How the WaterStation Scandal Exposed Gaps in Alternative Investment Due Diligence

The collapse of the WaterStation Ponzi scheme—unveiled in 2024 as one of the largest franchise frauds in U.S. history—has laid bare the vulnerabilities in alternative asset vetting. For years, Ryan Wear and his team sold investors on a dream: passive income from water vending machines. In reality, the machines either didn't exist or were stored in warehouses, their value a mirage. This case isn't just a cautionary tale about greed; it's a wake-up call for investors, lenders, and regulators to rethink how they approach due diligence in non-traditional assets.

The Anatomy of a Fraud

WaterStation's scheme hinged on three pillars: misrepresentation, SBA loan exploitation, and institutional complicity. Investors were promised 12% to 28% returns on water machines priced at $8,500 to $10,000. But the company manufactured only 2,100 units, while claiming to have deployed 21,000. The rest? Phantom assets. Funds were siphoned to pay early investors, cover operational costs, and even finance Wear's other ventures.

The SBA's Preferred Lender Program (PLP) became a critical enabler. Regional banks like UniBank and Celtic Bank, tasked with verifying loan use, ignored red flags—duplicate serial numbers, unverifiable machine locations—and issued over $115 million in SBA 7(a) loans to investors. These loans, intended to support active small businesses, were instead used to prop up a Ponzi machine.

Systemic Failures in Due Diligence

The WaterStation case highlights three systemic flaws in vetting alternative assets:

1. Lack of Collateral Verification:
   Investors and lenders failed to confirm the existence of the machines. A simple on-site inspection or third-party audit could have exposed the fraud. Instead, investors relied on glossy brochures and promises of “passive income.”

2. Weak Lender Oversight:
   Banks in the SBA's PLP prioritized loan volume over compliance. They coached borrowers on how to structure applications and ignored obvious inconsistencies. This laxity allowed the scheme to scale rapidly, particularly during the CARES Act era, when pandemic-era incentives like waived fees and deferred payments accelerated fraudulent activity.

3. Regulatory Gaps:
   The SBA's rules explicitly prohibit passive income models, yet WaterStation exploited this loophole. Regulators like the Washington Department of Financial Institutions (DFI) only intervened after the scheme collapsed, underscoring the need for proactive oversight.

Best Practices vs. Reality

Standard due diligence for alternative assets—such as small-cap stocks, private equity, or franchises—requires rigorous scrutiny. The SEC emphasizes third-party verification, risk assessments, and transparency. Yet in WaterStation's case, these practices were ignored.

For example:
- Third-Party Audits: Investors should demand independent verification of collateral. In WaterStation's case, a simple inventory check would have revealed the fraud.
- Business Model Feasibility: A basic analysis of revenue potential would have shown that the machines couldn't generate the promised returns.
- Lender Track Records: Investors should vet lenders' compliance histories. Banks like UniBank had prior warnings about their lending practices but continued to facilitate the scheme.

Lessons for Investors

The WaterStation collapse offers critical takeaways:
1. Skepticism of “Too Good to Be True”: High returns with low risk are a red flag. Investors should ask: Can this business model sustain itself without new capital?
2. Scrutinize Collateral: For asset-backed investments, verify the existence and value of collateral. A warehouse full of broken machines is not an asset.
3. Demand Transparency: Ask for audited financials, third-party valuations, and regulatory filings. If the operator resists, walk away.
4. Beware of Institutional Conflicts: When a fund manager has a personal stake in an investment, disclose it. Jordan Chirico's hidden $7.3 million investment in WaterStation while steering a $107 million fund is a textbook case of fiduciary failure.

The Road Ahead

The WaterStation case has sparked calls for reform. The SBA is under pressure to tighten oversight of its PLP, while regulators are pushing for stricter due diligence requirements for alternative investments. For investors, the message is clear: due diligence isn't optional—it's a lifeline.

As the market for alternative assets grows—from real estate to NFTs—so too must the rigor with which we vet them. The next big opportunity could be the next WaterStation. But with the right tools—skepticism, verification, and transparency—we can avoid the traps and build a more resilient investing ecosystem.

In the end, the WaterStation saga isn't just about one fraud. It's a mirror held up to the entire alternative investment landscape. And the reflection? A reminder that in investing, the only thing more important than returns is the truth.