their sponsorship and/or employment” at both YieldStreet and the company sponsoring or servicing loans offered to investors. YieldStreet says it would never happen, but the potential exists to sell less attractive deals to investors, who learn about the conflict issue if they click on a link to a 31-page regulatory filing on YieldStreet’s website.

YieldStreet says it has always had multiple measures to address potential conflicts, such as not allowing founders who double as originators to join discussions on whether their deals will be offered to YieldStreet investors. Lindsey Fielding, who handles marketing and investor relations, says YieldStreet benefited from the background its executives have in specialty assets, and that investors “sit above” executives in the repayment queue. Such arrangements were made “completely transparently and by the book,” she says. As the company has grown, she adds, it’s been offering deals from a wider variety of sources.

It all began when Mehere, soon to sell his small-business online marketing company for almost $350 million, joined forces with Dennis Shields and Michael Weisz to create a digital platform. Shields started LawCash, which finances litigants and is the originator of dozens of YieldStreet deals that largely consist of presettlement advances to plaintiffs in personal injury cases. (Shields, who had no operational role in YieldStreet, died in August.) Earlier this year, LawCash and another lender paid $2.3 million to settle a legal challenge by the Colorado attorney general, who said they were charging predatory interest rates at almost 100 percent.

Shields and Weisz in 2013 founded Soli Capital, a specialty finance company that’s originated securities for YieldStreet tied to everything from law firm credit lines to livery car companies. Weisz worked from 2009 to 2013 as an analyst at a unit of Centurion Credit Management, a hedge fund that in 2011 became part of Platinum Partners. Federal prosecutors would later charge six Platinum executives with defrauding investors beginning in 2011. (One has died; the others have pleaded not guilty.) Weisz says the credit unit where he worked was unconnected to any of the criminal charges; he wasn’t accused of any wrongdoing or questioned in the case.

The YieldStreet site lets investors comb through offerings and invest even modest amounts—sometimes as little as $5,000. YieldStreet uses complex structures that often involve forming a limited-liability company that houses a special-purpose vehicle created to acquire a loan. The LLC then issues “borrower payment dependent notes” to investors in the deal. A timely dose of deregulation, courtesy of the 2012 Jumpstart Our Business Startups (JOBS) Act, loosened crowdfunding and advertising restrictions to help make the whole thing possible.

Customers don’t seem to mind the looser oversight. “What I like about YieldStreet is their somewhat unique offerings,” says Peter Renton, co-founder of LendIt Fintech, a media and conference company serving the online lending industry, the niche in which YieldStreet operates. He invested $35,000 in a litigation-financing offering last year and is happily collecting the interest. “You can’t find a similar investment elsewhere,” he says.

That may be an understatement. A $25 million offering in June gave investors the chance to participate in a loan to an unnamed company privately owned by a family in Dubai and registered in Nevis. The company acquires older boats to sell for scrap metal. Parts of the deal are attractive, such as the target 10.25 percent interest after fees. (A footnote says such performance predictions are hypothetical.)

The offering doesn’t reveal who the borrowers are, yet the company and its principals’ personal guarantees stand behind the loan. A 15-page confidential memo available to YieldStreet members shortly before the offering opened says the three principals claim their collective net worth is $28 million, but that, despite efforts by the deal’s originator to verify it, “portions of the information may be incomplete, inaccurate or intentionally false.”

Here’s how the deal works: The $25 million is loaned to the unnamed borrower, identified only as “one of the premier buyers of recycling tonnage worldwide” and owned by a family with more than 40 years of experience in the scrapping business. Athens-based Global Marine Transport Capital, a subsidiary of New York investment firm Four Wood Capital Partners LLC, originated the deal and will act as the loan’s servicer. Over the two-year term, the scrapper will use the money to buy worn-out ships, with YieldStreet limiting how much money can be tapped for any one ship. The vessels are to be sold to so-called shipbreakers, deconstruction yards often located in India. Investors receive eight quarterly interest payments and, after two years, repayment of their principal. What could go wrong? “Global economic conditions” or an oversupply of new ships could scuttle the value of old ones, according to disclosures to potential investors. Steel prices could decline.

YieldStreet earns a 1 percent management fee on the ship-scrapping deal and charges as much as 4 percent on some of its other offerings. Ian Sigalow, a co-founder and partner at venture capital firm Greycroft LLC, which invested in YieldStreet, says he likes its mission of democratizing the debt market, which is 100 times bigger than the stock market but largely limited to institutions. “It’s a revolutionary concept,” he says, adding that YieldStreet has been careful not to put really risky deals on the site. People who use the platform “are perfectly capable of understanding the risks and returns” of asset-backed credit offerings, he says.

The Consumer Federation’s Roper points out that Wall Street said much the same a decade ago when it packaged and sold the mortgages that eventually triggered the financial collapse. Some financial advisers are also skeptical. Rob Hernandez, a certified financial planner in Queens, N.Y., says crowdfunded alternative investments can make sense for some of his more financially savvy clients seeking to boost returns in their portfolios. He’s invested in real estate loans through PeerStreet, a real estate-focused platform that competes with YieldStreet, but says he worries about how the assets would perform in a downturn. “All of these sites have proliferated since the crisis—none of these have been tested through a full cycle,” he says. “It’s really in a down market that we see who the winners and losers are.” YieldStreet says its investments have low correlation to stocks and are typically unaffected by market volatility.

William Reichenstein, an investment management professor at Baylor University, says most people should avoid alternative investments and would be better off buying high-grade bonds to diversify away from stocks. Deals offering higher yields usually entail higher risks, he says.

One of the JOBS Act’s early sponsors, U.S. Representative Patrick McHenry, says YieldStreet’s business model of crowdfunding alternative debt securities to accredited investors isn’t what he had in mind originally. Still, the North Carolina Republican likes what he sees and favors relaxing laws that restrict “enormous amounts of activity that should otherwise be accessible to everyday investors.”

YieldStreet supports loosening the definition of accredited investor. “We believe firmly that the concept is outdated,” Weisz says, adding that it made sense when the market was less transparent. If YieldStreet gets its way, it will be poised to grow. It doesn’t lack ambition. “I think we only have one real competitor,” Weisz says, “and that would be Goldman Sachs.”

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