I was expecting Prosper’s Quiet Period to go similar to Lending Club’s — Quiet for a few months and then come back out better than ever. Therefore, I am amazed at what I just read…
Prosper Receives a Cease and Desist Order from the SEC
Considering that Prosper was already in a quiet period and no longer talking bids on loans, this seems like an unnecessary step by the SEC, but they may have felt it was necessary to make a point. I also wonder if they had not received complaints because of their misleading marketing — including quotes in the media on horribly misleading default statistics. Or maybe it was their complete failure in collections as Prosper continued to focus on origination and not on operations.
I have transferred out all the money in my account possible and am glad that I stopped lending with Prosper some time ago.
Quotes from the Cease and Desist Letter
There were some interesting points to the cease and desist letter that I would like to highlight (any emphasis added is mine).
Prosper not vetting borrowers
These first two quotes have long been assumed by many critics of Prosper. There was belief that Prosper was doing very minimal vetting of borrowers’ personal information that lenders rely upon to make an investment decision.
Prosper assigns borrowers a credit grade based on a commercial credit score obtained from a credit bureau, but Prosper does not verify personal information, such as employment and income.
there are currently no appropriate regulatory safeguards for Prosper lenders, such as those against misleading statements by a borrower about the purpose of a loan, the borrower’s employment and income, or even the borrower’s identity, or against misleading statements by Prosper.
Prosper’s Investment Oriented Marketing Materials
It looks like it was much of Prosper’s own marketing material that may have landed them in hot water with the SEC because they sold the platform as an investment rather than simply social lending:
The notes offered by Prosper are investments. Lenders expect a profit on their investments in the form of interest… Prosper’s website has included statements that the Prosper notes provide returns superior to those offered by … equity stocks, CDs and money markets. The Prosper website has also stated that it offers lenders ways to “spread your risk out and ensure a more reliable return†… marketing to institutional lenders on the Prosper website characterizes the platform as an alternative to “stock or bond returns†that is “crucial for prudent portfolio management†in “turbulent markets.†Testimonials published on the Prosper website show that customers have used Prosper notes as investment vehicles.
Marketplace Does Not Exist for Lenders without Prosper
If you already lend on Prosper, you should be aware of this, but it is worth pointing out that without the Prosper Marketplace platform, you cannot collect on your loans. You have no right as a lender to collect from borrowers.
Prosper has the sole right to act as loan servicer of the notes. In this capacity, Prosper collects repayments of loans and interest, contacts delinquent borrowers for repayment, and reports loan payments and delinquencies to credit reporting agencies. Prosper also exclusively manages the process of referring delinquent loans to collection agencies for payment, and selling defaulted loans to debt purchasers. Since the lender does not know the borrower’s identity, the lender would be unable in any event to pursue his or her rights as a noteholder in the event of default
Cease and Desist or Cease to Exist?
With this cease and desist notice, is it possible that Prosper will cease to exist? Venture capitalists will not be interested in continuing to fund a legal toxic mess that is losing money. If Prosper fails, how will borrowers collect on their loans? As the letter from the SEC reminds us:
All lenders would be negatively affected if Prosper were unable to operate the platform… lenders are dependent upon the efforts of Prosper to realize any return on their investment… and must rely on Prosper to execute each element of the loan creation and repayment process.
Lack of Lender Sophistication
This statement from the SEC letter about the lack of lender sophistication or expertise placing Prosper under regulation is likely the reason for Globefunder having hedge fund like requirements.
Prosper notes are offered and sold on the internet to the public at large. There is no special level of financial sophistication or expertise that Prosper lenders must have.
What is next for Prosper?
Rateladder asked about liability? I wonder about criminal charges? I found at least a case in Utah where selling a security without a license resulted in criminal charges. If the Feds say that Prosper was selling securities without a license, it seems like criminal cases could follow at the state level.
For more discussion on the topic check out the unofficial Prosper Discussion board.
By the way. I have checked that the Wikipeia article has been updated with the SEC cease and desist order. I can only assume that Prosper will be smart enough to not edit their Wikipedia article from Prosper Marketplace IP addresses this time.
Loanio Next?
It looks like Loanio is in a similar legal issue boat and will be stopping operations. Which is rather unsettling since most people assumed that it took Loanio so long to launch because of legal issues and now only two months later they may already be halting operations. I am certainly glad I did not send them any money.
Full Text of the SEC Cease and Desist Letter
UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
SECURITIES ACT OF 1933 Release No. 8984 / November 24, 2008
ADMINISTRATIVE PROCEEDING File No. 3-13296In the Matter of PROSPER MARKETPLACE, INC., Respondent.
ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDERI.
The Securities and Exchange Commission (“Commissionâ€) deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 (“Securities Actâ€), against Prosper Marketplace, Inc. (“Prosper†or “Respondentâ€).II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the “Offerâ€) which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission’s jurisdiction over it and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Instituting Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing a Cease-and-Desist Order (“Orderâ€), as set forth below.III.
On the basis of this Order and Respondent’s Offer, the Commission finds that:
Respondent
Prosper is a Delaware corporation based in San Francisco, California, that owns and operates an online lending platform on its website, www.Prosper.com. Prosper was previously incorporated as JC Capital Solutions, Inc. (“JC Capitalâ€). Prosper is a private corporation and is not registered with the Commission.Summary
Prosper operates an online lending platform connecting borrowers with lenders. The loan notes issued by Prosper pursuant to this platform are securities and Prosper, from approximately January 2006 through October 14, 2008, violated Sections 5(a) and (c) of the Securities Act, which prohibit the offer or sale of securities without an effective registration statement or a valid exemption from registration.Prosper’s Platform
Prosper’s lending platform functions like a double-blind auction, connecting individuals who wish to borrow money, or “borrowers,†with individuals or institutions who wish to commit to purchase loans extended to borrowers, referred to on the platform as “lenders.†Lenders and borrowers register on the website and create Prosper identities. They are prohibited from disclosing their actual identities anywhere on the Prosper website. Borrowers request three-year, fixed rate, unsecured loans in amounts between $1,000 and $25,000 by posting “listings†on the platform indicating the amount they want to borrow and the maximum interest rate they are willing to pay. Prosper assigns borrowers a credit grade based on a commercial credit score obtained from a credit bureau, but Prosper does not verify personal information, such as employment and income. Potential lenders bid on funding all or portions of loans for specified interest rates, which are typically higher than rates available from depository accounts at financial institutions. Each loan is usually funded with bids by multiple lenders. After an auction closes and a loan is fully bid upon, the borrower receives the requested loan with the interest rate fixed by Prosper at the lowest rate acceptable to all winning bidders. Individual lenders do not actually lend money directly to the borrower; rather, the borrower receives a loan from a bank with which Prosper has contracted. The interests in that loan are then sold and assigned through Prosper to the lenders, with each lender receiving an individual non-recourse promissory note.
Since the inception of its platform in January 2006, Prosper has initiated approximately $174 million in loans. Prosper collects an origination fee from each borrower of one to three percent of loan proceeds and collects servicing fees from each lender from loan payments at an annual rate of one percent of the outstanding principal balance of the notes. Prosper administers the collection of loan payments from the borrower and the distribution of such payments to the lenders. Prosper also initiates collection of past due loans from borrowers and assigns delinquent loan accounts to collection agencies. Lenders and borrowers are prohibited from transacting directly and are unable to learn each others’ true identities.Discussion
The notes offered by Prosper are investments. Lenders expect a profit on their investments in the form of interest, which is at a rate generally higher than that available from depository accounts at financial institutions. Prosper’s website has included statements that the Prosper notes provide returns superior to those offered by alternative investments such as equity stocks, CDs and money markets. The Prosper website has also stated that it offers lenders ways to “spread your risk out and ensure a more reliable return†and describes how lenders are allowed to use payments from an outstanding loan to purchase a new loan “in order to maximize returns.†In addition, marketing to institutional lenders on the Prosper website characterizes the platform as an alternative to “stock or bond returns†that is “crucial for prudent portfolio management†in “turbulent markets.†Testimonials published on the Prosper website show that customers have used Prosper notes as investment vehicles. Prosper also offers Portfolio Plans that allow lenders to automatically bid on loans based on estimates of risk and return characterized by Prosper.Lenders rely on the efforts of Prosper because Prosper’s efforts are instrumental to realizing a return on the lenders’ investments. Prosper lenders are effectively passive with respect to elements important to realizing profit on their investments and Prosper is instrumental in each of these elements. Prosper established and maintains the website platform, without which none of the loan transactions could be effected. Prosper provides mechanisms for attracting lenders and borrowers, facilitating the exchange of information between borrowers and lenders, coordinating bids, and effecting the loans. It provides borrower information to potential lenders via the loan listings, including credit ratings. Prosper provides a matrix for evaluating performance and potential returns in the form of historical loan performance, Prosper Marketplace and individual borrower performance, and delinquency activity, among other things. Prosper manages the bidding and subscription process for every loan and has the sole contractual right to service the loans, including administering the borrower and lender accounts, and providing monthly statements that reflect payments made and received on the loan notes, as well as amounts available for bidding on new notes.
Furthermore, under the terms of the notes, Prosper has the sole right to act as loan servicer of the notes. In this capacity, Prosper collects repayments of loans and interest, contacts delinquent borrowers for repayment, and reports loan payments and delinquencies to credit reporting agencies. Prosper also exclusively manages the process of referring delinquent loans to collection agencies for payment, and selling defaulted loans to debt purchasers. Since the lender does not know the borrower’s identity, the lender would be unable in any event to pursue his or her rights as a noteholder in the event of default. Further, if a lender chooses to participate in Prosper’s Portfolio Plan, whereby lenders are permitted to choose portfolios that automatically allocate the lender’s funds among various loans based on risk and return characteristics categorized by Prosper, Prosper chooses the loans on which a bid is made. Lastly, the continued existence and operation of the Prosper platform is essential to the loan transactions taking place. Prosper lenders are too geographically diverse and diffuse to come together without Prosper. They lack the requisite experience to run a loan auction or to create and service a loan package. Rather, the Prosper lenders rely on Prosper’s continued operation of the platform in order to transact and to recoup any gain on their investments.Legal Discussion
The notes offered by Prosper are securities pursuant to Section 2(a)(1) of the Securities Act and under the Supreme Court’s decisions in both SEC v. W. J. Howey Co., 328 U.S. 293 (1946), and Reves v. Ernst & Young, Inc., 494 U.S. 56 (1990).A. Application of the Howey Investment Contract Analysis
Pursuant to SEC v. W. J. Howey Co., 328 U.S. 293 (1946), an investment contract exists if there is present “an investment of money in a common enterprise with profits to come solely from the efforts of others.†Id. at 301. An investment contract is a security under Section 2(a)(1) of the Securities Act, the offer or sale of which must be registered pursuant to Section 5 of the Securities Act.
The financial instrument offered by Prosper meets the definition of an investment contract as set forth in Howey. As discussed above, there is an investment of money when lenders invest money to purchase a loan. The lenders bear one-hundred percent of the risk of loss each time they fund a Prosper loan because the Prosper loans are non-recourse.There is a common enterprise for several reasons. For example, a common enterprise exists because lenders and borrowers are dependent on Prosper in order to engage in new loans or to complete the timely repayment of loans already funded. A common enterprise also exists because the vast majority of Prosper loans are funded by more than one lender and because the majority of lenders fund more than one loan. All lenders would be negatively affected if Prosper were unable to operate the platform. In addition, there is a common enterprise between Prosper and its members because borrowers pay Prosper an origination fee of one to three percent of the loan, and each lender pays annual servicing fees to Prosper of one percent of the outstanding principal balance of the notes.
Further, lenders are dependent upon the efforts of Prosper to realize any return on their investment. As discussed above, borrowers and lenders are prohibited from transacting directly and must rely on Prosper to execute each element of the loan creation and repayment process.B. Application of the Reves Note Analysis
A note is presumed to be a security under the Supreme Court’s opinion in Reves v. Ernst & Young, 494 U.S. 56 (1990), unless it is of a type specifically identified as a non-security. The types of non-security notes identified in Reves include notes delivered in a consumer financing; notes secured by a mortgage on a home; short-term notes secured by a lien on a small business or its assets; short-term notes evidenced by accounts receivable; notes evidencing “character†loans to bank customers; notes formalizing open account debts incurred in the ordinary course of business; and notes evidencing loans from commercial banks for ordinary operations. Id. at 65. A note that is not among the list identified in Reves is a security unless it bears a “strong family resemblance†to the non-security notes identified in the opinion. Id. at 64-65. Reves established a four-part family resemblance test to determine whether a note is a security, which is comprised of the following factors: (i) the motivations of the buyer and seller; (ii) the plan of distribution; (iii) the reasonable expectations of the investing public; and (iv) the existence of an alternate regulatory regime. Id. at 66-67. If a note fails the family resemblance test, it is deemed a security and the offer or sale of such security must be registered pursuant to Section 5 of the Securities Act. The Prosper loan notes are securities under Reves because they do not fall into any of the enumerated categories of non-security notes, and they fail the family resemblance test.With regard to the motivations of the buyer and seller, as discussed above, Prosper lenders are motivated by the desire to obtain a better return on their money than they otherwise could in another venue. While some Prosper lenders may be motivated, in part, by altruism, altruistic and profit motives are not mutually exclusive. See In the Matter of Robin Bruce McNabb, Rel. No. 34-43411 (Oct. 4, 2000), aff’d, 298 F.3d 1126 (9th Cir. 2002).
With respect to the plan of distribution, the Prosper notes are offered and sold on the internet to the public at large. There is no special level of financial sophistication or expertise that Prosper lenders must have. This wide dissemination and solicitation to the public with no attempt to limit investors is indicative of a security. See Reves, 494 U.S. at 68 (the notes “were…offered and sold to a broad segment of the public, and that is all we have held to be necessary to establish the requisite ‘common trading’ in an instrumentâ€); Pollack v. Laidlaw Holdings, Inc., 27 F.3d 808, 814 (2d Cir. 1994) (concluding that the broad-based, unrestricted sales to the general investing public supported a finding that mortgage participations were securities under federal securities laws).
In analyzing the expectations of the investing public, the lenders in this instance, the relevant issue is what a reasonable investor would believe about the character of the transaction, “even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not ‘securities’ as used in that transaction.†Reves, 494 U.S. at 66. The manner in which a transaction is characterized in advertisements is illustrative, and whether there is a “valuable return on an investment, which undoubtedly includes interest.†Id. at 69. As discussed above, Prosper lenders reasonably expect a valuable return on loaned funds and would reasonably believe that the Prosper loans are investments.
Finally, with regard to whether an alternate regulatory scheme exists to reduce risk to potential investors, there are currently no appropriate regulatory safeguards for Prosper lenders, such as those against misleading statements by a borrower about the purpose of a loan, the borrower’s employment and income, or even the borrower’s identity, or against misleading statements by Prosper.
Thus, the Prosper notes are securities under Reves because: (i) Prosper lenders are motivated by an expected return on their funds; (ii) the Prosper loans are offered to the general public; (iii) a reasonable investor would likely expect that the Prosper loans are investments; and (iv) there is no alternate regulatory scheme that reduces the risks to investors presented by the platform.As a result of the conduct described above, Prosper violated Section 5(a) of the Securities Act, which states that unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale.
Also as a result of the conduct described above, Prosper violated Section 5(c) of the Securities Act, which states that it shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security, unless a registration statement has been filed as to such security.
IV.In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Respondent Prosper’s Offer.
Accordingly, it is hereby ORDERED that:
Pursuant to Section 8A of the Securities Act, Respondent Prosper cease and desist from committing or causing any violations and any future violations of Sections 5(a) and (c) of the Securities Act.
By the Commission.
Florence E. Harmon Acting Secretary
Thank you for your comment on GlobeFunder, you are correct that the regulatory and business environment is exactly why we structured our business to focus on institutional and other accredited capital sources of loan funding. It is our mission to help borrowers through our leading channel partners in retail finance and direct personal lending get the loans they need at more attractive rates and terms in these credit challenged times.
Please visit us at www.globefunder.com to learn more and thank you for your discussion. Brian Mullally, CEO, GlobeFunder.
Brian,
Thank you for commenting. The hurdles you set for lenders are looking rather smart these days considering the SEC actions against Prosper Marketplace.
I wonder what this means for borrowers. Will anyone take the trouble to collect or refer to collections if borrowers just stop making payments?
Prosper should still be doing collections despite this. In fact, they have an interest in collecting since they earn one percent of the interest — although their interest is much smaller than the lenders. I fear that borrowers will be mistaken that they can avoid payment due to this judgment by the SEC which could overrun Prosper’s already poor collection process.
The SEC is on the wrong path with Prosper. The cease and desist document shows the failure of the SEC to understand and properly deal with a very important innovation in financial transactions. The SEC is mischaracterizing Prosper as a double-blind investment securities seller. Prosper is actually a service that helps individuals come together as a community to help each other financially. It is very oten used by friends and family members as a stuctured way to transact the lending of small amounts of money to each other.
Prosper works for individual borrowers and lenders like eBay acts for buyers and sellers. Prosper takes very responsible extra steps of gathering much personal financial information, including credit information, which helps individual lenders make much better informed decisions that they can without Prosper.
The SEC has a dirty hand in our currect economic recession, failing to focus on what should be its prime objective of protecting us from fraudsters such as dishonest mortgage brokers, and the $50 billion Bernie Maddoff ripoff that the SEC utterly and woefully failed to investigate even after many complaints.
It doesn’t take much financial knowledge to understand that the SEC is wrong to put complicated, irrelevant regulations and impossible lending requirements onto individual investors lending $50 to a friend, family member or Prosper community member.
Please contact the SEC to let them know that community lending services are about a community of individuals, and that the SEC must adapt to be able to recognize and deal with Prosper as the type of service that it really is.
Corey Chambers
Kudos Corey; tell it like it is.
I got (and still am paying on)a loan from Prosper about a year and a half ago. I tried to go thru my bank first but they turned me down. I really needed the loan for car repairs and consolidation and the good folks at Prosper took a chance on me (when my own bank wouldn’t). Face it; most financial institutions laughed when Prosper came onto the scene with their new innovative way to loan money; they just knew it would fall flat. Imagine the horror when they realized Prosper wasn’t just getting people with “poor credit” loans, but people with good credit were starting to get loans there also. Someone brought down the hatchet because OMG the people had taken matters into their own hands and was actually making it work!
Shame on you SEC- if you would go after the blood sucking mortgage brokers and lousy credit card companies with as much zeal we might have half a chance on surviving in this economy!
TL Hood
TL and Corey, After watching Madoff, the big banks, and the latest bank Ponzi scheme in Texas, I am inclined to agree with you. Big banks likely pay more in legal fees in a year than the dollar amount of loans Prosper generated.
TL, I am glad that you had a good experience with Prosper as a borrower. Unfortunately, the number of bad experiences for lenders was starting to reach the tipping point where borrowers were going to have much more difficulty getting a loan at a decent rate.
Prosper is NOT individuals loaning $50 to a friend. It’s Lenders and large investors ($150,000 or more) skirting consumer protection laws to charge usurious rates and discriminate, as shown in two recent scholarly studies.
It’s Lenders being allowed to cross state lines without properly registering as Lenders.
Prosper themselves admit to violating Truth-in-Lending, Equal Credit Opportunity Act, and Fair Credit and Reporting Act.
The Borrowers should unite and force Propser to prove the underlying debt before making another payment!
I am a Prosper lender, and I was really enjoying the platform and the service that they were providing. I am not a large lender, I have invested only $750 to date, although I had planned to keep investing small amount’s on a monthly basis. After seeing the results of the SEC’s efforts with guys like Madoff – I would be very happy to continue investing with Prosper. I hope this fails. I hope Prosper is back soon.
Thanks guys for stopping by to comment. I appreciate it!
David, Prosper nor Lending Club have ever had any trouble with lending across state lines that I am aware of. The quiet periods are actually due to investment rules rather than lending rules. Credit cards lend across state lines all the time — although they may not have the best practices either, but still it is your choice to use or not use their credit.
It sounds like you are rather mad at Prosper as a borrower. Borrowers received money at rates and terms that they could not have received in other places so I don’t feel much sympathy for any borrower. Lenders were led to believe that Prosper was a good investment but Prosper did not pay attention to the basics (verification and collections) while only worrying about loan volume.
Could you provide links to the scholarly studies? Also, Prosper has provided an incredible means for such studies. There is likely not evidence that that exact same discrimination does not occur in banks every day.
Also, most of the lenders are small investors. 90%+ of all lenders loaned $7,000 or less. If you look at lenders who have an average loan age grater than a year, have $1,000 or more invested on at least 20 loans, the median return is less than one percent. I don’t call that usury — that is called getting screwed. Prosper always advertised returns much higher than that it its advertising and used loans that had not even turned 30 days old in its estimated ROI calculations.
Chris, Although, I am not a huge fan of Prosper’s operational effectiveness. I still think it is a good idea and hope that they can come back. Hopefully, under new management. It is a finance company being run by web 1.0 people looking for eyeballs. And I completely agree with the sentiment that the SEC was was blind to extreme rip offs like Maddoff. While investors like Muleshoes did horribly, at least Prosper was not a Ponzi scheme and he will get most of his money back.
Anybody who says prosper suggested their loans are securities is nuts! As a lender I never once derived that these loans are securities. A security by nature usually needs a market place. I’m not interested in trading loans that are just reclassified as promissory notes. I understand the need to have safe guards in place, but now that P2P loaning is becoming successful the traditional loaning entities are crying foul and demand SEC to not allow the general public to become a lender without vast amounts of lending experience. Just another layer of bulls@!t to keep the big boys happy!
I’m a private borrower that used and currently still uses Prosper. I borrowed $1500 to supplement the funding of a used vehicle purchase for personal commuting. The interest rate I paid was a little high, but my credit hasn’t been terrific (we had a bankruptcy over 8 years before using Prosper). However, I elected to accept the loan and make payments as a way to 1) further work to improve my credit score and 2) establish a good payment history for loans on the site itself. I hope to continue having this option of alternative funding and lending. Overall, I very much enjoy using the site. I think it’s a terrific concept, and hope the fair and sensible regulations can enacted to protect borrowers and lenders equally, in order to allow this business to remain in operation.
When these person-to-person lending sites began there were no regulations in place that applied to their function,hence,it is not surprising that legal problems are being encountered as to how they should be governed under banking regulations,although the “cease and desist” order by the SEC is carrying things a bit far,I think.
The average loan on Prosper is “was” in the 6,000 dollar range but their loan limit is 25,000 which seems quite a bit high for a person-to-person loan to me – 10,000 would be adequate. Prosper and other sites depend on lenders – it’s hard to close a loan when you have nothing to loan – so why then do they charge fees to lenders? It would seem to me that the best way to attract the most “profit hungry” lenders is not to charge them any fees which would eat into their “profits”. Let the borrowers pay the fees – they want the money. Apparently though this novel idea has not yet occurred to the various lending sites and if one were to suddenly have a lightbulb go off over their head,or server,and start using this idea it might increase their loan volume by a significant percentage.