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SEC issues cease and desist ruling against P2P loan start up Prosper – setting important precedent
Last month, Prosper a Peer to Peer (P2P) lending market place site stopped all new lending on its site following intervention by the SEC.
Prosper is now registering under the Securities Act. Until now Prosper had argued that it was merely a marketplace matching lenders and borrowers and not actually selling investments itself
The SEC yesterday published its reasoning behind the decision to take cease and desist proceedings which effectively argue that Prosper is a seller of investment.
The SEC’s reasoning is that
…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.
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.
Lenders rely on the efforts of Prosper because Prosper’s efforts are instrumental to realizing a return on the lenders’ investments. . . . 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.
. . . 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.
. . . 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.
The decision puts all P2P lenders, on notice. Loanio, a new entrant into the P2P lending arena that just launched last month, has suspended new loans until it registers with the SEC as well. Last April, Lending Club was the first P2P lender to temporarily cease operations (the SEC has now approved its registration, and its members are now lending again in about half the states, including California which gave it the go-ahead last week.
The arguments may put other investment sites on notice about how not to develop their product portfolio, in particular social stock-picking sites, hoping to turn the information on their sites into investment products need to be careful about the rules and services that tie investors to their site. A wiser move might be to seek registration/advice earlier.
Article above sourced in edited form from: Techcrunch the rest below are entirely my own related thoughts….
Clearly the SEC did not need the credit crunch to justify throwing its weight around. But some European and Asian regulators would be less likely to be cast in the John Wayne Sheriff role than others. The role of national regulators on the web is still problematic. Would Prosper’s business model be acceptable in the UK for example? How would the SEC have reacted if it had registered in the UK under the Financial Services Authority? What about PayPal Europe registering as a bank in Luxembourg? How does that affect PayPals regulation in the US? The answer has so far depended on the type and size of the business, which territories the web site is selling to, and to some extent followed the “lead regulator” model adopted by the regulators of over seas bank branches.
The actions of the SEC over Prosper show a willingness by the SEC to walk into the Internet saloon and kick a few tables over to sort the locals out, but does it mean the sheriff will act quickly enough when the bandits come riding in from out of town?
Or to put the question in a slightly less colourful way, can effective regulation of a global financial services market be achieved through national regulators in the light of the credit crunch, the growth of the Internet and speed of business change?
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