Prosper logoThe SEC today issued a cease and desist order against Prosper, formalizing the rationale for Prosper’s sudden shutdown last month. The SEC’s argument is that Prosper has been issuing unlicensed securities in the form of loan promissory notes. Although Prosper’s original excuse for the shutdown was filing to create a secondary market, it is now clear that their filing will also contain a request to offer securities for loan originations.

The SEC’s argument is fairly simple, and is stated clearly in the first sentence of the “Discussion” section: “The notes offered by Prosper are investments.”

The report goes on to outline specific reasons it considers Prosper’s loan marketplace to be offering securities:

  1. Lenders expect a profit on their investments, in the form of interest which is higher than the interest on savings accounts.
  2. The Prosper web site advertises that lenders can earn returns on their money, and offers lending on Prosper as an alternative to investing in the stock market.
  3. Lenders rely completely on Prosper for the servicing and collection of loan payments. Were it not for Prosper, lenders wouldn’t be able to recoup their investment.
  4. Prosper runs the entire web site, manages the transfer of all monies, the placement of all bids, and the reporting of all transactions and returns.

There are a few other arguments, and some pointers to legal precedent, but seen through the SEC’s eyes, the case is fairly straightforward: Prosper has been offering unregistered securities, which is illegal, and they need to stop immediately.

Interestingly, the second paragraph in the order is an “offer of settlement” from Prosper, which the SEC has accepted. However, Prosper’s offer neither admits nor denies the SEC’s ruling, but simply accepts the SEC’s jurisdiction over the company, and consents to the cease and desist.

Although the SEC never issued a format C&D to LendingClub, it’s clear that between their actions against Prosper and Lending Club, the SEC is starting to outline specific rules for government regulation of peer to peer lending. Prosper had operated for several years without an SEC ruling, but as the industry has grown (with Lending Club and Zopa), the SEC was under increased pressure to make a decision. It’s unfortunate that these companies have had to suspend operations while they comply with the government’s requirements, but at least now there is a path to legitimacy.

Here is the full text of the ruling: (Source)

invest, investor, investing, lending