Peer-to-peer lending promised to be an alternative to traditional banks and credit cards for small borrowers. But this fledgling industry, which has been operating freely on the Internet, recently has come into regulators’ sights.
Regulators argue that some lending sites essentially are selling investments that need to be registered.
This has sidelined the largest peer-to-peer lending site, Prosper.com.
The timing couldn’t be worse for consumers, with many banks tightening their standards and making it difficult for even some good credit risks to get a loan.
But as much of a headache as regulation can be, it might be what the industry needs to take it to a higher level. Regulation can bring greater transparency and protections for investors who provide the money for loans. And if these investors feel more comfortable, they are more likely to pour money into new loans.
Peer-to-peer lending is only a few years old. These Internet sites match people who need a loan for, say, $1,000 to $25,000, with dozens or hundreds of strangers willing to lend amounts as small as $50. Lending sites act as the go-between, collecting borrowers’ payments and forwarding them, along with interest, to the various lenders.
Good deal for both
“It’s a great idea for the consumer. It’s a great idea for the consumer lender,” says Jim Bruene, editor of Online Banking Report. Borrowers can shop for loans from numerous lenders without dinging their credit scores, he says. Lenders can reap better returns than with some other investments.
San Francisco-based Prosper Marketplace is the biggest player in peer-to-peer lending. Prosper has handled more than $178 million in loans since launching in early 2006. Its site is filled with pictures and stories from consumers explaining why they need money.
But late last month, the Securities and Exchange Commission issued a cease-and-desist order against Prosper, claiming the company was selling unregistered securities.
According to the SEC, a borrower gets a loan from a bank that Prosper works with. Stakes in that loan, in the form of promissory notes, are then sold to lenders. The notes are investments, the SEC says. Prosper’s Web site tells lenders the notes can outperform stocks and money markets, the SEC says.
Within days of the SEC order, some lenders filed a lawsuit in California against Prosper, saying they were unknowingly sold unregistered securities. The plaintiffs, who say $21.7 million in Prosper loans had defaulted as of October, seek class-action status.
Last week, Prosper agreed to pay $1 million to about 20 states to settle claims that it sold unregistered securities.
Prosper in mid-October suspended making new loans, and it has filed to register its notes with the SEC and to get approval to create a secondary market, where lenders could sell their stake in loans to others. Prosper declined to comment while it’s in a so-called quiet period, when regulators limit what can be said publicly before a decision is made.
Regulatory issues have been rippling through the industry.
Zopa, based in the United Kingdom, withdrew from the U.S. market in October. It had tried a different business model here, hoping to avoid the regulatory issues now facing Prosper.
Sole registered lender
New York-based Loanio, which launched in October, recently suspended its activities to undergo registration with regulators.
Lending Club, a major player, is the only one with regulatory approval.
Founder and Chief Executive Renaud Laplanche says the company started talking to the SEC a year ago and concluded that the industry was headed toward regulation. Lending Club began its registration with the SEC in April and finished in early October.
“We are dealing with people’s money. It should be regulated,” Laplanche says.
California-based Lending Club reopened to new lenders in mid-October and has attracted more than 3,000, Laplanche says.
It helps that competitor Prosper stopped making new loans just as Lending Club reopened. But Laplanche says lenders see peer-to-peer lending as an attractive alternative to the stock market.
