
Prosper.com, P2P Lending Startup, Shut Down by SEC [pdf] - patio11
http://www.sec.gov/litigation/admin/2008/33-8984.pdf
======
patio11
Submitter here. Glad you liked the story.

Incidentally, I am a Prosper lender to the tune of $300. The dirt on this
story could fill a small book, or a large forum (<http://www.prospers.org>)

The long and short of it: Prosper really wanted to be a technology play like
Paypal which disintermediated banks and then got to take a small slice off
each transaction. However, their model required that they, in effect, take on
a lot of banklike aspects -- including investigating borrowers and collecting
on deadbeats. They were woefully unprepared for both of them, thinking at the
beginning that the lending peers would crowdsource it, before they realized
that this would be very, very illegal.

(Privacy/harassment laws + telling 50 pissed people the identity of a single
mom late on her payments + Google + lawyer = you tell me how this story ends.)

Anyhow, Prosper expected that despite the complete lack underwriting and
neigh-total lack of fraud checking they would get default rates roughly
similar to that of banks. Then, BEFORE the financial crisis started, reality
set in and lenders started losing lots of money. This made Prosper's claimed
rates of return ("Hey, if you loan money at 20% and only 5% default that means
you make 15% APR!"[1]) extraordinarily rosy. Rather than accepting the data
and revising the claimed rates of return downward, they instead started
slicing it in smaller and smaller pieces (creating, for example, a Prosper
Select Index filled with their best quality borrowers -- are we hearing the
word "tranches" yet?) to claim that the rate was still exceptionally positive.

Representative ad:

[Edit: Thank you to commenter who pointed out my URL was borked. I'll TinyURL
it: <http://tinyurl.com/63em2c> ]

Funny, "Earn 8.00% to 12.00% rates of return" looks like a security, it sounds
like a security, it feels like a security... except if it were an actual
security, well, the accountant who approved those numbers would be locked up.
(Seriously. I _liked_ the company, but the math is THAT bad. The average rate
of return lenders of size were actually achieving was, at the time, closer to
3%. About 25% were losing money. Only about 10% every achieved the rates that
were claimed in 36 pt font. And for what its worth, although my $300 doesn't
make me a large lender by any stretch of the imagination, up until my first
late payment a few weeks ago I was earning close to 18%.)

[1] Despite two years of trying to educate them about how math works via their
forum and their email, we lenders were unable to penetrate their ignorance
about high school math. Seriously. Three years after opening they still
thought 25% interest and 20% defaults meant a 5% return. Even if the defaults
were almost instantaneous, as most defaults on the platform are.

~~~
patio11
Oh, full disclosure: I am a former borrower, too. I got a loan from them to
assist in paying my younger brother's tuition. I paid it back in 6 months.

From the _borrower's_ perspective, if you can't qualify for a traditional bank
loan, they were amazing. (I fit that description at the time: there was a
dearth of traditional banks which were well set-up to service a young white
professional whose salary was paid in yen.)

My loan was one of the success stories: I couldn't have gotten a student loan
through a traditional lender ("Your brother is going to cosign this? From
Japan? Via fax? Pull the other one, kid, it's got bells on"). My peers, other
lenders from the official forums (which were later closed), trusted me after
several months of online interaction. I asked them for $5,000, they
crowdsourced it in $50 and $80 and $230 increments. They got all their money
back and 13% interest besides. Prosper got $50 and 1% APR for providing the
platform. My little brother got to register for classes at Notre Dame on time.
Everybody won.

And for a while, I thought loans like that were going to be common enough to
paper over the (numerous) faults. I was catastrophically wrong.

~~~
icky
_> My loan was one of the success stories: I couldn't have gotten a student
loan through a traditional lender ("Your brother is going to cosign this? From
Japan? Via fax? Pull the other one, kid, it's got bells on"). My peers, other
lenders from the official forums (which were later closed), trusted me after
several months of online interaction. I asked them for $5,000, they
crowdsourced it in $50 and $80 and $230 increments. They got all their money
back and 13% interest besides. Prosper got $50 and 1% APR for providing the
platform. My little brother got to register for classes at Notre Dame on time.
Everybody won._

William Gibson, eat your heart out...

------
crystalarchives
Thanks for submitting! This was really important news for me.

I'm actually a huge fan of Prosper - I'm a lender with $500 invested, and I've
actually gotten a 20% return because I spent a lot of time screening my
borrowers, who have still yet to make a late payment, much less default.

I only accepted B and above credit ratings and generally just used common
sense when selecting a borrower; very well written, well thought out profiles
got priority, limited (1 or 2) late payments in the past were required. I
always checked how much of their credit they were using versus how much they
made, I never funded a loan near the $25k borrowing limit to avoid a hit-and-
run default, I only funded good causes that suggested the borrower spends
wisely, etc. Prosper gave a lot of financial information about these people,
so I felt that I could make a pretty educated decision.

I hope Prosper registers with SEC so they can continue doing business. The
platform is pretty amazing, and I think they really added value to the world.
I was totally looking forward to scaling up my selection system by automating
it, and Prosper was working on an API that would actually let me do that.

I never bought into their math, and didn't even really think about it. My plan
was always to pick loans very carefully so that very few if any would default.
In retrospect, I'm glad I didn't do any subprime lending. :)

That said, I probably jinxed myself now and everyone in my portfolio will
default...

------
rms
I loaned $1000 to rather risky people with an average interest rate of 21.2%.
I lost $200 dollars with a 39% default rate.

~~~
dpapathanasiou
So you experienced the sub-prime crisis in microcosm ;)

~~~
rms
I really did... my tactic was to loan to high risk people that were
homeowners. I was making money until the whole subprime troubles started
bubbling up.

Though I wasn't using 35:1 leverage.

------
ig1
The SEC regulation are their to prevent companies taking advantage of naive
investors. From what I've read Prosper mis-represented the risks of these
loans, which is precisely the kind of thing which SEC regulated companies are
not allowed to do.

Regulations exist for a reason. As long as your willing to follow the
regulations (which exist to prevent mis-selling, market abuse, insider
trading, and other such things) getting SEC approval isn't that hard.

The other alternative is to partner with a regulated firm and use their
approval, this it the route Zopa has taken. But again you need to make sure
your company follows SEC guidelines.

------
drewcrawford
With our current economic institutions failing, we can't afford to have
innovative and successful financial institutions. That would just make
everyone look bad.

~~~
patio11
I am as Republican as the day is long, I invested on Prosper and made a
profit, I believed then and believe now that innovation in the financial
markets would lower prices and raise returns, and I default to the assumption
that government meddling in the free market is almost always to the detriment
of the participants.

That said? If you knew about the particulars of this situation, which I
covered a wee bit about in a post above, you would say Prosper is about as
close as you can get as a poster child for Why The Market Should Be Regulated
without being founded by Ponzi himself.

~~~
mattmaroon
Preventing innocent people from getting ripped off by scammers asking for
investments is necessary for a healthy market.

~~~
jhancock
it sure is...where was the SEC when every major bank in the world was doing
it?

~~~
mattmaroon
Eh, banks weren't really ripping people off (I'm assuming you're talking about
subprime mortgages) because the banks didn't stand to gain from it unless the
people they lent to did as well.

They weren't malicious, they were just stupid.

~~~
jhancock
I'm wouldn't agree that they were "just stupid". I would choose the phrase
"blinded by greed".

Anyway, I was referring to the banks "investors/shareholders" that have been
fleeced, not those the bank lent money to.

~~~
mattmaroon
How would you say they were fleeced? If you're talking about executive
compensation, that runs through all industries, not just banking.

I do believe that most of the people making the decisions that led to this
crisis had the standard capitalistic intentions of making money for themselves
and their shareholders. I wouldn't say they were "ripping off" their
shareholders, though they certainly did let them down.

~~~
jhancock
Most publicly traded financial entities were slow and limited in the amount of
risk they reveled to their investors. Many of the really bad bets they made
are still hidden from public view. These entities were not caught "by
surprise". This was not an accident or a surprise. Executives of these
companies have for years been talking behind closed doors about the risks of
the bets they were placing but not disclosing this information to their
investors (mostly public shareholders).

On a smaller scale (relative to this crash), the dot com boom saw massive
public market fraud as well. I was in the middle of it in NYC during this time
and personally witnessed massive fraud and insider trading with NASDAQ
entities. The direct result was that the outside public investors paid for
this fraud.

I have seen enough details of what bank and related financial entities have
done over the last 10 years (and another cycle of bad behavior another 10
years prior and then another) to understand that they did not come close to
disclosing the nature of the risks on and off their books. This is actually
pretty scary to think that a public financial entity can even have such a
thing as an "off the books" position.

------
cabalamat
The problem with this type of ruling is that it prevents new and innovative
financial services from springing up which (if allowed to exist) might
supercede the present financial system. It's not as if the present system is
perfect.

Having said that, there are sensible reasons for regulating companies in the
financial industry, for example preventing unsophisticated customers from
losing lots of money.

~~~
nickb
_... might supercede the present financial system_

And that's precisely why they will be always shut down. Government hates
competition. Gov also shut down Liberty Dollar which was a commodity-backed
currency.

<http://en.wikipedia.org/wiki/Liberty_Dollar>

<http://www.flickr.com/photos/71392301@N00/1404773871/>

~~~
jhancock
from <http://en.wikipedia.org/wiki/Liberty_Dollar> ->

"Community currencies may present problems for users because there is little
to stop the issuer from producing more currency."

ahh...brutal irony in a wikipedia article ;)

~~~
gills
That's a good argument for repealing the Federal Reserve Act.

Did anyone else listen to NPR yesterday morning and hear the open admission
that they were printing to fund their new failout package?

------
nickb
Kiva, Zopa next? What exactly do the other two differently so they stay on the
legal side (or maybe they're all illegal)? Anyone know?

~~~
cabalamat
Kiva are legal because they don't pay interest.

~~~
bokonist
You'd think that by 2008 we wouldn't still be banning usury, but I guess not.

~~~
nickb
Banking is a racket and they can practice usury all they want. They just hate
competition, that's all. Credit cards have 21% limit in some states and no
limit in others. How's that for usury?!

------
DEinspanjer
I am a lender to the tune of a few thousand dollars. I actually recently
pulled all my cash out of it in a transaction that completed on the 24th.
Still have a lot of outstanding loans though. I was doing pretty well, I got
hit by one big default early on in my experimentation with the site and only
recently came into the green again from that. If I discount that one poor
investment, I was actually making a pretty decent return of about 13%.

------
pjharrin
I really liked Prosper, I thought they were doing a very good job of executing
their idea. It will be very interesting to see where this goes

------
NotAtAllHapy
Put several thou into this puppy - mostly A & AA - loans started going belly
up about 8-10 months out. Have basically written off this as a worthless
investment - will be happy to get back ANYthing at this point.

And NOW...prosper is "off the air"...fascinating.

------
epall
There's always Lending Club! They seem to have made it through the whole SEC
process and out the other side recently. They do have some lender requirements
that I don't meet, unfortunately.

------
pjharrin
How has techcrunch not picked up this story yet?

~~~
alexandros
just did.

[http://www.techcrunch.com/2008/11/26/sec-outlines-its-
reason...](http://www.techcrunch.com/2008/11/26/sec-outlines-its-reasoning-
for-shutting-down-p2p-lender-prosper/)

------
globalrev
Not to be a know-it-all and I-told-you-so but how could they not see the
problem with this model?

