Person-To-Person Lending
New Regulatory Challenges Could Emerge as the Industry Grows
Gao ID: GAO-11-613 July 7, 2011
Over the last decade, Internet-based platforms have emerged that allow individuals to lend money to other individuals in what has become known as person-to-person lending. These online platforms present a new source of credit for borrowers and a potential investment opportunity for those with capital to lend. Both for-profit and nonprofit options exist, allowing for income-generating and philanthropic lending to a variety of people and groups around the world. The Dodd- Frank Wall Street Reform and Consumer Protection Act directed GAO to conduct a study of person-toperson lending. This report addresses (1) how the major person-to-person lending platforms operate and how lenders and borrowers use them; (2) the key benefits and risks to borrowers and lenders and the current system for overseeing these risks; and (3) the advantages and disadvantages of the current and alternative regulatory approaches. To do this work, GAO reviewed relevant literature, analyzed regulatory proceedings and filings, and interviewed federal and state officials and representatives of the three major person-to-person lending platforms currently operating in the United States. GAO assessed options for regulating person-to-person lending using a framework previously developed for evaluating proposals for financial regulatory reform. The Bureau of Consumer Financial Protection, Federal Deposit Insurance Corporation, and Securities and Exchange Commission provided written comments on the report, and they all noted the need to continue to monitor the development of the industry.
The three major U.S. person-to-person lending platforms facilitate lending by allowing individuals acting as lenders to invest in loans to individual borrowers. Prosper Marketplace, Inc. (Prosper) and LendingClub Corporation (LendingClub), the two major for-profit platforms, screen and rate the creditworthiness of potential borrowers. Individual lenders (and a growing number of institutional investors) browse the approved loan requests on the companies' Web sites and purchase notes issued by the company that correspond to their selections. Kiva Microfunds (Kiva), the major nonprofit platform, allows individual lenders to indirectly fund loans to entrepreneurs around the world by funding interest-free loans to microfinance institutions. The three platforms have grown rapidly and, as of March 2011, Prosper and LendingClub had made about 63,000 loans totaling approximately $475 million, and Kiva about 273,000 loans totaling about $200 million. The for-profit companies said that borrowers were often consolidating or paying off debts or were seeking alternate sources of credit, while lenders were seeking attractive returns. Kiva said that its lenders were not seeking to generate income and were motivated mostly by charitable interests. Person-to-person lending platforms offer lenders the potential to earn higher returns than traditional savings vehicles and may offer borrowers broader access to credit. Individual lenders and borrowers face risks that are currently overseen by a complex regulatory structure. For example, lenders risk losing their principal and, on the for-profit platforms, the interest on their investments. Borrowers face risks typical of consumer lending, such as unfair lending and collection practices. Currently, the Securities and Exchange Commission and state securities regulators enforce lender protections, mostly through required disclosures. The Federal Deposit Insurance Corporation and state regulators enforce protections for borrowers on the major for-profit platforms, and the newly formed Bureau of Consumer Financial Protection will also play a role in borrower protection as it becomes operational. The Internal Revenue Service and the California attorney general enforce reporting and other requirements for Kiva as a charitable organization. Kiva's microfinance institution partners are subject to varying consumer financial protection requirements that apply where they lend. The two options that GAO identified for regulating person-to-person lending-- maintaining the status quo or consolidating borrower and lender protections under a single federal regulator--both offer advantages and disadvantages. The current system offers protections that are consistent with those for traditional borrowers and investors. Some industry observers suggested that protecting lenders through securities regulation under this system lacked flexibility and imposed inefficient burdens on firms. Under a consolidated regulatory approach, current protections for borrowers would likely continue and, depending on how implemented, lender protections could be expanded. But uncertainty exists about shifting to a new regulatory regime and about the potential benefits. Finally, regardless of the option selected, new regulatory challenges could emerge as the industry continues to evolve or if it were to grow dramatically, particularly if that growth was primarily due to the increased participation of institutional versus individual investors.
GAO-11-613, Person-To-Person Lending: New Regulatory Challenges Could Emerge as the Industry Grows
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United States Government Accountability Office:
GAO:
Report to Congressional Committees:
July 2011:
Person-To-Person Lending:
New Regulatory Challenges Could Emerge as the Industry Grows:
GAO-11-613:
GAO Highlights:
Highlights of GAO-11-613, a report to congressional committees.
Why GAO Did This Study:
Over the last decade, Internet-based platforms have emerged that allow
individuals to lend money to other individuals in what has become
known as person-to-person lending. These online platforms present a
new source of credit for borrowers and a potential investment
opportunity for those with capital to lend. Both for-profit and
nonprofit options exist, allowing for income-generating and
philanthropic lending to a variety of people and groups around the
world. The Dodd-Frank Wall Street Reform and Consumer Protection Act
directed GAO to conduct a study of person-to-person lending. This
report addresses (1) how the major person-to-person lending platforms
operate and how lenders and borrowers use them; (2) the key benefits
and risks to borrowers and lenders and the current system for
overseeing these risks; and (3) the advantages and disadvantages of
the current and alternative regulatory approaches.
To do this work, GAO reviewed relevant literature, analyzed regulatory
proceedings and filings, and interviewed federal and state officials
and representatives of the three major person-to-person lending
platforms currently operating in the United States. GAO assessed
options for regulating person-to-person lending using a framework
previously developed for evaluating proposals for financial regulatory
reform.
The Bureau of Consumer Financial Protection, Federal Deposit Insurance
Corporation, and Securities and Exchange Commission provided written
comments on the report, and they all noted the need to continue to
monitor the development of the industry.
What GAO Found:
The three major U.S. person-to-person lending platforms facilitate
lending by allowing individuals acting as lenders to invest in loans
to individual borrowers. Prosper Marketplace, Inc. (Prosper) and
LendingClub Corporation (LendingClub), the two major for-profit
platforms, screen and rate the creditworthiness of potential
borrowers. Individual lenders (and a growing number of institutional
investors) browse the approved loan requests on the companies‘ Web
sites and purchase notes issued by the company that correspond to
their selections. Kiva Microfunds (Kiva), the major nonprofit
platform, allows individual lenders to indirectly fund loans to
entrepreneurs around the world by funding interest-free loans to
microfinance institutions. The three platforms have grown rapidly and,
as of March 2011, Prosper and LendingClub had made about 63,000 loans
totaling approximately $475 million, and Kiva about 273,000 loans
totaling about $200 million. The for-profit companies said that
borrowers were often consolidating or paying off debts or were seeking
alternate sources of credit, while lenders were seeking attractive
returns. Kiva said that its lenders were not seeking to generate
income and were motivated mostly by charitable interests.
Person-to-person lending platforms offer lenders the potential to earn
higher returns than traditional savings vehicles and may offer
borrowers broader access to credit. Individual lenders and borrowers
face risks that are currently overseen by a complex regulatory
structure. For example, lenders risk losing their principal and, on
the for-profit platforms, the interest on their investments. Borrowers
face risks typical of consumer lending, such as unfair lending and
collection practices. Currently, the Securities and Exchange
Commission and state securities regulators enforce lender protections,
mostly through required disclosures. The Federal Deposit Insurance
Corporation and state regulators enforce protections for borrowers on
the major for-profit platforms, and the newly formed Bureau of
Consumer Financial Protection will also play a role in borrower
protection as it becomes operational. The Internal Revenue Service and
the California attorney general enforce reporting and other
requirements for Kiva as a charitable organization. Kiva‘s
microfinance institution partners are subject to varying consumer
financial protection requirements that apply where they lend.
The two options that GAO identified for regulating person-to-person
lending-”maintaining the status quo or consolidating borrower and
lender protections under a single federal regulator-”both offer
advantages and disadvantages. The current system offers protections
that are consistent with those for traditional borrowers and
investors. Some industry observers suggested that protecting lenders
through securities regulation under this system lacked flexibility and
imposed inefficient burdens on firms. Under a consolidated regulatory
approach, current protections for borrowers would likely continue and,
depending on how implemented, lender protections could be expanded.
But uncertainty exists about shifting to a new regulatory regime and
about the potential benefits. Finally, regardless of the option
selected, new regulatory challenges could emerge as the industry
continues to evolve or if it were to grow dramatically, particularly
if that growth was primarily due to the increased participation of
institutional versus individual investors.
View [hyperlink, http://www.gao.gov/products/GAO-11-613] or key
components. For more information, contact Mathew J. Scirč at (202) 512-
8678 or sciremj@gao.gov.
[End of section]
Contents:
Letter:
Background:
The Major Person-to-Person Lending Platforms Serve as Intermediaries
and Facilitate Loans Generally for Consumer Lending and Microfinance:
Although Person-to-Person Lending Offers Potential Benefits to Lenders
and Borrowers, It Also Poses Risks Currently Overseen by a Complex
Regulatory Structure:
Options for Regulating Person-to-Person Lending Have Advantages and
Disadvantages Related to Borrower and Lender Protection, Flexibility,
and Efficiency:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Analysis of Prosper and LendingClub's Prospectus
Supplement Filings:
Appendix III: Comments from the Consumer Financial Protection Bureau:
Appendix IV: Comments from the Federal Deposit Insurance Corporation:
Appendix V: Comments from the Securities and Exchange Commission:
Appendix VI: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Examples of Risks to Lenders Identified by the Major For-
Profit, Person-to-Person Lending Platforms:
Table 2: Federal Lending and Consumer Financial Protection Laws Cited
by the Major For-Profit Companies as Applicable to Person-to-Person
Lending:
Table 3: Elements of GAO's Framework for Evaluating Proposals for
Financial Regulatory Reform:
Figures:
Figure 1: Quarterly Cumulative Loan Origination, Prosper and
LendingClub:
Figure 2: Lending Process for the For-Profit Platforms:
Figure 3: Lending Process for Kiva:
Figure 4: Example from Prosper's Web Site Identifying Benefits to
Lenders:
Figure 5: Example from LendingClub's Web Site Identifying Benefits to
Lenders:
Figure 6: Timeline of Events Culminating in Prosper's and
LendingClub's Securities Registrations, November 2005 through December
2009:
Figure 7: Status of Prosper's and LendingClub's State Securities
Registrations, as of April 2011:
Figure 8: Examples from Kiva's Web Site Identifying Benefits to
Lenders:
Abbreviations:
CFPB: Bureau of Consumer Financial Protection, known as Consumer
Financial Protection Bureau:
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection
Act:
EDGAR: Electronic Data Gathering, Analysis, and Retrieval System:
FDIC: Federal Deposit Insurance Corporation:
Federal Reserve: Board of Governors of the Federal Reserve System:
FSOC: Financial Stability Oversight Council:
FTC: Federal Trade Commission:
Gramm-Leach-Bliley Act: Gramm-Leach-Bliley Financial Modernization Act:
IRS: Internal Revenue Service:
NASAA: North American Securities Administrators Association:
NCUA: National Credit Union Administration:
OCC: Office of the Comptroller of the Currency:
SEC: Securities and Exchange Commission:
Treasury: Department of the Treasury:
UDFI: Utah Department of Financial Institutions:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
July 7, 2011:
Congressional Committees:
Over the last decade, Internet-based platforms have emerged that allow
individuals to lend money to other individuals in what has become
known as person-to-person lending.[Footnote 1] These online platforms
present a new source of credit for borrowers and a potential
investment opportunity for those with capital to lend. Both for-profit
and nonprofit options exist, allowing for income-generating and
philanthropic lending to a variety of people and groups around the
world. The two main for-profit platforms in the United States are
operated by Prosper Marketplace, Inc. (Prosper) and LendingClub
Corporation (LendingClub).[Footnote 2] As of March 2011, these two
platforms combined had facilitated about 63,000 unsecured, fixed-term
and fixed-rate loans totaling to about $469 million, most of which
were consumer loans.[Footnote 3] The main nonprofit platform in the
United States, operated by Kiva Microfunds (Kiva), had facilitated
approximately 273,000 interest-free loans totaling to about $200
million to microfinance institutions that provided corresponding loans
to individual entrepreneurs, mostly in developing countries.[Footnote
4] On all three of these platforms, lenders receive a prorated share
of any corresponding repayments of principal and, on the for-profit
platforms, interest on the loans they helped fund. If borrowers on any
of the platforms fail to repay their loans, however, the lenders lose
their principal and, on the for-profit platforms, interest.
Broadly, the emergence of person-to-person lending and its potential
for continued growth have raised questions about how the financial
regulatory system should promote the transparency of such novel
financial products and help ensure adequate protection for borrowers
and lenders without stifling business innovation. Specifically,
industry participants, researchers, and policymakers have generally
agreed that person-to-person lending warrants regulation but have
different views as to the appropriate roles of federal and state
regulators.
Section 989F of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) requires GAO to report on the federal
regulatory structure for person-to-person lending.[Footnote 5] In this
report, we address (1) how the major person-to-person lending
platforms operate and how lenders and borrowers use them; (2) the key
benefits, risks, and concerns that person-to-person lending poses for
lenders and borrowers and how the risks are currently regulated; and
(3) advantages and disadvantages of the current and alternative
approaches to regulating person-to-person lending.
To address these questions, we conducted a review of relevant research
and reports, regulatory proceedings and filings, and company Web sites
and documents. We also reviewed relevant laws and regulations, and
interviewed officials from federal agencies, four state securities
regulators, and one state banking regulator. In addition, we obtained
information from and interviewed executives and other representatives
of several companies that have operated person-to-person lending
platforms, including the three major person-to-person lending
platforms currently operating in the United States. We assessed the
reliability of data obtained from the three major person-to-person
lending companies by reviewing relevant documents, including the for-
profit companies' audited financial statements filed with the
Securities and Exchange Commission (SEC), and interviewing company
officials. We determined that data the companies provided were
sufficiently reliable for purposes of our report. We also interviewed
researchers and consumer advocacy organizations that were familiar
with person-to-person lending. Furthermore, we reviewed previously
issued GAO reports--in particular, a report on crafting and assessing
proposals to modernize the U.S. financial regulatory system--proposed
legislation, and interviews with relevant officials to identify and
assess options for regulating person-to-person lending.[Footnote 6] A
more extensive discussion of our scope and methodology appears in
appendix I.
We conducted this performance audit from August 2010 to July 2011 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
Background:
Ensuring adequate consumer protections is one of the broad goals of
the financial regulatory system in the United States, together with
ensuring the integrity and fairness of markets, monitoring the safety
and soundness of institutions, and acting to ensure the stability of
the financial system.[Footnote 7] U.S. regulators take steps to
address information disadvantages that consumers of and investors in
financial products may face, ensure that consumers and investors have
sufficient information to make appropriate decisions, and oversee
business conduct and sales practices to prevent fraud and abuse.
Responsibilities for helping ensure consumer financial protection and
otherwise overseeing the financial services industry, including person-
to-person lending, are shared among various federal and state
regulatory agencies and numerous self-regulatory organizations. The
manner in which these regulators oversee institutions, markets, or
products varies depending upon, among other things, the regulatory
approach Congress has fashioned for different sectors of the financial
industry. For example:
* Federal banking regulators subject depository institutions
(hereafter, for simplicity, banks) to comprehensive regulation and
examination to ensure their safety and soundness. Until July 2011, the
banking regulators serve as the primary consumer protection enforcers
and supervisors for the banks under their jurisdictions.[Footnote 8]
These regulators include the Office of the Comptroller of the Currency
(OCC) for national banks; Board of Governors of the Federal Reserve
System (Federal Reserve) for domestic operations of foreign banks and
for state-chartered banks that are members of the Federal Reserve
System; Federal Deposit Insurance Corporation (FDIC) for insured state-
chartered banks that are not members of the Federal Reserve System;
National Credit Union Administration (NCUA) for federally insured
credit unions; and the Office of Thrift Supervision for federal
thrifts.[Footnote 9] Both FDIC and the Federal Reserve share oversight
responsibilities with the state regulatory authority that chartered
the bank.
* The Federal Trade Commission (FTC) is responsible for enforcing many
federal consumer protection laws. Until July 21, 2011, FTC is the
primary enforcer of federal consumer financial laws for nonbank
financial services providers. After that date, FTC will share
responsibility for such enforcement with the Bureau of Consumer
Financial Protection (known as the Consumer Financial Protection
Bureau or CFPB), as discussed later. In addition, FTC investigates
nonbank financial services providers that may be engaged in unfair or
deceptive acts or practices and takes enforcement action. Because it
is a law enforcement agency, and not a supervisory agency, FTC does
not regularly examine nonbank financial services providers or impose
reporting requirements on them, but instead focuses on enforcement.
State regulators have been the primary supervisors of nonbank
financial services providers, and state-level powers and levels of
supervision have varied considerably.
* SEC is the primary federal agency responsible for investor
protection. Like FTC, it does not comprehensively regulate and examine
companies that issue securities. Rather, federal securities regulation
is intended to protect investors in specific securities through
disclosure requirements and antifraud provisions that can be used to
hold companies liable for providing false or misleading information to
investors. State securities regulators--represented by the North
American Securities Administrators Association (NASAA)--generally are
responsible for registering certain securities products and, along
with SEC, investigating securities fraud.[Footnote 10]
As a result of the Dodd-Frank Act, which mandated the creation of
CFPB, federal regulation of consumer financial products and services
is in the process of consolidation.[Footnote 11] CFPB will serve as
the primary supervisor of federal consumer protection laws over many
of the banks and other financial institutions that offer consumer
financial products and services and will be one of the enforcers of
these laws. Upon assuming its full authorities, CFPB will, among other
things:
* assume rulemaking authority for more than a dozen existing federal
consumer financial laws from other federal agencies, as well as new
rulemaking authorities created by the Dodd-Frank Act itself;[Footnote
12]
* supervise compliance with federal consumer financial laws with
respect to certain nondepository financial services providers,
including those involved in residential mortgage lending, private
student lending, payday lending, and "larger participant[s] of a
market for other consumer financial products or services," to be
defined through CFPB rulemaking;[Footnote 13]
* supervise compliance with federal consumer financial laws with
respect to banks holding more than $10 billion in total assets and
their affiliates;[Footnote 14] and:
* research, monitor, and report on developments in markets for
consumer financial products and services to, among other things,
identify risks to consumers.[Footnote 15]
The date for transferring consumer protection functions to CFPB is
July 21, 2011.[Footnote 16] Until a director takes office, the
Secretary of the Treasury has the power to perform some of CFPB's
functions, and the Department of the Treasury (Treasury) has formed an
implementation team to start up the agency.
The Dodd-Frank Act also established the Financial Stability Oversight
Council (FSOC) to convene financial regulatory agencies to identify
risks and respond to emerging threats to the financial stability of
the United States.[Footnote 17] Chaired by the Secretary of the
Treasury, FSOC is comprised of the heads of CFPB, FDIC, SEC, and other
voting and nonvoting members--including a state banking supervisor and
a state securities commissioner. Among other duties, FSOC is to:
* monitor the financial services marketplace in order to identify
potential threats to the financial stability of the United States;
* facilitate information sharing and coordination among federal and
state financial regulatory agencies on developing policies and
regulatory activities for financial services;
* identify gaps in regulation that could pose risks to the financial
stability of the United States; and:
* provide a forum for discussion and analysis of emerging market
developments and financial regulatory issues.[Footnote 18]
The Major Person-to-Person Lending Platforms Serve as Intermediaries
and Facilitate Loans Generally for Consumer Lending and Microfinance:
Two Major For-Profit Platforms Connect Borrowers Seeking Mostly
Consumer Loans with Lenders Seeking a Return on Their Investment:
Prosper and LendingClub provide two major Internet-based platforms
currently operating in the United States that allow lenders to select
and fund loans to borrowers for consumer and business purposes.
[Footnote 19] Lenders participate on these two platforms by buying
notes that correspond to a specific loan, or share of a loan, with the
goal of being repaid principal and receiving interest. As shown in
figure 1, according to data provided by the companies, Prosper grew
rapidly after launching its platform in November 2005, facilitating
about $176 million in loans by September 2008 (about $5 million per
month).[Footnote 20] After suspending its operations in October 2008
to register a securities offering with SEC--as we discuss later--
Prosper resumed operation in July 2009 at a lower loan volume than
before (about $2 million per month through December 2010) but grew
more rapidly beginning in 2011 (about $4 million per month from
January 2011 to March 2011). LendingClub facilitated about $15 million
in loans between when it issued its first loan in June 2007 and March
2008 (roughly $1.5 million per month). Between April 2008 and October
2008, LendingClub suspended its sales of notes to lenders to register
a securities offering, although it continued to make loans to
borrowers using its own funds. LendingClub grew rapidly after resuming
operations in October 2008, facilitating about $7.6 million in loans
per month. As of March 31, 2011, about 60,000 Prosper lenders had
funded about $226 million in loans to more than 33,000 borrowers. At
the same time, about 20,600 LendingClub lenders had funded about $243
million in loans to about 25,000 borrowers.[Footnote 21]
Figure 1: Quarterly Cumulative Loan Origination, Prosper and
LendingClub:
[Refer to PDF for image: multiple line graph]
Quarter: 1, 2006;
Prosper: $1.6 million.
Quarter: 2, 2006;
Prosper: $7.3 million.
Quarter: 3, 2006;
Prosper: $16.7 million.
Quarter: 4, 2006;
Prosper: $28.2 million.
Quarter: 1, 2007;
Prosper: $48.1 million.
Quarter: 2, 2007;
Prosper: $71.6 million.
Quarter: 3, 2007;
Prosper: $90 million;
LendingClub: $1.3 million.
Quarter: 4, 2007;
Prosper: $109 million;
LendingClub: $4.8 million.
Quarter: 1, 2008;
Prosper: $129.5 million;
LendingClub: $14.8 million.
Quarter: 2, 2008;
Prosper: $155.8 million;
LendingClub: $17.8 million.
Quarter: 3, 2008;
Prosper: $175.6 million;
LendingClub: $19.4 million.
Quarter: 4, 2008;
Prosper: $178.6 million;
LendingClub: $24.8 million.
Quarter: 1, 2009;
Prosper: $178.6 million;
LendingClub: $33 million.
Quarter: 2, 2009;
Prosper: $178.6 million;
LendingClub: $43 million.
Quarter: 3, 2009;
Prosper: $180.8 million;
LendingClub: $56.3 million.
Quarter: 4, 2009;
Prosper: $187.5 million;
LendingClub: $76.6 million.
Quarter: 1, 2010;
Prosper: $193.4 million;
LendingClub: $100.1 million.
Quarter: 2, 2010;
Prosper: $199.8 million;
LendingClub: $129.7 million.
Quarter: 3, 2010;
Prosper: $206 million;
LendingClub: $165.3 million.
Quarter: 4, 2010;
Prosper: $214.4 million;
LendingClub: $202.9 million.
Quarter: 1, 2011;
Prosper: $225.9 million;
LendingClub: $248.9 million.
Source: Prosper and LendingClub.
Note: While LendingClub registered a securities offering with SEC from
April 7, 2008, to October 13, 2008 (as we discuss later), it stopped
selling notes to lenders but continued to facilitate loans to
borrowers using its own funds. In contrast, while Prosper registered
with SEC from October 16, 2008, to July 13, 2009, it did not sell
notes to lenders or facilitate loans to borrowers. We did not
independently verify the data that the companies provided for this
report.
[End of figure]
According to industry officials, researchers, and online discussion
forums, individuals participate as lenders in for-profit, person-to-
person lending platforms as an alternative to traditional savings
vehicles (e.g., savings accounts, money market accounts, certificates
of deposit) that pay low interest rates. As of March 31, 2011, Prosper
reported that lenders received average net annualized returns
exceeding 11 percent for loans originated since it completed
registration with SEC in July 2009, while LendingClub reported net
annualized platform returns exceeding 9 percent for all loans since it
issued its first loan in June 2007.[Footnote 22] Around the same time,
the annual percentage yields for savings and money market accounts and
3-year certificates of deposit listed on bankrate.com were lower,
ranging from 0.1 percent to 1.2 percent and 1.3 percent to 2.2
percent, respectively.
Borrowers use person-to-person lending as an alternative source of
credit. Interest rates on these loans may be lower than those on
traditional unsecured bank loans or credit cards. As of March 31,
2011, the annual percentage rate for a 3-year loan was as low as 6.3
percent for Prosper and 6.8 percent for LendingClub, depending on the
borrower's credit ratings or loan grades, while the average annual
percentage rate for credit cards around that time was 14.7 percent.
[Footnote 23] Nonetheless, the annual percentage rate could be as high
as 35.6 percent for Prosper and 25.4 percent for LendingClub.[Footnote
24] In contrast, one credit card issuer had an annual percentage rate
of 49.9 percent for cash advances and purchases made using its credit
card. Prosper reported that the average annual percentage rate for all
3-year loans since its inception was 20.6 percent, and LendingClub
reported that the same average for its loans was 11.4 percent.
Lenders using these platforms generally provide capital in relatively
small amounts for borrowers who are typically seeking fairly small,
unsecured loans for consumer purposes--such as consolidating debts,
paying for home repairs, or financing personal, household, or family
purchases--or, to a lesser extent, for business purposes. Lenders can
invest in many loans and may fund an entire loan request or only a
fraction of each loan request--as little as $25 per loan. As of March
31, 2011, Prosper lenders invested on average about $3,700, while
LendingClub lenders invested on average about $8,640.[Footnote 25]
Both platforms restrict borrowers' loan request amounts to between
$1,000 and $25,000 for Prosper and up to $35,000 for LendingClub, and
the average amount borrowed was $5,886 for Prosper and approximately
$9,980 for LendingClub. As of March 31, 2011, according to Prosper
officials, about 25 percent of its borrowers since the platform's
inception used the loans to consolidate debt or pay off credit cards,
4 percent used the loans for home repairs, 10 percent used the loans
for business purposes, and 14 percent used the loans for other
purposes.[Footnote 26] The corresponding percentages for LendingClub
were approximately 57 percent to consolidate or pay off debt, 7
percent for home repairs, 10 percent for financing purchases for
consumer use, and 5 percent for business purposes.
The Two Major For-Profit Platforms Have Similar Processes for
Facilitating Loans:
As shown in figure 2, the lending process is similar for Prosper's and
LendingClub's platforms, with the company acting as an intermediary
between borrowers and lenders. To borrow or lend money on one of the
platforms, each participant must register as a member on that
company's Web site under a screen name (to maintain anonymity) and
provide basic information to determine their eligibility as a borrower
or lender.[Footnote 27] Each borrower must complete a loan application
that is reviewed to determine creditworthiness. For example,
prospective borrowers must have minimum credit scores to be accepted
on either platform--at least 640 for Prosper and 660 for LendingClub.
Prosper and LendingClub assign a proprietary letter grade to each loan
request--based on credit score, credit history, and other factors
(e.g., requested loan amount and past reported delinquencies)--to help
lenders gauge borrowers' creditworthiness.[Footnote 28] In comparison,
prospective lenders are not evaluated for creditworthiness. Beyond
demonstrating basic eligibility requirements, including identity
verification, lenders may only have to attest that they meet the
minimum income or asset requirements imposed by a number of state
securities regulators or, in the case of LendingClub, by the company
itself (we discuss these requirements later in this report). In
aggregate, a Prosper lender can invest up to $5 million, while a
LendingClub lender can invest no more than 10 percent of that lender's
total net worth.[Footnote 29]
Figure 2: Lending Process for the For-Profit Platforms:
[Refer to PDF for image: illustration]
1) Lending platform sells notes to lenders, corresponding to a
specific loan.
2) WebBank originates and disburses the loan to corresponding borrower
and then sells it to the lending platform in exchange for principal
amount received from sale of corresponding notes.
3) Borrower makes monthly repayments including interest.
4) Lending platform pays principal and interest on notes (minus
servicing and other fees) proportionate to the share of loan funded.
Source: GAO analysis based on information from Prosper and
LendingClub; Art Explosion.
[End of figure]
The companies post approved loan requests, including loan amounts,
interest rates, and assigned letter grades, on their Web sites for
lenders to review and choose to fund. Approved loan requests are for
unsecured, fixed-rate loans with a 1-, 3-, or 5-year maturity
(Prosper) and a 3-or 5-year maturity (LendingClub), with interest
rates reflecting the assigned credit rating or loan grade. Lenders may
also view information such as borrowers' income levels, and the
purpose of the loans, to the extent borrowers provide such data.
Lenders may scroll through approved loan listings manually to select
which loans to fund, or they may build a portfolio based on their
preferred criteria, such as loan characteristics (e.g., amount, term,
interest rate) or borrower characteristics (e.g., location, number and
balance of credit lines, length of employment). Lenders may also use
automated portfolio building tools, offered by both platforms, that
allow lenders to search for loans using criteria defined by the
platforms, such as credit quality, average annual interest rate, or a
combination of these characteristics.[Footnote 30]
On both platforms, lenders do not make loans directly to borrowers.
Rather, lenders purchase payment-dependent notes that correspond to
the selected borrower loans. Once lenders choose which loans to fund,
WebBank, an FDIC-insured Utah-chartered industrial bank, approves,
originates, funds, and disburses the loan proceeds to the
corresponding borrowers.[Footnote 31] WebBank then sells and assigns
the loans to the respective platform in exchange for the principal
amount that the platform received from the sale of corresponding notes
to the lenders. WebBank officials said that the bank does not have
long-term ownership of the loans and does not bear the risk of
nonpayment. Rather, they noted that, due to the nature of the
platforms, the risk of nonpayment is transferred (through the notes)
to the lenders.[Footnote 32]
Prosper and LendingClub have exclusive rights to service the loans and
collect monthly payments from borrowers, generally via electronic fund
transfers. After deducting a 1 percent servicing fee and any other
fees, such as insufficient fund fees, the platforms credit each
lender's account his or her share of the remaining funds. Also, the
platforms can attempt to recover any loans that become delinquent, and
they have exclusive rights to determine whether and when to refer the
loans to third-party collection agencies. As we discuss later, for
both companies, 2 percent or less of the loans in their top three
credit grades originated in the first half of 2010 had defaulted as of
March 31, 2011.
A Major Platform Allows Lenders to Support Microloans to Entrepreneurs
on a Not-for-Profit Basis:
Founded in November 2005, Kiva is the major nonprofit platform in the
United States that offers lenders opportunities to support economic
development and entrepreneurship, mostly in developing countries,
through partnerships with local microfinance institutions.[Footnote
33] As part of its efforts to alleviate poverty by connecting people
through lending, Kiva facilitates the collection and transfer of
capital for interest-free loans, funded by its lenders, to
approximately 130 microfinance institutions around the world to fund
interest-bearing loans to entrepreneurs in their communities. Kiva
screens, rates, and monitors each microfinance institution on its
platform and assigns it a risk rating for lenders to consider in their
funding decisions.[Footnote 34] As of March 31, 2011, about 570,000
Kiva lenders had funded approximately $200 million for 273,000
microloans across 59 countries.
Much like the two major for-profit platforms, Kiva is set up to allow
lenders to register for an online account to select and fund loans to
borrowers, primarily in developing countries, who are seeking money to
support their small business (microenterprise) operations. As shown in
figure 3, Kiva's lending process contains some key differences from
the process used by the major for-profit platforms. Rather than
transacting directly with individual borrowers, Kiva aggregates funds
from lenders and forwards them to microfinance organizations, which
make and manage loans to the borrowers and transmit the borrowers'
repayments to Kiva, which in turn distributes the lenders' shares of
the funds received back to the lenders. Individuals are eligible to
become lenders on Kiva simply by providing basic information,
including their name and e-mail address.[Footnote 35] Once lenders
have registered, Kiva automatically generates a profile page, but
lenders may choose to remain anonymous. Through the platform Web site,
lenders can look through the loan requests and select the
microenterprises that they are interested in funding. Lenders can fund
as little as $25 and as much as the entire amount of the loan.
Officials said that requested loan amounts vary geographically,
ranging from $1,200 to $10,000. Kiva relies on the local microfinance
institutions to screen and evaluate borrowers and set loan amounts and
terms. Additionally, the local microfinance institutions work with the
borrowers to collect their entrepreneurial stories, pictures, and loan
details and upload the information to Kiva's Web site for potential
lenders to view.
Figure 3: Lending Process for Kiva:
[Refer to PDF for image: illustration]
1) Lending platform collects money from willing lenders.
2) Lending platform makes loan to field partner (Microfinance
institution).
3) Periodic repayment (plus interest) from borrower to microfinance
institution.
4) Field partner makes periodic repayments (no interest).
5) Lending platform repays lenders proportionate to their original
loan amount.
Source: GAO analysis based on information from Kiva; Art Explosion.
Note: The microfinance institutions often disburse loans to borrowers
before the loans are funded by lenders.
[End of figure]
When lenders select the microenterprises they want to fund on Kiva's
platform, they do not make loans directly to the borrowers. Rather,
the loan proceeds typically replenish the microfinance institutions
for the loans that they distributed to borrowers when they were
needed. Often, the loans are disbursed before the loan details are
posted on Kiva's Web site for lenders to view.[Footnote 36] Even
though Kiva lenders provide loan funds free of interest, the
microfinance institutions charge the entrepreneurs interest on their
loans to help cover the institutions' operating costs. As of February
2011, the average portfolio yield among Kiva's microfinance
institution partners was about 37 percent.[Footnote 37] As the
microfinance institutions collect the scheduled repayments from
borrowers, they retain the interest payments and any other fees they
charge to help finance their operations, and transfer the amount of
principal payments to Kiva, which credits lenders' accounts for their
share of the corresponding loans. If a borrower fails to make a
scheduled payment, the microfinance institution notifies Kiva and
lenders could potentially receive a late or partial payment or receive
no payment. According to Kiva, the repayment rate for all of its loans
from all partners as of March 31, 2011, was approximately 99 percent.
[Footnote 38]
According to Kiva officials and online discussion forums, many lenders
participate on Kiva's platform because they are motivated to help
individuals in developing countries escape poverty and improve their
quality of life. Kiva reported that, as of March 31, 2011, each of its
lenders had funded an average of about 11 loans for about $380 per
borrower. Furthermore, Kiva officials said that, based on its market
research, the bulk of its lenders said that they chose to lend to make
a difference in someone's life without spending a lot of money and
that they would be likely to use any repayments they received to fund
more loans to other entrepreneurs.
Other Domestic and Foreign Companies Demonstrate the Variety of Person-
to-Person Lending Platforms:
Several U.S. companies have introduced a variety of other person-to-
person lending platforms.[Footnote 39] For example, some companies
have offered, and at least one continues to offer, a more direct form
of person-to-person lending that formalizes lending among friends and
families. Lenders can use such platforms to make loans directly to
borrowers they know by arranging a promissory note that outlines
explicit conditions, such as the loan amount, terms and rate, and
repayment terms. Other companies have offered platforms that, like
Prosper and LendingClub, facilitate interest-bearing loans between
individuals who do not know one another, but these companies have
often targeted a more specific lending market. For example, these
platforms may provide financing for small businesses, mortgages, or
private student loans for higher education.
Foreign companies have also offered an array of person-to-person
lending platforms in a number of other countries. For example, Zopa, a
UK company, operates a major for-profit, person-to-person lending
platform similar to Prosper and LendingClub in the United Kingdom and
has begun to franchise its model in other countries.[Footnote 40] As
of March 2011, Zopa had facilitated more than £125 million (roughly
$200 million) in loans since its launch in 2005. Additionally, other
foreign companies in countries such as Australia, Canada, China,
France, Germany, India, Japan, and Korea have also offered both for-
profit, person-to-person lending platforms and nonprofit platforms
that offer lenders opportunities to fund microfinance loans.
Although Person-to-Person Lending Offers Potential Benefits to Lenders
and Borrowers, It Also Poses Risks Currently Overseen by a Complex
Regulatory Structure:
Person-to-person lending offers lenders the potential to earn
relatively high returns and may provide borrowers with broader access
to credit than they would otherwise have. In return, lenders face the
risk of losing their principal and the expected interest on their
investments on for-profit platforms. While borrowers using the person-
to-person lending platforms face risks largely similar to those facing
borrowers using traditional banks, including unfair lending and
collection practices, borrowers face some privacy issues unique to the
person-to-person lending platforms. The current regulatory structure
for the oversight of person-to-person lending consists of a complex
framework of federal and state laws and the involvement of numerous
regulatory agencies. For the major for-profit platforms, SEC and state
securities regulators enforce lender protections, mostly through
disclosures required under securities laws, and FDIC and state
regulators enforce borrower protections. The Internal Revenue Service
(IRS) and California attorney general have authority to enforce
reporting and other requirements for Kiva as a charitable
organization, while Kiva's microfinance partners are subject to
varying consumer financial protection requirements that apply in the
jurisdictions where they lend.
Person-to-Person Lending Poses Risks to Lenders That Have Been Subject
to Securities Regulation:
The major for-profit, person-to-person lending companies (Prosper and
LendingClub) offer lenders the potential to earn higher returns than
they might through conventional savings vehicles, as the examples of
the companies' Web sites show (figures 4 and 5). As we have seen, the
companies have reported average net annualized returns for lenders
that have exceeded recent returns for savings accounts and
certificates of deposit. According to Prosper and LendingClub, lenders
can also select loans that match their appetite for risk and return,
something they cannot do with bank deposits, and diversify their
portfolios by investing in consumer and commercial (i.e., small
business) loans as an alternative asset class to stocks or mutual
funds.
Figure 4: Example from Prosper's Web Site Identifying Benefits to
Lenders:
[Refer to PDF for image: illustration of web site]
Smart, Diversified Investing:
Flexible Options, Great Returns:
Actual Returns: 10.1%.
With our huge marketplace of qualified borrowers, Prosper allows you
to diversify your investment by spreading your money out over multiple
loans with minimal effort. You reap higher returns without the
overhead and hidden fees. It's easy, reliable, and safe to invest
through Prosper, and-”the best reward of all-”you're investing
directly in people.
When you invest with Prosper, you get:
* The ability to choose your level of risk versus return.
* A pre-screened pool of credit-worthy borrowers.
* Transparency with who you are lending to.
* Control over the parameters of your investment.
* Diversification of your overall portfolio.
* The gratification of investing in real people.
All in just a few simple steps.
Source: Prosper [hyperlink, http://www.prosper.com/invest], accessed
4/7/11).
[End of figure]
Figure 5: Example from LendingClub's Web Site Identifying Benefits to
Lenders:
[Refer to PDF for image: illustration of web site]
LendingClub:
Investors earn better returns, borrowers pay lower rates.
Invest & Earn 9.65%.
Better Returns:
Invest directly in creditworthy borrowers and earn more.
More Control:
Choose the risk and return of your investment.
Fast and Easy:
Build a diversified portfolio of Notes in minutes.
Source: LendingClub [hyperlink, http://www.lendingclub.com] accessed
4/7/11).
[End of figure]
Lenders participating on the platforms are also exposed to various
risks--particularly credit risk (the possibility that borrowers may
default on their loans) and operational risks associated with relying
on the platforms to screen loan applicants and service and enforce
collection of the loans (see table 1). In contrast with traditional
savings vehicles, such as FDIC-insured savings accounts or
certificates of deposit with fixed rates of return, the notes that
lenders purchase from Prosper and LendingClub do not guarantee that
they will recover their principal or achieve expected returns. While
the companies take steps to confirm loan applicants' identities and
use information from their credit reports to screen loan requests and
assign credit ratings, they often do not verify information that
borrowers supply, such as their income, debt-to-income ratio, and
employment and homeownership status.[Footnote 41] Lenders face the
risk that inaccuracies in the platforms' assigned credit ratings or
borrower-supplied information could result in lower-than-expected
returns. Also, lenders have no direct recourse to the borrowers to
obtain loan payments, so their returns depend on the success of the
platforms and their collection agents in obtaining repayments from
borrowers. For all loans originated between January 1, 2010, and June
30, 2010, about 55 percent of Prosper's and more than 70 percent of
LendingClub's loan volume went to borrowers with the top three credit
grades and, of those loans, 1.2 percent (Prosper) and 2 percent
(LendingClub) had entered into default or been charged off by March
31, 2011.[Footnote 42]
Table 1: Examples of Risks to Lenders Identified by the Major For-
Profit, Person-to-Person Lending Platforms:
Risk: Credit risk;
Definition: Potential for financial losses resulting from the failure
of a borrower to perform on an obligation;
Examples:
* The notes that lenders purchase from the platforms are not secured
by any collateral, or guaranteed or insured by any third party, and
payments on the notes depend entirely on payments the platforms
receive on corresponding borrower loans;
* If the corresponding borrower loans become delinquent, lenders are
unlikely to receive the full principal and interest payments they
expected to receive on their notes because of collection fees and
other costs, and they may not recover any of their original investment;
* If a lender decided to concentrate his or her investment in a single
note, the entire return would depend on the performance of a single
loan.
Risk: Operational risk;
Definition: Potential for unexpected financial losses due to
inadequate or failed internal processes, people, and systems, or from
external events;
Examples:
* The platforms generally do not verify information supplied by
borrowers, which may not be accurate and may not accurately reflect
borrowers' creditworthiness;
* Actual loan default and loss rates may be different than expected
because the platforms have limited historical loan performance data,
and their credit rating systems may not accurately predict how loans
will perform;
* Lenders must rely on the platforms and their designated third-party
collection agencies to pursue collection if a borrower defaults,
instead of pursuing collection themselves;
* Because lenders who hold notes do not have a direct security
interest in the corresponding borrower loans, their rights could be
uncertain if the platform were to become bankrupt, and payments on the
notes may be limited, suspended, or stopped.
Risk: Liquidity risk;
Definition: Potential for financial losses resulting from an inability
to liquidate assets;
Examples:
* The notes are not transferable except to other lenders on each
platform;
* Each platform offers a proprietary note trading platform for its
members, but neither platform guarantees that lenders will be able to
find purchasers for notes they wish to sell.
Risk: Market risk;
Definition: Potential for financial losses due to the increase or
decrease in the value or price of an asset or liability resulting from
broad movements in prices;
Examples:
* Reductions in prevailing market interest rates could induce
borrowers to prepay their loans, affecting lenders' returns;
* Increases in prevailing market interest rates could result in
lenders receiving less value from their notes in comparison with other
investment opportunities.
Risk: Legal risk;
Definition: Potential for tax consequences due to incorrect
interpretation of tax laws;
Examples:
* Person-to-person lending is a novel approach to borrowing and
investing. If regulators or the courts took a different interpretation
than the companies have of the income tax implications of the notes,
it could have tax consequences for lenders.
Source: GAO analysis of Prosper and LendingClub prospectuses.
[End of table]
To mitigate some of the credit risk that loans might default, lenders
on the platforms may choose to diversify their investments by funding
a broad portfolio of loans, in the same way that investors might
diversify their investments across and within asset classes to
minimize the impact of a single asset losing value. However, investing
in a diverse portfolio of loans on a given platform does not eliminate
other risks, such as those associated with lenders relying on
unverified borrower information and the companies' credit rating
systems when selecting which loans to fund.
Federal Securities Regulation:
The risks to lenders of participating on person-to-person lending
platforms are currently addressed through securities registration of
the notes the companies sell to lenders. Although officials from
Prosper and LendingClub said that they had initially questioned the
applicability of federal securities registration requirements to
person-to-person lending, both companies ultimately registered
securities offerings with SEC.[Footnote 43] Prosper and LendingClub
launched their platforms in 2005 and 2007, respectively, without
registering securities offerings.[Footnote 44] Prosper subsequently
filed a registration statement in October 2007 for a proposed
secondary trading platform that its lenders could use to trade their
notes, but it did not seek to register the notes themselves.[Footnote
45] Prosper continued to sell notes to lenders until October 2008. In
November 2008, SEC entered a cease-and-desist order against Prosper,
in which SEC found that Prosper violated Section 5 of the Securities
Act for engaging in unregistered offerings of securities.[Footnote 46]
Prosper resumed selling notes to lenders when its registration
statement became effective in July 2009. LendingClub suspended its
sales of notes to lenders from April to October 2008 to register with
SEC. This progression of events is illustrated in figure 6.
Figure 6: Timeline of Events Culminating in Prosper's and
LendingClub's Securities Registrations, November 2005 through December
2009:
[Refer to PDF for image: timeline]
Prosper:
November 2005:
Began making loans.
October 2007:
Filed registration statement with SEC.
October 2008:
Suspended sales of notes to lenders.
November 2008:
SEC entered cease-and-desist order.
December 2008:
Reached settlement with state securities regulator.
July 2009:
Registration statement became effective; resumed
operations.
LendingClub:
June 2007:
Began making loans.
April 2008:
Suspended sales of notes to lenders.
June 2008:
Filed registration statement with SEC.
October 2008:
Registration statement became effective; resumed operations.
Source: Prosper and LendingClub prospectuses.
[End of figure]
SEC's oversight of person-to-person lending, as with its oversight of
other companies that issue securities, focuses on reviewing the
companies' required disclosures rather than examining or supervising
the companies or their operations, or reviewing the merits of the
notes they offer. Specifically, staff from SEC's Division of
Corporation Finance led the agency's review of Prosper's and
LendingClub's registration statements and other required filings for
compliance with legal requirements for an issuer to disclose all
information that may be material to an investor's decision to buy,
sell, or hold a security.[Footnote 47] For example, Prosper's and
LendingClub's prospectuses identify, among other things, the general
terms of the notes, the risks to lenders of investing in the notes,
and details about the operations of the platforms.[Footnote 48] In
addition, both Prosper and LendingClub continually offer new series of
notes to investors to fund corresponding loans and thus are required
to update their prospectuses with supplements containing information
about the new notes and their corresponding loans as they are offered
and sold.[Footnote 49] These supplements include required information
on the terms of each note, such as interest rate and maturity. Prosper
and LendingClub also include other information concerning the
underlying loan that is available to lenders on their Web sites as
part of the loan listing, including anonymous information from the
borrower's credit report, and anonymous information supplied by the
borrower, such as loan purpose, employment status, and income.
SEC staff explained that the federal securities laws and rules require
that certain information--including information in the prospectus
supplements--be provided to investors in order to document the final
terms of their investments. Including these disclosures in the
prospectus also ensures that certain protections of the securities
laws are available to investors in the event the information is found
to be incorrect or misleading.[Footnote 50] For example, SEC staff
told us that the borrower and loan information included in the
prospectus supplements established a permanent record of all material
information that the companies provided to their lenders about the
notes offered and purchased. Staff from SEC and officials from the
companies agreed that lenders were unlikely to consult the prospectus
supplements--which are available to the public online on SEC's
Electronic Data Gathering, Analysis, and Retrieval (EDGAR) database--
at the time they invest, because the same information is available in
real time on the platforms. However, investors who purchase securities
and suffer losses have recovery rights, through litigation, if they
can prove that material information was omitted or stated untruthfully
in the prospectus or prospectus supplements.[Footnote 51] Information
is only deemed part of a prospectus when it is required to be filed
with SEC under its rules.
State Securities Regulation:
In addition to registering with SEC, Prosper and LendingClub have
registered with selected state securities regulators in order to be
permitted to offer and sell notes to state residents.[Footnote 52] The
Securities Act of 1933 exempts certain types of securities, such as
those of companies listed on national exchanges, from state securities
registration requirements.[Footnote 53] However, because the notes
that Prosper and LendingClub offer do not qualify for such an
exemption, the companies have sought to register the notes on a state-
by-state basis. As of April 2011, 30 states and the District of
Columbia had approved the registration statements or applications of
one or both companies (figure 7).[Footnote 54] Lenders in the
remaining 20 states cannot participate on either platform, but
officials from both companies said that they were continuing to seek
approval in some of the remaining states.
Figure 7: Status of Prosper's and LendingClub's State Securities
Registrations, as of April 2011:
[Refer to PDF for image: illustrated U.S. map]
Neither company registered within the state:
Alabama;
Arkansas;
Arizona;
Indiana;
Iowa;
Kansas;
Maryland;
Massachusetts;
Michigan;
Nebraska;
New Jersey;
New Mexico;
North Carolina;
North Dakota;
Ohio;
Oklahoma;
Pennsylvania;
Tennessee;
Texas;
Vermont.
LendingClub registered to sell notes to lenders:
Kentucky;
West Virginia.
Prosper registered to sell notes to lenders:
Alaska;
Oregon.
Both companies registered to sell notes to lenders:
California;
Colorado;
Connecticut;
Delaware;
Florida;
Georgia;
Hawaii;
Idaho;
Illinois;
Louisiana;
Maine;
Minnesota;
Mississippi;
Montana;
Nevada;
New Hampshire;
New York;
Rhode Island;
South Carolina;
South Dakota;
Utah;
Virginia;
Washington;
Wisconsin;
Wyoming.
State has imposed investor suitability requirements for lenders:
California;
Idaho;
Kentucky;
New Hampshire;
Oregon;
Virginia;
Washington.
Source: Prosper and LendingClub; MapInfo.
[End of figure]
NASAA officials explained that, while some states take a disclosure-
based approach similar to SEC's, other states have a merit-based
approach that, in addition to disclosure, also requires the securities
regulators to determine whether a securities offering is fair, just,
and equitable. These merit-review states may impose financial
suitability standards, such as minimum income or asset requirements
and caps on the percentage of an investor's assets that can be
invested in a security. Seven merit-review states have required their
residents to meet such suitability standards to participate as lenders
on Prosper's or LendingClub's platforms.[Footnote 55] The state
securities regulators do not examine compliance with these suitability
standards, and the companies are not required to verify that lenders
meet them. Rather, the companies require lenders to attest that they
meet the standards. NASAA officials said that a company could be held
liable if it sold notes to a lender without receiving the proper
attestation of suitability or when it knew, or should have known, that
the lender's attestation of suitability was false. In either event,
the state securities regulator or SEC could bring an enforcement
action against the company.
Officials of the securities regulators in the four merit-review states
that we contacted (California, Kentucky, Oregon, and Texas) identified
risk factors and other considerations that led their agencies to
impose financial suitability requirements for lenders or that have
prevented them from approving one company's, or both companies',
registration statements.[Footnote 56]For example, all four of these
states cited the risks lenders face, particularly related to their
reliance on the platforms to screen borrowers and service the loans,
the companies' limited verification of information supplied by
borrowers, and the novelty and untested nature of person-to-person
lending. Officials from Kentucky and Oregon said that, by imposing
suitability requirements that restricted lenders' investments to 10
percent of their net worth, their agencies aimed to protect investors
in their states by limiting their exposure to losses on the notes.
They also said that their states' minimum income or net worth
requirements helped to ensure that lenders could afford to withstand
any losses incurred and increased the likelihood that they would have
the sophistication to understand the risks of investing in the notes.
Officials from Texas said that the companies' registration statements
had not yet satisfied Texas' conditions for approving registrations.
The officials said that one of the applicable conditions was a cash
flow standard for debt securities--which holds that a company issuing
debt securities should have sufficient cash flows to service the debt
securities being offered--even though Prosper and LendingClub are not
obligated to make payments on the notes if the borrowers fail to repay
the corresponding loans.[Footnote 57] In contrast, officials from
California said that the financial condition of person-to-person
lending companies has little relevance for lenders compared with the
financial conditions of the borrowers in the underlying transactions.
However, they noted that securities regulators cannot assess
borrowers' financial conditions. These officials said that, in
imposing financial suitability requirements for California residents,
the agency sought to balance the risks to lenders with the overall
benefits that person-to-person lending confers on lenders and
borrowers.
Various Regulators Oversee Risks to Borrowers on Person-to-Person
Lending Platforms:
Person-to-person lending platforms may broaden the supply of unsecured
consumer and commercial loans, and borrowers who obtain loans through
the platforms may be able to obtain better terms than they could from
more conventional lenders. To the extent that lenders invest in
consumer and commercial loans, person-to-person platforms may provide
borrowers with an alternative to traditional sources of unsecured
credit such as credit cards and personal loans from banks. Borrowers
may also be able to obtain lower annual percentage rates through
Prosper and LendingClub than through more traditional credit sources.
As with traditional loans, however, these terms will vary according to
the borrower's credit score and history, as well as the amount and
terms of the loan.
As with any source of credit, borrowers on the two major for-profit,
person-to-person lending platforms face risks--such as potentially
unclear or misleading lending terms, predatory or discriminatory
credit decisions, and unfair, deceptive, or abusive servicing or
collection acts or practices. The regulators, researchers, and
consumer advocacy organizations we interviewed generally characterized
these risks as similar to the risks borrowers faced in obtaining
consumer loans from banks or other institutions. Borrowers face the
risk of unclear or misleading lending terms, but regulators and
consumer advocacy organizations generally agreed that the major for-
profit, person-to-person lending platforms currently offer loans with
fairly straightforward terms (e.g., fixed-rate, fully amortizing
loans). Some of these commentators also said that, as they would with
other types of credit providers, borrowers could face the risk of
predatory or discriminatory credit decisions or other unfair,
deceptive, or abusive acts or practices by the major for-profit
platforms or the third-party collection agencies they hire.
Unlike with traditional lending, borrowers also face the risk of
having their privacy compromised through their participation on the
major for-profit platforms because borrowers may reveal enough
information online to permit the platforms' members and members of the
public to deduce their identities.[Footnote 58] Prosper and
LendingClub present borrowers' information anonymously, including
credit report data, and take steps to deter borrowers from posting
personally identifiable information. Nonetheless, any personally
identifiable information borrowers choose to reveal is available to
members online and, because it is included in the prospectus
supplements filed with SEC, publicly through SEC's EDGAR database. Our
review of selected prospectus supplements filed by Prosper and
LendingClub between August 31, 2010, and November 26, 2010, identified
cases in which borrowers revealed information that potentially could
be pieced together to determine their identities. For example, a few
borrowers listed Web site addresses for their small businesses, while
others revealed their city of residence, employer, and job title or
other specific occupation information. In April 2011, LendingClub
implemented additional controls to help address some of the issues we
identified. Also, in June 2011, Prosper officials said that they
intended to modify their privacy policy to disclose to borrowers that
certain information they provide in their loan listings becomes
publicly available through SEC filings. Appendix II offers a more
detailed discussion of our analysis.
Federal and State Laws and Regulation:
A number of federal and state regulators currently play a role in
monitoring and enforcing Prosper and LendingClub's compliance with
laws that address risks related to consumer lending and Internet
commerce. As shown in table 2, these laws require creditors to
disclose lending terms, prohibit discrimination, and regulate debt
collection. The laws also prohibit unfair or deceptive acts or
practices and require companies to protect personal financial
information, adopt anti-money-laundering procedures, and meet
requirements for electronic transactions. Officials from Prosper and
LendingClub identified these laws as being applicable to the
platforms' lending activities directly or indirectly through their
relationships with WebBank (the FDIC-insured industrial bank in Utah
that originates and disburses the platforms' loans) and third-party
debt collection agencies.[Footnote 59] Prosper, LendingClub, and
WebBank officials also described the steps that they have taken to
ensure compliance with many of these laws and their regulations. For
example, WebBank officials said that loans are originated based on
WebBank-approved credit policies, which Prosper and LendingClub
implement. The officials said that WebBank reviews and approves all
materials and policies related to loan advertising and origination,
and also performs transaction-level testing of the platforms' credit
decisions to, among other things, help ensure compliance with
antidiscrimination provisions of the Equal Credit Opportunity Act. The
officials noted that Prosper and LendingClub were responsible for
providing, on behalf of WebBank as the lender, disclosures of loan
terms for approved loan requests, as required under the Truth in
Lending Act, and of reasons for denying loan applications for consumer
credit, as required under the Equal Credit Opportunity Act and the
Fair Credit Reporting Act. They added that WebBank's transaction-level
testing validated the companies' calculations of annual percentage
rates and finance charges and ensured that the platforms' disclosures
were generated correctly.
Table 2: Federal Lending and Consumer Financial Protection Laws Cited
by the Major For-Profit Companies as Applicable to Person-to-Person
Lending:
Law: Truth in Lending Act[A];
Examples of relevant requirements or provisions: Requires creditors to
provide uniform, understandable disclosures concerning certain terms
and conditions of their loan and credit transactions; regulates the
advertising of credit and gives borrowers, among other things, certain
rights regarding updated disclosures and the treatment of credit
balances.
Law: Equal Credit Opportunity Act[B];
Examples of relevant requirements or provisions: Prohibits creditors
from discriminating against credit applicants on the basis of race,
color, religion, national origin, sex or marital status, or age, or
the fact that all or part of the applicant's income derives from any
public assistance program or the fact that the applicant has in good
faith exercised any right under the federal Consumer Credit Protection
Act or any applicable state law.
Law: Servicemembers Civil Relief Act[C];
Examples of relevant requirements or provisions: Entitles borrowers
who enter active military service to an interest rate cap and permits
servicemembers and reservists on active duty to suspend or postpone
certain civil obligations.
Law: Fair Credit Reporting Act[D];
Examples of relevant requirements or provisions: Requires a
permissible purpose to obtain a consumer credit report, and requires
persons to report information to credit bureaus accurately; imposes
disclosure requirements on creditors who take adverse action on credit
applications based on information contained in a credit report;
requires creditors to develop and implement an identity theft
prevention program.
Law: Section 5 of the Federal Trade Commission Act[E];
Examples of relevant requirements or provisions: Prohibits unfair or
deceptive business acts or practices.
Law: Gramm-Leach-Bliley Financial Modernization Act[F];
Examples of relevant requirements or provisions: Limits when a
"financial institution" may disclose a consumer's "nonpublic personal
information" to nonaffiliated third parties; requires financial
institutions to notify their customers about their information-sharing
practices and to tell consumers of their right to "opt out" if they do
not want their information shared with certain nonaffiliated third
parties.
Law: Electronic Fund Transfer Act[G];
Examples of relevant requirements or provisions: Provides certain
consumer rights regarding the electronic transfer of funds to and from
consumers' bank accounts.
Law: Electronic Signatures in Global and National Commerce Act[H];
Examples of relevant requirements or provisions: Authorizes the
creation of legally binding and enforceable agreements utilizing
electronic records and signatures and requires businesses that want to
use electronic records or signatures in consumer transactions to
obtain the consumer's affirmative consent to receive information
electronically.
Law: Bank Secrecy Act[I];
Examples of relevant requirements or provisions: Requires financial
institutions to implement anti-money-laundering procedures, apply
customer verification program rules, and screen names against the
federal list of Specially Designated Nationals, whose assets are
blocked and with whom companies are generally prohibited from dealing.
Law: Fair Debt Collection Practices Act[J];
Examples of relevant requirements or provisions: Provides guidelines
and limitations on the conduct of third-party debt collectors in
connection with the collection of consumer debts; limits certain
communications with third parties, imposes notice and debt validation
requirements, and prohibits threatening, harassing, or abusive conduct
in the course of debt collection.
Source: Interviews and documents from Prosper and LendingClub and the
listed statutes and their implementing regulations.
[A] Pub. L. No. 90-321, Title I, 82 Stat. 146 (1968), codified at 15
U.S.C. §§ 1601-1667f.
[B] Pub. L. No. 93-495, Title V, 88 Stat. 1521 (1974), codified at 15
U.S.C. §§ 1691-1691f.
[C] 54 Stat. 1178 (1940), codified at 50 App. U.S.C. §§ 501-596.
[D] Pub. L. No. 91-508, Title VI, § 601, 84 Stat. 1128 (1970),
codified at 15 U.S.C. §§ 1681-1681x.
[E] § 5, 38 Stat. 719 (1914), codified at 15 U.S.C. § 45.
[F] Pub. L. No. 106-102, 113 Stat. 1338 (1999) (codified in scattered
sections of 12 U.S.C. and 15 U.S.C.).
[G] Pub. L. No. 95-630, Title xx, § 2001, 92 Stat. 3728 (1978),
codified at 15 U.S.C. §§ 1693-1693r.
[H] Pub. L. No. 106-229, 114 Stat. 464 (2000), codified at 15 U.S.C.
§§ 7001-7006, 7021, 7031.
[I] Pub. L. No. 91-508, Titles I, II, 84 Stat. 1114-1124 (1970),
codified at §§ 12 U.S.C. 1951-1959.
[J] Pub. L. No. 95-109, 91 Stat. 874 (1977), codified at 15 U.S.C. §§
1692-1692p.
[End of table]
Several federal and state regulators, including FDIC, FTC, and the
Utah Department of Financial Institutions (UDFI), either play a role
or could play a role in helping ensure Prosper's and LendingClub's
compliance with applicable laws and regulations. First, WebBank's
primary federal and state regulators--FDIC and UDFI--have the
authority to indirectly oversee Prosper's and LendingClub's compliance
with applicable lending, consumer protection, and financial privacy
laws, because the bank originates and disburses the platforms' loans,
and Prosper and LendingClub are the bank's servicers for this purpose.
FDIC and UDFI generally evaluate institutions' risk management
programs, including third-party relationships.[Footnote 60] These
evaluations focus on the institutions' oversight programs and
generally not include direct examination of third-party platforms.
[Footnote 61] Officials from FDIC and UDFI said that they could take
enforcement action against a bank or refer the companies operating
platforms to law enforcement agencies if they identified problems in a
bank's relationship with the companies, or found evidence that the
companies had violated federal or state laws.
Second, FTC has some enforcement responsibilities related to person-to-
person lending. FDIC enforces applicable financial privacy provisions
of the Gramm-Leach-Bliley Financial Modernization Act (Gramm-Leach-
Bliley Act) against WebBank. FTC staff said that, while FTC has not
determined whether Prosper or LendingClub are financial institutions
as defined by the act, if the companies were engaged in any of the
financial activities incorporated by reference into the act, they
would be subject to FTC's jurisdiction if they were not specifically
assigned to another regulator's jurisdiction.[Footnote 62] FTC also
has the authority to enforce Section 5 of the FTC Act--which prohibits
unfair or deceptive acts or practices. FTC staff said that, unless
Prosper and LendingClub were exempt from the agency's jurisdiction,
FTC could enforce Section 5 against them.[Footnote 63] FTC also has
primary enforcement responsibility under the Fair Debt Collection
Practices Act--which prohibits abusive, unfair, or deceptive acts or
practices by third-party debt collectors--although banks and certain
other entities are exempt from FTC's authority. FTC staff said that
FTC could enforce the act against Prosper and LendingClub if they were
not exempt from FTC's authority and if they were engaged in third-
party debt collection.
However, FTC officials noted that FTC was primarily a law enforcement
agency and did not have examination authority. To identify targets for
law enforcement investigations and prosecutions, FTC staff monitors
consumer complaints, among other sources, for trends and for
information about problematic practices and companies. As of March
2011, FTC reported that it had received 29 consumer complaints related
to person-to-person lending out of more than 6 million complaints it
had received overall in the last 5 years.[Footnote 64]
Third, some states have lending, servicing, and debt collection laws
that apply to Prosper and LendingClub. Officials from both companies
said that, although WebBank originates and disburses loans on their
behalf, some states require them to be licensed or otherwise
authorized to perform their roles in marketing and servicing the
loans.[Footnote 65] The officials said that they could be subject to
inspection by these states' licensing authorities but added that state
oversight had generally been limited to periodic reporting
requirements.
The federal regulatory structure for person-to-person lending as
related to borrower protection will be affected as CFPB assumes its
new authorities under the Dodd-Frank Act.[Footnote 66] For example:
* CFPB will assume authority to make rules under many existing
consumer financial protection laws and will have the authority to
prescribe rules defining what acts or practices pertaining to consumer
financial products or services constitute unfair, deceptive, or
abusive acts or practices.[Footnote 67] Similarly, CFPB will have the
authority to prescribe rules imposing disclosure requirements to help
consumers understand the terms, benefits, costs, and risks of consumer
financial products and services.[Footnote 68] CFPB representatives
noted that many regulations promulgated by CFPB will generally apply
to consumer loans made through person-to-person lending platforms.
* CFPB will assume responsibility for supervising compliance with
federal consumer financial laws for (1) banks with more than $10
billion in assets and their affiliates and (2) certain categories of
nondepository financial services providers including, as discussed
earlier, nondepository entities that are "larger participant[s] of a
market for other consumer financial products or services," as defined
by CFPB in regulations after consultation with FTC.[Footnote 69] CFPB
will also have substantial authority to examine "service providers"
who provide material services to depository or nondepository "covered
persons" under the Dodd-Frank Act.[Footnote 70] CFPB representatives
emphasized that determining the scope of CFPB's supervision authority
with regard to particular person-to-person lending platforms would be
highly fact-dependent, but that, in general, a nondepository
institution operating a person-to-person lending platform could become
subject to CFPB's supervision authority if it was involved in
residential mortgage lending, private student education lending, or
payday lending; if it met the definition of a "larger participant of a
market for other consumer financial products or services;" or under
certain circumstances as a service provider.[Footnote 71]
* CFPB is required to establish a unit whose functions shall include
establishing a database or utilizing an existing database to
facilitate the centralized collection of, monitoring of, and response
to consumer complaints about consumer financial products or services.
[Footnote 72] CFPB representatives said that the complaint unit would
collect complaints related to borrowers' experiences with person-to-
person lending platforms to the extent the complaints relate to
consumer loans or other consumer financial products or services. As a
general matter, CFPB is still defining the scope of its complaint
handling function, including whether it would collect complaints
related to lenders' experiences with person-to-person lending
platforms and how it would coordinate with agencies such as FDIC, FTC,
and SEC to route and respond to such complaints.
The Major Nonprofit Platform Is Subject to Regulation as a Charitable
Organization:
The major U.S. nonprofit person-to-person lending platform, Kiva,
offers lenders the opportunity to help alleviate poverty through
funding loans and entrepreneur borrowers the opportunity to benefit
from these funds. As we have seen, Kiva lenders do not earn interest
on the loans they fund. Instead, Kiva emphasizes the potential social
and economic benefits that lenders may help achieve through their
support of microfinance and entrepreneurship, as shown in figure 8. To
the extent that the funds from lenders provide Kiva's microfinance
partners the capital to finance loans that they would not have
otherwise made, the platform's activities may increase the supply of
credit for individual entrepreneurs who might not have access to
traditional banking services in their home countries.
Figure 8: Examples from Kiva's Web Site Identifying Benefits to
Lenders:
[Refer to PDF for image: web site illustrations]
Kiva:
The people behind Kiva include volunteers, Kiva Fellows, Field
Partners, our board, and a team of employees (shown above) and
contractors. The Kiva headquarters is located in San Francisco,
California.
We are a non-profit organization with a mission to connect people
through lending to alleviate poverty. Leveraging the internet and a
worldwide network of microfinance institutions, Kiva lets individuals
lend as little as $25 to help create opportunity around the world.
Learn more about how it works.
Since Kiva was founded in 2005:
571,731 Kiva lenders;
$205 million in loans;
98.65% Repayment rate.
We work with:
131 Field Partners;
450 volunteers around the world;
59 different countries.
Why we do what we do:
We envision a world where all people - even in the most remote areas
of the globe - hold the power to create opportunity for themselves and
others.
We believe providing safe, affordable access to capital to those in
need helps people create better fives for themselves and their
families.
Source: Kiva [hyperlink, http://www.kiva.org], accessed 4/7/11).
[End of figure]
Lenders on Kiva's platform face some risks similar to those facing
lenders on the for-profit, person-to-person lending platforms,
principally credit risk--the possibility that they will lose their
principal if borrowers or Kiva's microfinance partners fail to repay
their loans. Kiva and its microfinance partners do not guarantee
lenders' loans, so the lenders assume the risk that borrowers may not
repay. In addition, lenders face risks because they rely on Kiva's
microfinance partners to screen borrowers, service their loans, and
transmit payments to Kiva. As a result, even if borrowers repay their
loans, lenders may not be repaid due to a microfinance partner's
bankruptcy, fraud, or poor operations. Kiva discloses these risks on
its Web site. Similarly, lenders face operational risks associated
with their reliance on Kiva to screen and monitor its microfinance
partners and effectively maintain its platform for servicing the loans
and transmitting payments to lenders. Kiva also discloses on its Web
site that lenders face potential currency risks and country-specific
risks that do not affect lenders on the major for-profit platforms.
For example, Kiva's microfinance partners may choose to pass on to
lenders a share of the foreign currency risks associated with their
receiving loan payments in local currency and needing to repay loans
to Kiva in U.S. dollars.[Footnote 73] Also, broader risks of economic
or political disruption or natural disaster in borrowers' home
countries can affect repayments to lenders.
Borrowers who receive loans funded by lenders on the Kiva platform
also face risks that are similar to those facing borrowers who receive
loans through other types of lenders, based on actions of the
microfinance institutions that actually disburse the funds and service
the loans posted to the Kiva Web site. These risks include the
potential for a microfinance institution to provide unclear or
misleading lending terms, make predatory or discriminatory credit
decisions, and use unfair, deceptive, or abusive servicing or
collection acts or practices. For Kiva's microfinance partners that
lend to borrowers in the United States, the legal standards for
lending terms and practices would depend in part on whether they
extend consumer or commercial credit, but would likely be similar to
those for Prosper and LendingClub and other institutions involved in
domestic lending of the same type, according to CFPB representatives.
For Kiva's microfinance partners that lend in foreign countries,
however, the local lending regulations may vary.
As a 501(c)(3) nonprofit tax-exempt organization, Kiva is subject to
federal and state charity regulation and IRS financial reporting
requirements.[Footnote 74] For example, to obtain and maintain its
exemptions from federal and state income taxes and its ability to
receive tax-deductible donations, Kiva must be organized and operated
exclusively for charitable or other exempt purposes and must comply
with federal limitations on lobbying activities.[Footnote 75] Although
Kiva is exempt from income taxation, the IRS and California's
Franchise Tax Board require charitable organizations to file annual
information returns of their income and expenses. Also, under
California law, Kiva must prepare and have audited annual financial
statements. While Kiva must disclose its annual returns and financial
statements to the public on request, federal and state charities
regulations do not require it to disclose information about its
platform or the risks involved for lenders. IRS can examine Kiva's
returns for compliance with requirements for federal income tax-
exemption, and Kiva could be subject to enforcement action by the IRS
or the California Attorney General if it is not in compliance with the
relevant requirements. Kiva is not subject to further federal or state
supervision or examination of its operations or activities.
Because Kiva does not offer lenders the opportunity to earn interest,
it has not been subject to federal securities registration
requirements. Staff from SEC's Division of Corporation Finance said
that Kiva had not invited SEC to take a position on whether its
arrangement with lenders was subject to securities regulation.
However, these staff said that based on Supreme Court precedent, SEC
generally considered a security to be present only where the purchaser
expects to make a profit or return that is the result of a third
party's efforts.[Footnote 76] Even if a security were present--if, for
example, Kiva or another nonprofit platform offered notes that paid
interest--nonprofit organizations issuing securities can potentially
obtain an exemption from federal and state registration requirements.
FTC cannot enforce Section 5 of the FTC Act's prohibition against
unfair or deceptive acts or practices against a corporation that does
not carry on business for its profit or the profit of its members.
[Footnote 77] FTC staff said that, if Kiva is such an entity, the
agency would lack the authority to challenge its conduct under Section
5 of the FTC Act. As of March 2011, FTC reported that the agency had
received no complaints related to Kiva in the last 5 years.
Kiva officials said that, because its microfinance partners make loans
to individuals, the microfinance partners are responsible for
compliance with any applicable consumer financial protection
requirements. For example, Kiva's microfinance partners that lend in
the U.S. could be subject to the Truth in Lending Act to the extent
that they extend consumer credit and the Fair Debt Collection
Practices Act to the extent that they engage in third-party
collections of consumer credit, according to CFPB representatives.
They also said that, because the Equal Credit Opportunity Act applies
to both consumer and commercial credit, it may apply to the
microfinance partners regardless of whether the transactions involve
consumer or commercial credit. FTC staff also noted that the Gramm-
Leach-Bliley Act and the Fair Credit Reporting Act could also apply,
and that the debt collection practices of Kiva's domestic microfinance
partners and their third-party debt collectors could be subject to the
prohibitions on abusive, unfair, or deceptive acts or practices under
the Fair Debt Collection Practices Act and Section 5 of the FTC Act.
Kiva's microfinance partners that lend outside the U.S. are subject to
varying national and local borrower protection laws and regulations in
the foreign countries where they lend, according to Kiva officials.
These officials said that Kiva facilitates its microfinance partners'
compliance with some requirements. For example, for microfinance
partners that are subject to prohibitions on publicly identifying
borrowers who are delinquent on their loan payments, Kiva offers a
feature that informs lenders when loans are delinquent but keeps the
identity of the borrowers anonymous to other Kiva members and the
public on Kiva's Web site.
Options for Regulating Person-to-Person Lending Have Advantages and
Disadvantages Related to Borrower and Lender Protection, Flexibility,
and Efficiency:
We identified two primary options for regulating person-to-person
lending that differ primarily in their approach to lender protection:
(1) continuing with the current bifurcated federal system--that is,
protecting lenders through securities regulators and borrowers
primarily through financial services regulators, which will include
the newly formed CFPB--or (2) consolidating borrower and lender
protection under a single federal regulator, such as CFPB. We
considered the advantages and disadvantages of these two options
primarily in relation to three key elements--consistent consumer and
investor protection, regulatory flexibility, and efficiency and
effectiveness--from a framework that we had previously developed for
evaluating proposals for financial regulatory reform. The current
regulatory system offers borrowers and lenders on the major for-profit
platforms protections consistent with those for other borrowers and
investors, but some industry observers suggested that using securities
regulation to protect lenders on person-to-person lending platforms
lacked flexibility and imposed burdens on companies that hampered
efficiency. Under a consolidated regulatory approach, borrowers on
person-to-person lending platforms would likely continue to receive
the same kinds of protections as other borrowers, and, depending on
how implemented, lender protections could be expanded. Some industry
observers, however, were uncertain about the efficiency and
effectiveness of shifting to a new regulatory regime under an agency
that is still in its formative stages. Finally, new regulatory
challenges could emerge if the person-to-person lending industry
introduced new products or services or if it grew dramatically, making
it difficult to predict which regulatory option would be optimal in
the future.
The Two Options for Regulating Person-to-Person Lending Differ
Primarily in Their Approach to Lender Protection:
The key distinction between the two primary options for regulating
person-to-person lending is how they would protect lenders using the
for-profit platforms. First, as we have seen, under the current
regulatory system, SEC and state securities regulators protect lenders
on the major for-profit platforms primarily through disclosure
requirements and the antifraud and other liability attending those who
offer and sell securities, while, for borrower protection, FDIC and
UDFI have authority to oversee banking institutions and their third-
party relationships. In addition, CFPB will play a role in borrower
protection under the current regulatory system as it assumes
rulemaking authority for federal consumer financial laws and as its
database for collecting and routing consumer complaints becomes
operational.[Footnote 78] Also, CFPB could have a number of potential
bases for conducting direct examinations of person-to-person lending
platforms, as discussed earlier, including, but not limited to,
nondepository platforms that qualify as "larger participant[s] of a
market for other consumer financial products or services," to be
defined by CFPB rulemaking.[Footnote 79]
Second, a consolidated regulatory approach for person-to-person
lending would assign primary federal responsibility for borrower and
lender protection to a single regulator, such as CFPB.[Footnote 80] A
consolidated approach would require exempting person-to-person lending
platforms from federal securities laws. Under such an approach, CFPB
could be assigned responsibility for lender protection, in addition to
the roles that it would play with respect to borrower protection under
the current regulatory system for person-to-person lending. Depending
on how a consolidated regulatory approach was implemented, CFPB might,
for example, require disclosures for lenders as well as borrowers,
impose requirements or restrictions on person-to-person lending
companies' practices in facilitating loans to borrowers and selling
the loans (or corresponding notes) to lenders, and perform supervisory
examinations of person-to-person lending companies. Under a
consolidated regulatory approach, other federal and state regulatory
agencies might still be involved in regulating and overseeing person-
to-person lending, unless preempted by law. For example, even if
person-to-person lending was exempt from federal securities law,
person-to-person lending companies could still be required to register
offerings with state securities regulators. Also, bank regulators
could continue to examine third-party relationships of banking
institutions with companies, and states could continue to require
person-to-person lending companies to obtain licenses or other
authorizations to perform their role in facilitating loans.
The federal and state regulators, current and former U.S. industry
participants, researchers, and consumer advocacy organizations that we
contacted took different views of these options for regulating person-
to-person lending. The staff of federal and state agencies we
contacted cited advantages and disadvantages of each approach but did
not take positions on which would be optimal. Officials from NASAA and
some of the industry observers we contacted favored the current
regulatory system.[Footnote 81] A few industry observers have
supported a consolidated regulatory approach, albeit it with some
reservations about the effects on the existing companies of shifting
to a new regulatory system. A number of the other industry observers
we contacted did not express a preference between the options, in some
cases because they were uncertain how a consolidated approach would be
implemented.
We assessed the advantages and disadvantages of these two regulatory
options in relation to our previously developed framework for
evaluating proposals for financial regulatory reform. The framework
consists of nine elements that are key to developing a successful
financial regulatory system (see table 3).[Footnote 82] We focused on
three of these elements--providing consistent consumer and investor
protection, being flexible and adaptable, and being efficient and
effective. When we asked regulators, industry participants, consumer
advocacy organizations, and researchers that we contacted to comment
on the advantages and disadvantages of the two regulatory options,
they most frequently cited issues related to these three elements.
(For more information on our methodology, see appendix I.)
Table 3: Elements of GAO's Framework for Evaluating Proposals for
Financial Regulatory Reform:
Element: Consistent consumer and investor protection;
Description: Consumer and investor protection should be included as
part of the regulatory mission to ensure that market participants
receive consistent, useful information, as well as legal protections
for similar financial products and services, including disclosures,
sales practice standards, and suitability requirements.
Element: Flexible and adaptable;
Description: A regulatory system that is flexible and forward looking
allows regulators to readily adapt to market innovations and changes.
Element: Efficient and effective;
Description: Efficient and effective oversight should be developed,
including eliminating overlapping federal regulatory missions where
appropriate, and minimizing regulatory burden without sacrificing
effective oversight. Any changes to the system should be continually
focused on improving the effectiveness of the financial regulatory
system.
Element: Clearly defined regulatory goals;
Description: Goals should be clearly articulated and relevant, so that
regulators can effectively carry out their missions and be held
accountable.
Element: Appropriately comprehensive;
Description: Financial regulations should cover all activities that
pose risks or are otherwise important to meeting regulatory goals and
should ensure that appropriate determinations are made about how
extensive such regulations should be, considering that some activities
may require less regulation than others.
Element: Consistent financial oversight;
Description: Similar institutions, products, risks, and services
should be subject to consistent regulation, oversight, and
transparency, which should help minimize negative competitive outcomes
while harmonizing oversight.
Element: Regulators provided with independence, prominence, authority,
and accountability;
Description: Regulators should have independence from inappropriate
influence, as well as prominence and authority to carry out and
enforce statutory missions, and be clearly accountable for meeting
regulatory goals.
Element: Systemwide focus;
Description: Mechanisms should be included for identifying,
monitoring, and managing risks to the financial system regardless of
the source of the risk.
Element: Minimal taxpayer exposure;
Description: A regulatory system should foster financial markets that
are resilient enough to absorb failures and thereby limit the need for
federal intervention and limit taxpayers' exposure to financial risk.
Source: GAO.
[End of table]
Federal and state regulators, industry participants, researchers, and
a consumer advocacy organization we contacted generally regarded all
of the elements as somewhat or very important to regulating person-to-
person lending.[Footnote 83] However, they agreed that having a
systemwide focus and minimizing taxpayer exposure were less
significant considerations at present, but some thought that such
considerations could become more significant if the person-to-person
lending industry and participating firms were to grow dramatically.
While the Current Regulatory System Generally Protects Borrowers and
Lenders, Some Industry Observers Questioned Its Flexibility and
Efficiency:
As we have seen, the current regulatory system provides borrowers and
lenders on for-profit, person-to-person lending platforms with
protections consistent with those afforded to conventional bank
borrowers and investors in registered securities. The current
regulatory regime for person-to-person lending does not have goals and
agency responsibilities that are specific to the industry and its
activities. Rather, it applies broader consumer financial and
securities laws, regulations, and agency oversight and enforcement
responsibilities to this new industry.
SEC staff noted that comprehensive protections of the type afforded to
investors under federal securities laws are particularly important
considering that some lenders compare returns on the notes they
purchase from the for-profit platforms to relatively risk-free,
federally insured bank products. They explained that the breadth and
scope of disclosure and attendant liability for false disclosure under
these laws are key to investor protection. However, some industry
observers saw drawbacks to protecting lenders by relying primarily on
the disclosures required under current securities registration
requirements. Specifically:
* The disclosure-based approach allows LendingClub and Prosper to
report on loan performance and returns on investment differently.
[Footnote 84] Four industry observers said that this approach
increases the difficulty to lenders of assessing risk and potential
returns and comparing performance across the platforms. Staff from
SEC's Division of Corporation Finance said that SEC could potentially
encourage or require Prosper and LendingClub to report in the same
way, either through the SEC staff comment process for the companies'
financial disclosures or by proposing a rule that would require them
to use consistent reporting methods. However, SEC staff pointed out
that there could be trade-offs between the benefit to lenders of
standardized reporting and the additional reporting burden on the
companies. They also noted that proposing a rule would entail a
substantial investment of SEC's limited staff resources to address an
issue that currently affects only two registered companies.
* Three industry observers we interviewed noted some concerns about
the limited role of securities regulators in helping ensure lender
protection if a person-to-person lending company entered bankruptcy.
As we have seen, because lenders who hold notes do not have a direct
security interest in the corresponding borrower loans, their rights
could be uncertain if the platform were to enter bankruptcy. Prosper
and LendingClub's prospectuses disclose this risk and describe their
back-up plans for servicing loans. However, staff from SEC's Division
of Corporation Finance said that prescribing steps that a person-to-
person lending company should take to protect lenders in case of a
bankruptcy would be inconsistent with the role of securities
regulation--a role that is intended to ensure adequate disclosures for
investors rather than to regulate companies' operations.
Four industry observers also raised concerns about the flexibility and
adaptability of securities regulation as it is applied to person-to-
person lending. SEC staff members and three industry observers said
that, under the current regulatory system, issuing securities is
central to the business of person-to-person lending companies, so the
companies' ability to navigate securities regulation requirements is
critical to their success. However, four industry observers questioned
the applicability of securities regulations to person-to-person
lending, in part because securities regulation treats the platforms as
issuers of a debt security, while in actuality borrowers are
responsible for fulfilling the debt obligation. Three commentators
questioned whether securities requirements that preceded the emergence
of the person-to-person lending industry could continue to be applied
to the industry without stifling its innovation and growth--that is,
they questioned whether the current system was adaptable and flexible
enough to respond to this nascent industry. For example, officials
from one company said that the company's ability to quickly adapt to
changing market conditions or to experiment with changes to its
business model had at times been hampered by the time and cost
involved in amending its prospectus to reflect such changes.
To some extent, some of these concerns have been alleviated or will
likely be addressed in the future. According to officials from Prosper
and LendingClub, SEC staff have developed an understanding of person-
to-person lending and have been increasingly receptive to working with
the companies involved to enable them to meet registration
requirements in a way that fits with their business models. For
example, officials from Prosper and LendingClub said that SEC staff
were considering the companies' proposal to streamline how the
companies would disclose changes to their credit policies and lending
terms to reduce the time and cost involved. Also, SEC staff said that
they were willing to continue to work with the companies through the
comment process on their ongoing filings. But they also noted that
their role was primarily to respond to proposals or analyses of
concerns provided by the companies, not to suggest changes themselves.
Industry observers we interviewed raised other concerns about the
efficiency of using securities regulation to provide lender
protection, noting in particular the burdens that the registration
process imposed on existing firms and potential new entrants. For
example, because each borrower's loan corresponds to a series of
lenders' notes that can be for as little as $25, Prosper and
LendingClub must register a large volume of notes with relatively
small denominations.[Footnote 85] Officials from LendingClub and
Prosper said that it was costly to establish their processes to
register these series of notes in their prospectus supplement filings,
although they have reduced their ongoing costs by largely automating
the filings. SEC staff and officials from both companies agreed that
lenders were unlikely to consult these filings, except for litigation
purposes. One researcher also questioned the utility of the prospectus
supplement filings and suggested that their volume could make it
difficult for investors to identify disclosures containing more useful
information.[Footnote 86]
Four industry observers also suggested that new entrants could
effectively be barred from entering the market by the cost and other
burdens associated with securities registration, which two of them
said restricts competition and discourages development of new credit
options for consumers. Whereas Prosper and LendingClub launched their
platforms and had built a base of borrowers and lenders before they
registered with SEC and state securities regulators, new person-to-
person lending companies would likely need to register before
launching platforms under the current regulatory system. New entrants
could potentially begin to sell notes without registering with SEC or
could meet reduced registration requirements under existing
exemptions--such as those for small offerings or private offerings
that are made available only to a limited number of sophisticated
investors. However, SEC staff noted that the existing exemptions might
not be compatible with the business of person-to-person lending
companies, which have generally been widely available online and have
sought to attract investment from many lenders. Instead, these staff
noted that SEC could use rulemaking to exempt securities issued for
person-to-person lending from certain registration requirements but
only if its commissioners deemed doing so to be in the public interest.
At least three industry observers also raised concerns about the
burdens associated with meeting varying state securities registration
requirements. Officials from Prosper and LendingClub said that the
registration process at the state level had already been costly and
laborious, and 20 states had yet to approve either of their
registration applications. One former industry executive said that the
burden of state securities requirements, and particularly the states'
ability to impose varying financial suitability requirements, was a
key consideration in his company's decision to exit the market rather
than pursue federal and state registration. Officials from the major
for-profit platforms suggested that the notes of person-to-person
lending companies should be exempt from state registration
requirements, as the securities of companies listed on national
exchanges are. However, officials from NASAA and selected state
securities regulators said that the states play an important role in
helping ensure investor protection, and those officials generally
favored states' continued participation in securities regulation of
the person-to-person lending industry. Furthermore, to promote greater
consistency in how states reviewed the registration statements of
person-to-person lending companies, NASAA officials said that it was
considering two options: (1) a comprehensive policy statement
applicable to person-to-person lending, or (2) particular standards
for merit review that states could use in reviewing applications of
person-to-person lending companies.[Footnote 87]
Although a Consolidated Regulatory Approach Could Provide Adequate
Protections, Its Flexibility, Efficiency, and Effectiveness Are
Uncertain:
Depending on how it was implemented, a consolidated approach to
borrower and lender protection could continue to provide borrowers on
person-to-person lending platforms with the protections they currently
receive. But how the protections provided to lenders would compare
with those under the current regulatory system is uncertain.[Footnote
88] As they do under the current system, borrowers would presumably
continue to receive the same kinds of protections afforded to
borrowers using more traditional sources for consumer or commercial
credit. Also, legislation adopting a consolidated regulatory approach
could create specifically targeted protections Congress deemed
necessary, such as industry-specific authority to perform supervisory
examinations of person-to-person lending companies' compliance with
requirements for both borrower and lender protection. While CFPB could
also be given the authority to prescribe lender protections under a
consolidated regulatory approach, it is uncertain whether CFPB would
require disclosures for lenders that are similar in substance to those
required under securities regulation, whether any required disclosures
would be more or less extensive, and whether any required disclosures
of borrower and loan information would be made publicly available. In
addition, legislation could authorize liability for false disclosure.
Furthermore, legislation adopting a consolidated regulatory approach
could authorize CFPB to go beyond the current disclosure requirements
by prescribing standardized reporting on loan performance and returns
on investment or requiring companies to take steps related to the
effect on lenders of a company's bankruptcy. While such steps could
address the concerns about lender protection under the current system
that we noted earlier, the benefits to lenders would need to be
weighed against the burden that such requirements would impose on the
companies involved.
Three of the industry observers we interviewed suggested that a
consolidated regulatory approach might be better suited than the
current system to resolve tensions between borrower and lender
protection. Two of them cited, for example, the tension in person-to-
person lending between lenders' interests in gaining valid information
about the credit risk they are assuming and borrowers' privacy
interests. Borrowers have the discretion to determine how much
personal information to provide anonymously with their loan requests,
and the platforms could address any concerns that borrowers raised
about their privacy by limiting the data they request. Nonetheless,
these commentators thought that it would be beneficial to have a
consolidated regulator that would be charged with balancing the need
to disclose to lenders material information about borrowers and loans
with borrowers' concerns about the vulnerability of such information,
when made publicly available, to searching activity that could result
in borrowers being identified by name. However, staff from SEC
cautioned that easing disclosure requirements could reduce lender
protections and suggested that, considering the financial risks facing
lenders who participate in the platforms, it would be important for a
consolidated regulator to seek to ensure at least the same level of
lender protection as the current system provides.
Adopting a consolidated regulatory approach would provide an
opportunity to examine the appropriate level of oversight for
nonprofit platforms, particularly with respect to lender protection.
The researchers we interviewed all questioned whether it was
appropriate that a nonprofit platform that offered no returns to
lenders would not be subject to disclosure requirements, while one
that offered minimal returns potentially would be subject to the full
burden of securities registration requirements. The researchers all
suggested that nonprofit platforms should be subject to financial
regulation rather than disclosing risks to lenders only on a voluntary
basis, as they do now.[Footnote 89] A consolidated regulatory approach
to person-to-person lending could be designed to encompass nonprofit
platforms. However, Kiva officials suggested that the costs of
imposing additional regulatory burden on nonprofit platforms might
outweigh the benefits of regulation to philanthropically motivated
lenders.
The flexibility, efficiency, and effectiveness of creating a new
regulatory regime under a new agency are uncertain. Depending on how
it was implemented, a consolidated regulatory approach that vested
responsibility for borrower and lender protections in a single agency
could potentially be more efficient than the current system, and it
could potentially be designed to adapt to changes in the industry.
However, seven of the federal and state regulators and industry
observers we interviewed cited uncertainties about how a consolidated
regulatory approach would be defined in statute and regulation or how
CFPB would carry out its responsibilities, making it difficult to
predict how flexible, adaptable, and efficient CFPB would be were it
to become the consolidated supervisor for person-to-person lending.
Three commentators were uncertain how effective CFPB would be in
protecting lenders on person-to-person lending platforms, in part
because the Dodd-Frank Act generally focuses the agency's mission and
jurisdiction on protection of consumers of financial products and
services rather than on protection of investors.[Footnote 90]
Furthermore, officials from both of the major for-profit platforms
raised concerns about the costs of transitioning to a new regulatory
regime, especially considering that they had already invested
substantial costs and time adapting to the current one. Also,
officials from one of the firms raised concerns that, under a
consolidated regulatory approach, lenders who were already familiar
with and reliant on the protections afforded by securities regulation
might be less willing to invest in notes on the platforms and thus
could set back the industry's growth at least temporarily. Company
officials also raised a concern that losing the precedent set by SEC
and the courts in securities-related rulings would create uncertainty
for the industry.
Furthermore, reductions in the regulatory burden on person-to-person
lending companies under a consolidated regulatory approach would
likely be limited if state securities regulations continued to apply.
Officials from NASAA and the state securities regulators we
interviewed said that even if person-to-person lending was exempt from
federal securities law, the notes the companies sold could still be
treated as securities under state law. In that case, person-to-person
lending companies might still be required to register with state
securities regulators to allow lenders in those states to participate.
The continuing evolution and growth of person-to-person lending could
give rise to new regulatory concerns or challenges, making it
difficult to predict what the optimal regulatory structure will be.
For example, while the major for-profit platforms have focused on
providing relatively straightforward unsecured consumer loans, they
and other platforms have explored or could explore more complex loan
products, other forms of lending--such as auto loans or mortgages--or
variants on the concept of person-to-person lending that could affect
regulatory concerns, such as ensuring the fairness and transparency of
lending terms and practices.[Footnote 91] Also, the major for-profit
platforms have increasingly been attracting sophisticated individual
and institutional investors, and the potential exists for these and
other platforms to offer advisory services to these investors that
could introduce new regulatory issues. For example, LC Advisors, LLC,
a wholly owned subsidiary of LendingClub, has registered with SEC and
state securities regulators as an investment adviser firm that will
offer and manage separately managed accounts and other services for
high net worth and institutional clients to invest through the
LendingClub platform.[Footnote 92] Furthermore, platforms could
develop different features or products for lenders--such as allowing
companies to select loans on a lender's behalf or allowing lenders to
invest in pools of loans assembled by the company--that have generally
been subject to regulation by SEC. Such activities could raise new
questions about protecting the interests of lenders and, if a
consolidated regulatory approach were adopted, could introduce
challenges in defining and coordinating CFPB's and SEC's regulatory
jurisdictions.
In addition, the regulators and industry observers we contacted did
not raise having a systemwide focus and minimizing taxpayer risk as
significant regulatory considerations because of the small size of the
market and the firms involved in person-to-person lending. Further,
two industry observers suggested that, from a systemwide perspective,
one of the potential benefits of person-to-person lending is that it
shifts credit risk from banks and nondepository lenders to individual
lenders. Five of the regulators and industry observers we contacted
suggested that systemwide concerns could increase only if the industry
grew dramatically and were to focus more on attracting large
institutional investors.
Regardless of whether the current regulatory system is retained or a
consolidated approach is adopted, mechanisms currently exist for
monitoring the person-to-person lending industry for emerging risks
and regulatory challenges. Staff from SEC's Divisions of Corporation
Finance, Trading and Markets, and Investment Management said that they
routinely monitor changes in Prosper's and LendingClub's business
models through their review of the companies' securities registration
filings, and they noted that the companies' growth would be evident
through their required disclosures. Also, as previously discussed,
CFPB's duties include researching, monitoring, and reporting on
developments in markets for consumer financial products and services
to, among other things, identify risks to consumers. However, CFPB
representatives said that the agency is still in the process of
developing this function and that they had not determined the methods
by which the agency would monitor the industry. Finally, FSOC could
come to play a role in monitoring the industry if person-to-person
lending were to grow dramatically.
Further Changes and Growth in Person-to-Person Lending Could Pose New
Regulatory Challenges:
Agency Comments and Our Evaluation:
We provided a draft of this report for review and comment to FDIC, the
Federal Reserve, FTC, NASAA, NCUA, SEC, and Treasury (including the
CFPB implementation team). We also provided relevant excerpts from the
draft report to UDFI, the four state securities regulators we
interviewed, Kiva, LendingClub, Prosper, WebBank, and Zopa for review
and technical comment. These agencies and companies provided technical
comments, which we incorporated as appropriate. In addition, we
received written comments from the Deputy Associate Director of
Research, Markets & Regulations, CFPB; the Director of the Division of
Depositor and Consumer Protection, FDIC; and the Chairman of SEC,
which are summarized below and reprinted in appendixes III to V.
In its written comments, CFPB said that the person-to-person lending
industry could have significant implications for consumers seeking
alternative sources of credit. CFPB agreed and stated that monitoring
the industry as it evolves would be important and, as the draft report
noted, CFPB will collect and analyze complaints about consumer
financial products and services over time. Additionally, CFPB noted
that it expects to keep abreast of consumers' experiences with
providers of person-to-person lending and developments in the industry.
FDIC in its written comments stated that it agreed with our
description of the types of risks identified related to person-to-
person lending as well as the federal consumer protection laws and
regulations that may be applicable. FDIC said that, as the draft
report noted, there is one FDIC-supervised institution currently
involved in person-to-person lending. FDIC noted that its supervisory
program examines for these products from both a risk-management and a
consumer-protection perspective, including a review of third parties
involved in the offering of the product as appropriate. FDIC said that
it will continue to monitor this evolving industry and adjust its
supervisory program as warranted.
In its written response, SEC said that the draft report provided a
comprehensive overview of the person-to-person lending industry and an
important contribution to the overall understanding of the regulatory
structure of the industry. SEC stated that for several years, its
staff have been actively involved in working with the two for-profit
platform operators, Prosper and LendingClub, to facilitate ways for
them to conduct their offerings in a manner that realizes their
business objectives and is consistent with the federal securities
laws. SEC said that, because Prosper and LendingClub conduct
registered offerings of securities, investors in these securities are
being provided with the information they need to make informed
investment decisions and have the protections of the liability and
antifraud provisions of the Securities Act of 1933 and the Securities
Exchange Act of 1934. SEC also said that Prosper and LendingClub file
prospectus supplements containing the information that borrowers
voluntarily disclose on the companies' Web sites because that
information--particularly credit report data--is the basis on which
investment decisions are being made. SEC said that, while it remains
concerned about any violation of borrowers' privacy rights in this
information, it believes that these rights should be addressed within
a framework where investors continue to receive appropriate
disclosures and protections to which they are entitled under the
federal securities laws. SEC stated that, as indicated in the draft
report, the person-to-person lending industry is relatively new and
that future innovations could pose new regulatory challenges. SEC said
that the Commission and its staff seek to be vigilant in this regard
and that they look forward to helping address concerns about the
adequacy and effectiveness of the current regulatory structure.
We are sending copies of this report to interested congressional
committees, the Chairman of FDIC, the Chairman of the Federal Reserve,
the Chairman of the FTC, the Executive Director of NASAA, the Chairman
of NCUA, the Chairman of SEC, and the Secretary of the Treasury. This
report will also be available at no charge on the GAO Web site at
[hyperlink, http://www.gao.gov].
If you have any questions about this report, please contact me at
(202) 512-8678 or sciremj@gao.gov. Contact points for our Offices of
Congressional Relations and Public Affairs may be found on the last
page of this report. GAO staff who made key contributions to this
report are listed in appendix VI.
Signed by:
Mathew J. Scirč:
Director, Financial Markets and Community Investment:
List of Congressional Committees:
The Honorable Tim Johnson:
Chairman:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Spencer Bachus:
Chairman:
Committee on Financial Services House of Representatives:
The Honorable Barney Frank:
Ranking Member:
Committee on Financial Services:
House of Representatives:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
Our report objectives were to address (1) how the major person-to-
person lending platforms operate and how consumers use them; (2) the
key benefits, risks, and concerns that person-to-person lending poses
for consumers and how the risks are currently regulated; and (3)
advantages and disadvantages of the current and alternative approaches
to regulating person-to-person lending.
To describe how the major person-to-person lending platforms operate
and how consumers use them, we reviewed existing studies and reports
related to the operation of major person-to-person lending platforms
and the regulatory challenges for both the for-profit and the
nonprofit platforms.[Footnote 93] We interviewed executives from the
three major U.S. firms operating person-to-person lending platforms--
two for-profit companies (Prosper Marketplace, Inc. (Prosper) and
LendingClub Corporation (LendingClub) and one nonprofit organization
(Kiva Microfunds (Kiva))--and the bank (WebBank) that partners with
Prosper and LendingClub to disburse loans made through their
platforms. We reviewed materials on the companies' Web sites and
documents on their operations, in particular information on how the
platforms work for both lenders and borrowers. For the for-profit
companies, we further reviewed offering documents (i.e., prospectus
and prospectus supplements) and quarterly and annual reports.
Additionally, we obtained data from the companies and their Web sites
regarding loan performance and consumer characteristics. We did not
independently verify the data the companies provided. We assessed the
reliability of these data by reviewing relevant documents, including
the for-profit companies' audited financial statements filed with the
Securities and Exchange Commission (SEC), and interviewing company
officials. We concluded that the data were sufficiently reliable for
our purposes. We also interviewed representatives of three companies
that previously operated platforms in the United States, and two
foreign person-to-person lending companies operating abroad.
Furthermore, we reviewed online discussion forums where borrowers and
lenders on the platforms post their views, to obtain more direct
information on the purposes for which consumers use both the for-
profit and nonprofit person-to-person lending platforms.
To identify the key benefits, risks, and concerns that person-to-
person lending poses for consumers and how the risks are currently
regulated, we interviewed executives from the three major U.S. person-
to-person lending platforms and reviewed regulatory filings and
relevant documents. We also reviewed laws that may be applicable to
the platforms and their third-party relationships, including the
Securities Act of 1933, the Truth in Lending Act, Section 5 of the
Federal Trade Commission Act, and the Gramm-Leach-Bliley Financial
Modernization Act.[Footnote 94] Furthermore, we reviewed relevant
regulations and guidance and interviewed officials at the Bureau of
Consumer Financial Protection (known as the Consumer Financial
Protection Bureau or CFPB) implementation team at the Department of
the Treasury (Treasury), Federal Deposit Insurance Corporation (FDIC),
Board of Governors of the Federal Reserve System (Federal Reserve),
Federal Trade Commission (FTC), National Credit Union Administration
(NCUA), SEC, and Treasury officials involved with the Financial
Stability Oversight Council, as well as the Utah Department of
Financial Institutions (UDFI), and the North American Securities
Administrators Association (NASAA). Because state securities
regulators approach person-to-person lending differently, we
interviewed four state securities regulators--California, Kentucky,
Oregon, and Texas--to understand the risks and concerns they have
identified. Specifically, we selected states with merit-review
standards (as opposed to less complex disclosure-review standards
similar to the federal securities regulation system) that had approved
both, one, or neither of the securities registration statements of the
two major for-profit U.S. platforms. In addition, we conducted
interviews with three consumer advocacy organizations--the Center for
Financial Services Innovation, Consumer Federation of America, and
Consumers Union. Three organizations that we contacted declined to
participate because the person-to-person lending industry is beyond
the scope of their work. To assess the potential risk of disclosure of
personally identifiable information, we randomly selected a small
sample of prospectus supplements which the two major for-profit
platforms are required to file with SEC, from the period from August
31, 2010, through November 26, 2010, and systematically reviewed a
sample of the loan listings to identify any examples of where the
borrowers disclosed enough information with their loan requests to
allow them to be potentially identified by name. (See appendix II for
more details on this analysis.)
To identify the advantages and disadvantages of the current and
alternative approaches to regulating person-to-person lending, we
reviewed previously proposed legislation and discussed other
regulatory options with relevant federal and state officials,
executives and representatives from person-to-person lending
companies, researchers, and consumer advocacy organizations listed
earlier. While other options may exist for a consolidated regulatory
approach including assigning responsibility to a different federal
regulator, such as SEC or one of the federal banking regulators, we
focused on two options most frequently identified by the entities we
interviewed and that were considered in legislation. First, we
considered the current regulatory structure. Second, we focused on the
possibility for a consolidated regulatory approach under CFPB because
it is assuming a role in supervising nondepository lenders and because
the version of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act) passed by the House of Representatives
included a provision that would have exempted person-to-person lending
from federal securities regulatory requirements and vested primary
jurisdiction for regulating person-to-person lending platforms and
their lending activities in the new consumer financial protection
agency, now known as CFPB.[Footnote 95] The provision would have
created an exemption from federal securities requirements for person-
to-person lending in section 3(a) of the Securities Act of 1933 (15
U.S.C. § 77c(a)) and would instead have given CFPB the authority to
prescribe regulations or issue orders pertaining to person-to-person
lending, including disclosure requirements with respect to the sale of
loans, or notes representing an interest in loans, to individuals.
However, the provision was not included in the Senate or enacted
versions of the Dodd-Frank Act. We assessed the advantages and
disadvantages of these two primary options we identified using our
previously developed framework for evaluating proposals for financial
regulatory reform, which consists of nine elements that are key to
developing a successful financial regulatory system.[Footnote 96] We
contacted 20 of the entities we interviewed to obtain their views on
the importance of the elements of this framework and received 11
responses, from CFPB representatives, FDIC, SEC, one state securities
regulator, the two major U.S. for-profit platforms and the bank that
they work with to disburse loans, three researchers, and one consumer
advocacy organization. On the basis of their ratings and the
information we obtained through our interviews and other research, we
chose to focus our discussion of the advantages and disadvantages of
the two regulatory options for person-to-person lending on three of
the nine elements from our framework--consistent consumer and investor
protection, regulatory flexibility and adaptability, and efficiency
and effectiveness.
We conducted this performance audit from August 2010 to July 2011 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Analysis of Prosper and LendingClub's Prospectus
Supplement Filings:
Prosper and LendingClub, the two major U.S. for-profit, person-to-
person lending platforms, have registered as securities the series of
notes that they continually offer to investors to fund corresponding
loans. The companies thus are required to update their prospectuses,
filed with the SEC, with supplements containing information about the
notes and their corresponding loans as they are offered and sold.
Because certain terms of the notes sold to lenders--such as maturity
date, interest rate, and amount--depend on the terms of the
corresponding loans, Prosper and LendingClub submit prospectus
supplements to disclose information about the notes they offer and
sell. Specifically, the companies submit prospectus supplements to
disclose information about the notes they offer one or more times per
business day, before they post the corresponding loan requests to
their Web sites. They also submit prospectus supplements on a daily or
weekly basis to disclose information about the notes they have sold.
The prospectus supplements include required information on the terms
of each note, such as interest rate and maturity. Prosper and
LendingClub also include other information concerning the underlying
loan that is available to lenders on their Web sites as part of the
loan listing, including anonymous information from the borrower's
credit report, anonymous information supplied by the borrower, such as
loan purpose, employment status, and income, and (in the case of notes
sold) the borrower's online responses to questions posted by lenders.
These prospectus supplements are publicly available through SEC's
online Electronic Data Gathering, Analysis, and Retrieval System
(EDGAR).
Borrowers face the risk that they may reveal enough information as
part of their loan requests to permit the platforms' members and
members of the public (through EDGAR) to deduce their identities.
Lenders could attempt to identify borrowers by name and contact them
(for example, regarding loan repayment) but such an action would
violate the terms of a lender's agreement with either platform.
Officials from Prosper said that they were not aware of any incidents
of lenders identifying and attempting to contact borrowers but that
they would expel lenders from the platform if that did occur. Also,
some current and former industry participants raised a concern that
EDGAR users could attempt to search LendingClub's and Prosper's
prospectus supplements to obtain identifiable information about
borrowers.[Footnote 97]
To assess the potential for disclosure of information in prospectus
supplements that could be used to identify borrowers by name, we
reviewed selected prospectus supplements describing notes that
LendingClub and Prosper sold, and their corresponding loans.
Specifically, we randomly selected 4 weeks from the period August 31,
2010, through November 26, 2010, and obtained from EDGAR all
prospectus supplements that both companies filed, listing notes sold,
during those weeks.[Footnote 98] Within the selected prospectus
supplements, we reviewed every fifth loan listing to identify examples
of information that could potentially be pieced together to infer
someone's identity using additional Internet research or telephone
calls.
Of the 275 loan listings that we reviewed in the selected prospectus
supplements, we identified 47 instances where we thought that
borrowers potentially revealed information that could be used to
determine their identities. In nearly all of these cases, borrowers
revealed information about their location, employer, and job title or
occupation, often in combination with personal information--such as
their first or last names or initials, or details about marriages,
divorces, bankruptcies, or their children--that we thought could
potentially be used to identify them by name. However, in many of
these cases, substantial effort might be needed to identify borrowers,
such as contacting employers directly to match a job title with a name
or searching for marriage announcements. In a few remaining cases,
borrowers voluntarily provided a business name or Web site address to
support a loan request for small business purposes. We shared the
results of our analysis with officials from Prosper and LendingClub,
who confirmed our assessment that the information we identified could
be used to identify some borrowers.
On April 15, 2011, after the time period covered by our analysis,
LendingClub adopted changes to its question-and-answer process that
company officials said were intended to reduce the likelihood that
borrowers would reveal personally identifiable information.
LendingClub's loan listings have fields for borrowers to enter their
current city and state of residence and employer name, information
that company officials said its lenders considered important in
evaluating borrowers and their creditworthiness. In addition, prior to
April 15, 2011, LendingClub's borrowers could voluntarily reveal their
job title or occupation in their loan descriptions or in their
optional responses to lenders' online questions. LendingClub officials
said that, on that date, the company modified its question-and-answer
process to only permit lenders to select from a set of "pre-screened"
questions approved by LendingClub and WebBank. The officials said that
LendingClub also screens each borrower's answers and loan descriptions
for personally identifiable information or information that could be
reasonably combined to identify the borrower, including the borrower's
job title or occupation.
We did not assess the extent to which borrowers on the platforms are
aware that the anonymous information they disclose with their loan
requests can be accessed by the general public. LendingClub's privacy
policy discloses to borrowers that their personal, but not personally
identifiable, and financial information contained in loan listings are
filed with SEC and, as such, are made publicly available. In addition,
LendingClub officials said that, during the loan application process,
the company labels certain information fields that are completed by
the borrower as being publicly available. During the time period
covered by our analysis, Prosper's privacy policy did not contain a
similar disclosure, nor did its terms of use statement or borrower
agreement. However, in June 2011, Prosper officials said that the
company intended to modify its privacy policy to provide such a
disclosure.
While the Gramm-Leach-Bliley Financial Modernization Act restricts the
sharing of nonpublic personal information by financial institutions
with unaffiliated third parties, the act exempts disclosures that are
necessary to effect, administer, or enforce a transaction that the
consumer has requested. Staff at the CFPB, FDIC, and the Federal
Reserve indicated that a detailed legal analysis would be necessary to
evaluate any potential legal concerns related to privacy protection
for borrowers on the platforms.
[End of section]
Appendix III: Comments from the Consumer Financial Protection Bureau:
Department of the Treasury:
Washington, DC 20220:
June 27, 2011:
Mr. Mathew J. Scirč:
Director, Financial Markets and Community Investment:
U.S, Government Accountability Office:
441 G Street, N.W.
Washington, D.C. 20548:
Dear Mr. Scirč:
Thank you for the opportunity to comment on the GAO draft report
entitled Person-to-Person Lending: New Regulatory Challenges Could
Emerge as the Industry Grows.
The CFPB welcomes this study as an important contribution to
understanding an industry that could have significant implications for
consumers seeking alternative sources of credit. The study also
explains the characteristics of the financial products and services
currently offered by the three major U.S. person-to-person lending
platforms and frames questions for consideration regarding the optimal
federal regulatory framework for the industry.
The report finds that borrowers on such platforms could Pace risks
common in traditional consumer lending, such as potentially unclear or
misleading lending terms, and that it is important to ensure that such
risks are effectively addressed. We agree that it will be important to
monitor the industry as it evolves. As the report notes, the CFPB will
also collect and analyze complaints about consumer financial products
and services over time. The CFPB expects to keep abreast of consumers'
experiences with providers of person-to-person lending and
developments in the industry.
Sincerely yours,
Signed by:
Dan S. Sokolov:
Deputy Associate Director:
Research, Markets & Regulations:
Consumer Financial Protection Bureau:
[End of section]
Appendix IV: Comments from the Federal Deposit Insurance Corporation:
FDIC:
Federal Deposit Insurance Corporation:
Division of Depositor and Consumer Protection:
550 17th Street NW:
Washington, D.C. 20429-9990:
Mathew Scirč:
Director, Financial Markets & Community Investment:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Scirč:
The FDIC appreciates the opportunity to participate in the GAO's
report on Person-to-Person Lending: New Regulatory Challenges Could
Emerge as the Industry Grows (GAO-11-613). The FDIC agrees with GAO's
description of the types of risks identified related to this product
as well as the federal consumer protection laws and regulations that
may be applicable. As the report notes, there is one FDIC-supervised
institution currently involved in this type of lending. Our
supervisory program examines for these products from both a risk
management and a consumer protection perspective, including a review
of third parties involved in the offering of this product as
appropriate.
The FDIC will continue to monitor this evolving industry and adjust
our supervisory program as warranted. Thank you again for your work on
this issue.
Sincerely,
Signed by:
Mark Pearce:
Director:
[End of section]
Appendix V: Comments from the Securities and Exchange Commission:
United States Securities And Exchange Commission:
The Chairman:
Washington, D.C. 20549
July 1, 2011:
Mathew J. Scirč:
Director:
Financial Markets and Community Investment:
United States Government Accountability Office:
441 G Street, NW:
Washington. DC 20548:
Dear Mr. Scirč:
Thank you for the opportunity to comment on the Government
Accountability Office's (GAO) draft report titled Person-to-Person
lending: New Regulatory Challenges Could Emerge as the Industry Grows.
The report provides a comprehensive overview of the person-to-person
lending industry. which is comprised of Internet-based "platforms
that] facilitate lending by allowing individuals acting as lenders to
invest in loans to individual borrowers." As your report notes. state
and federal regulators oversee various aspects of the person-to-person
lending industry, including providing consumer protections for the
individual borrowers and investor protections for individuals who lend
their money on the platforms.
For several years, the SEC staff has been actively involved in working
with the two for-profit platform operators, Prosper Marketplace and
LendingClub, to facilitate ways for them to conduct their offerings in
a manner that realizes their business objectives and is consistent
with the federal securities laws. Currently, these platform operators
arc conducting registered offerings of securities. which means that
investors in these securities are being provided with the information
they need to make informed investment decisions and have the
protections of the liability and anti-fraud provisions of the
Securities Act of 1933 and the Securities Exchange Act of 1934 in the
event there are material misstatements or omissions in that
information.
Your report notes that a significant amount of information regarding
the individual borrowers is disclosed as part of the marketing and
sales process for person-to-person notes. Borrowers voluntarily
disclose this information on the platform operator's website for the
benefit of potential investors who lend money to these borrowers.
Prosper Marketplace and LendingClub file prospectus supplements
containing the borrowers' information because that information ”
particularly credit report data -- is the basis on which investment
decisions are being. made. Once tiled. this information becomes part
of the prospectus and thereby is subject to the liability provisions
of the federal securities laws. While the SEC remains concerned about
any violation of borrowers. privacy rights in this information, we
believe that these rights should he addressed within a framework where
investors continue to receive appropriate disclosures and protections
to which they are entitled under the federal securities laws.
As indicated in your report, the person-to-person lending industry is
a relatively new market, and innovation is occurring at a rapid pace,
which could pose new regulatory challenges. The Commission and its
staff seek to be vigilant in this regard, and we look forward to
working with the Congress, our fellow regulators, established lending
platforms and new entrants, investors and other interested parties to
address concerns about the adequacy and effectiveness of the current
regulatory structure.
The GAO report on the person-to-person lending industry is an
important contribution to the overall understanding of the regulatory
structure of the industry. We greatly appreciate your attention to
these matters and the thoughtfulness and comprehensive nature of your
review.
Sincerely,
Signed by:
Mary L. Schapiro:
Chairman:
[End of section]
Appendix VI: GAO Contact and Staff Acknowledgments:
GAO Contact:
Mathew J. Scirč, (202) 512-8678 or sciremj@gao.gov:
Staff Acknowledgments:
In addition to the individual named above, Harry Medina, Assistant
Director; Emily Chalmers; William Chatlos; Rachel DeMarcus; Julianne
Dieterich; Chir-Jen Huang; Matthew McDonald; Marc Molino; and Patricia
Moye made key contributions to this report.
[End of section]
Footnotes:
[1] Prosper Marketplace, Inc. refers to those seeking to provide
capital through its platform as "lender members" in its prospectus
while LendingClub Corporation refers to them as "investors."
Throughout this report, we will refer to those seeking to provide
capital through the person-to-person lending platforms as "lenders."
Some institutional investors participate as lenders on the for-profit,
person-to-person lending platforms, but the focus of this report is on
individual lenders and borrowers.
[2] Prosper Marketplace, Inc. and LendingClub Corporation are Delaware
corporations with principal offices in California.
[3] Consumer loans are loans taken out primarily for personal, family,
or household purposes. Some loans on the major for-profit, person-to-
person lending platforms are commercial loans made to individuals
(e.g., small business loans).
[4] Microfinance institutions generally supply microloans, savings,
and other financial services, typically as an alternative for low-
income people who have limited or no access to traditional financial
services. Kiva Microfunds is a 501(c)(3) nonprofit corporation located
in California.
[5] Pub. L. No. 111-203, § 989F, 124 Stat. 1376 (2010).
[6] See GAO, Financial Regulation: A Framework for Crafting and
Assessing Proposals to Modernize the Outdated U.S. Financial
Regulatory System, [hyperlink, http://www.gao.gov/products/GAO-09-216]
(Washington, D.C.: Jan. 8, 2009).
[7] [hyperlink, http://www.gao.gov/products/GAO-09-216].
[8] The Dodd-Frank Act fundamentally changed the structure of consumer
protection oversight by creating the Bureau of Consumer Financial
Protection, as discussed later. The responsibility for consumer
financial protection transfers to this agency in July 2011. However,
SEC remains responsible for investor protection under the act.
[9] Title III of the Dodd-Frank Act abolishes the Office of Thrift
Supervision and allocates its functions among the existing bank
regulators; OCC will regulate federally chartered thrifts, and FDIC
will regulate state-chartered thrifts. The Office of Thrift
Supervision will cease to exist 90 days after the transfer date, which
is July 21, 2011, unless it is extended to another date that is within
18 months of July 21, 2010. 12 U.S.C. §§ 5411-13.
[10] NASAA is a voluntary association of state, provincial, and
territorial securities administrators in the 50 states, the District
of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico.
Through the association, NASAA members participate in multi-state
enforcement actions and information sharing.
[11] Section 1011 of the Dodd-Frank Act established the Bureau of
Consumer Financial Protection to regulate "the offering and provision
of consumer financial products or services under the Federal consumer
financial laws." 12 U.S.C. § 5491(a). CFPB's jurisdiction is generally
focused on consumer credit that is extended primarily for personal,
family, or household purposes. 12 U.S.C. § 5481(5)(A). With certain
limited exceptions, CFPB does not have jurisdiction over loans to
businesses or to individuals primarily for business purposes.
[12] 12 U.S.C. § 5512.
[13] 12 U.S.C. § 5514.
[14] 12 U.S.C. § 5515.
[15] 12 U.S.C. § 5493(b)(1)(A).
[16] See Designated Transfer Date, 75 Fed. Reg. 57252-02 (Sept. 20,
2010).
[17] 12 U.S.C. §§ 5321-22.
[18] 12 U.S.C. § 5322(a)(2)(M).
[19] Although only individuals can borrow through Prosper's and
LendingClub's platforms, small business owners can use loan proceeds
for business purposes.
[20] We did not independently verify the data that the companies
provided for this report.
[21] The number of lenders includes both individual and institutional
(i.e., nonindividual) lenders. Officials from both companies said that
their lenders are predominantly individuals, but that a growing number
of institutional investors participate. For the purposes of this
report, we will focus on individuals acting as lenders.
[22] Prosper and LendingClub use different formulas to calculate net
annualized returns, and they use different criteria to select the
loans used to calculate the average net annualized return statistics
cited on their home pages. For example, Prosper features its net
annualized returns as measured from July 2009, when it completed
registration with SEC. Prosper had a lower minimum credit score of 520
for borrowers before October 2008, and its loans from that period had
higher default rates than later loans, so lenders' average net
annualized return for all loans since Prosper's inception was -3
percent as of March 31, 2011. LendingClub features its net annualized
returns as measured from June 2007, when it made its first loan. Also,
whereas Prosper excludes from its calculations loans that originated
10 or fewer months ago, on the logic that these less seasoned loans
are not very predictive of ultimate loan performance, LendingClub
includes all loans that have gone through at least one billing cycle.
[23] The national average credit card annual percentage rate, as of
April 13-20, 2011, is calculated by CreditCards.com, which according
to the company was based on about 100 of the most popular credit cards
in the country.
[24] The differences between the companies' maximum and average annual
percentage rates may reflect in part that Prosper serves borrowers
with a lower minimum credit score than those LendingClub serves.
[25] The average amount per lender member included only individual
(noninstitutional) investors. For institutional investors, the average
investment amount was about $32,700 for Prosper and about $207,000 for
LendingClub.
[26] For Prosper, loans for other purposes include auto, education,
and other personal loans. According to Prosper officials, data are not
available for 47 percent of the loans because borrowers did not
indicate the loan purpose.
[27] At a minimum, registered lenders or borrowers must be U.S.
citizens or permanent residents who are at least 18 years old with a
valid bank account and a valid Social Security number. Prosper and
LendingClub compare the applicant's name, Social Security number,
address, telephone number, and bank account information against
consumer reporting agency records and other antifraud and identity
verification databases.
[28] Both Prosper and LendingClub have seven broad credit grades--from
AA (the highest rating) through HR (the lowest) for Prosper and A (the
highest rating) through G (the lowest) for LendingClub. LendingClub
further divides each grade into five subgrades.
[29] The maximum aggregate lending amount for Prosper lenders is $5
million for individuals and $50 million for institutional lenders.
[30] Prosper officials said that, in July 2011, the company planned to
replace its automated plan system with a new loan search tool. When
the new loan search tool is implemented, lenders will no longer be
able to create automated plans, but will instead be able to use the
search tool to identify notes that meet their investment criteria. A
lender using the search tool will be asked to indicate (1) the desired
Prosper Rating or Ratings of the loans, (2) the total lending amount,
and (3) the amount to lend per note. The search tool will then compile
a basket of notes based on the designated search criteria.
[31] If a loan is not fully funded, both Prosper and LendingClub allow
the borrower to relist the loan request. However, LendingClub also
allows borrowers the option to accept a partial funding amount if the
amount has been 60 percent funded and exceeds $1,000. Industrial
banks, also known as industrial loan corporations, are state-chartered
financial institutions that are typically owned or controlled by a
holding company that may also own other entities. For more information
on industrial loan corporations, see GAO, Industrial Loan
Corporations: Recent Asset Growth and Commercial Interest Highlight
Differences in Regulatory Authority, GAO-05-621 (Washington, D.C.:
Sept. 15, 2005).
[32] Pursuant to their agreements with WebBank, Prosper and
LendingClub each pay the bank origination fees as part of the purchase
price for the loans. LendingClub charges borrowers an origination fee
that ranges from 2 percent to 5 percent of the loan amount. Prosper's
origination fee ranges from 0.5 percent to 4.5 percent of the loan
amount, with a minimum of $75 for non-AA Prosper Rating borrowers.
[33] Kiva partners with a few microfinance institutions in the United
States that provide loans and financial education to domestic
borrowers with low incomes, women, minorities, and immigrants.
However, most of the microfinance institutions that receive funding
through Kiva are located outside the United States and lend to
borrowers abroad.
[34] Kiva categorizes risks into 10 variables: board, management,
staff, planning, audit, earnings, liquidity, capital, management
information system and controls, and transparency.
[35] Although lenders that are not individuals, such as institutional
lenders, are not precluded from registering, a Kiva official said that
most of its lenders are individuals.
[36] The microfinance institutions can disburse loans up to 40 days
before or up to 30 days after the loan request is posted on Kiva's Web
site.
[37] According to Kiva officials, average portfolio yield is a
representation of the average interest rate and fees charged by the
microfinance institutions, divided by the average portfolio
outstanding during any given year.
[38] Prior to February 2010, Kiva permitted its microfinance
institution partners to guarantee borrowers' loans by allowing the
microfinance institutions to repay Kiva regardless of whether the
borrower repaid. Kiva no longer allows this as an option.
[39] We identified at least 14 companies that have offered person-to-
person lending platforms in the United States since 2001, at least 7
of which were operating as of May 2011. We did not perform an
exhaustive search, so other companies may currently operate platforms,
or may have previously done so.
[40] Using a model that differs from its original person-to-person
lending platform, Zopa briefly operated a platform in the United
States in partnership with several credit unions, but the platform did
not allow lenders to fund particular borrowers' loans. According to
Zopa officials, the company withdrew from the U.S. market in October
2008, primarily due to deteriorating credit conditions at that time.
[41] Prosper and LendingClub both select some loan requests for income
or employment verification, which occurs after a loan listing has been
posted but before it has been fully funded and closed. Prosper selects
loan requests for income and employment verification based on factors
such as loan amount and stated income. In its May 17, 2011,
prospectus, Prosper reported that it selected approximately 39 percent
of loans listed from July 14, 2009, through December 31, 2010 for
income and/or employment verification. For these loan requests,
approximately 47 percent of prospective borrowers provided
satisfactory responses and received loans, approximately 12 percent
failed to respond or provided unsatisfactory information, and the
remaining 41 percent withdrew their listings or failed to have their
loans fully funded. Among other reasons, LendingClub selects loan
requests for income or employment verification in cases where the loan
amount is high or the borrower appears to be highly leveraged. In its
April 21, 2011, prospectus, LendingClub reported that, for the period
of April 1, 2010, through December 31, 2010, it selected approximately
60 percent of its loan listings for employment or income verification.
For these listings, approximately 65 percent of prospective borrowers
provided satisfactory responses, approximately 20 percent failed to
respond or provided unsatisfactory information, and roughly 15 percent
withdrew their loan applications.
[42] It is important to note that the default rates provided by the
companies were based on loans that ranged from 9 months to 15 months
old as of March 31, 2011, and thus, are not necessarily reflective of
how these groups of loans will ultimately perform. Both Prosper and
LendingClub consider a borrower's loan to have defaulted when at least
one payment is more than 120 days late. To illustrate how some of the
companies' highest-rated loans, representing a large share of their
volume, had performed, we chose loans originated in the first half of
2010, a period after both companies had completed the registration
process with SEC and that reflected at least 9 months of performance
since loan origination. Loans originated during different periods and
loans with lower credit grades would have different default rates than
those illustrated here, and lenders' actual investment returns would
depend on the performance of the loans they chose to fund.
[43] To enable investors to make informed judgments about whether to
purchase a company's securities, the securities laws require companies
to disclose important financial and other information by filing a
registration statement that has as its principal part a prospectus--a
legal offering document that must be accessible to anyone who is made
an offer to purchase the securities or who buys them--that describes
the securities offered and the company's business operations,
financial condition, and management. Securities Act of 1933, §§ 7, 10,
Sched. A., 48 Stat. 74, codified at 15 U.S.C. §§ 77a-77aa.
[44] According to their prospectuses, before they registered with SEC,
Prosper and LendingClub made loans to borrowers that were evidenced by
separate promissory notes, made payable to the company, in the amount
of each lender member's portion of the loan. The companies then sold
and assigned the promissory notes (maintaining the borrowers' and
lenders' anonymity to each other) to the respective lenders. In
registering with SEC, the companies modified this approach and,
instead, now retain the promissory notes for borrowers' loans and sell
to lenders corresponding notes, registered as securities, that depend
for their payment on borrowers' repayment of their loans. Lenders do
not have a security interest in the loans themselves.
[45] Ultimately, Prosper and LendingClub each entered into
arrangements with a registered broker-dealer to offer separate
secondary trading platforms to their respective members. These
secondary trading platforms are registered with the SEC as alternative
trading systems. Persons who buy and sell notes on these secondary
platforms must open a brokerage account with the broker-dealer
operating the alternative trading system.
[46] In the order relating to the cease-and-desist proceeding against
Prosper, SEC concluded that the notes were securities under section
2(a)(1) of the Securities Act, and Supreme Court decisions
interpreting that provision, as either "investment contracts" or
"notes." 15 U.S.C. § 77b(a)(1). As securities, the notes offered and
sold by Prosper needed to be registered under the Securities Act,
unless a valid exemption were available. Prosper Marketplace, Inc.,
Securities Act Release No. 8984, 94 SEC Docket 1913 (Nov. 24, 2008).
Essentially, an investment contract exists if there is "an investment
of money in a common enterprise with profits to come solely from the
efforts of others." SEC v. W.J. Howey, Co., 328 U.S. 293, 301 (1946).
A "note" is a security unless it is of a type specifically identified
as a nonsecurity by the Supreme Court in Reves v. Ernst & Young, Inc.
494 U.S. 56 (1990). If not, the note must bear a "family resemblance"
to the nonsecurity notes identified in the Reves opinion in order to
rebut the presumption of being considered a security. Id. at 64-65.
[47] See generally 15 U.S.C. § 77g.
[48] Also, as the companies adopt changes that affect how their
platforms operate, their credit policies, or the terms of the notes
and corresponding loans, they amend their prospectuses to reflect
these changes. Since their registration statements became effective in
2008 and 2009, respectively, LendingClub had completed 10 amendments
to its prospectus, and Prosper had completed 6, as of May 31, 2011.
[49] Under SEC's Rule 415, an issuer may register a security to be
offered on a delayed or continuous basis if, for example, the offering
will be commenced promptly, will be made on a continuous basis, and
may continue for a period in excess of 30 days. 17 C.F.R. § 230.415.
Because certain terms of the notes sold to lenders--such as maturity
date, interest rate, and amount--depend on the terms of the
corresponding loans, Prosper and LendingClub submit prospectus
supplements to disclose information about the notes they offer one or
more times per business day, before they post the corresponding loan
requests to their Web sites. They also submit prospectus supplements
on a daily or weekly basis to disclose information about the notes
they have sold. 17 C.F.R. § 230.424.
[50] For example, sections 11 and 12(a)(2) of the Securities Act
provide remedies for investors for disclosure deficiencies in a
registration statement or prospectus. 15 U.S.C. §§ 77k, 77l(a)(2).
Rules relating to prospectus supplements ensure that prospectus
supplements are deemed part of a registration statement for liability
purposes. See, e.g., 17 C.F.R. § 230.430C.
[51] See 15 U.S.C. §§ 77k, 77l(a)(2), 77q(a). Defective registration
materials may also result in SEC administrative proceedings, judicial
proceedings brought by the SEC, and criminal sanctions by the
Department of Justice. SEC staff said that, if a loan listing with a
material misstatement or omission was included in a prospectus
supplement, then Prosper or LendingClub may be liable under Section 11
and/or Section 12 of the Securities Act of 1933 to a purchaser for the
misstatement or omission, as they might be for any such statement in a
prospectus or registration statement. 15 U.S.C. §§ 77k, 77l(a)(2). In
addition, Section 10(b) of the Securities Exchange Act of 1934
(Exchange Act) and Rule 10b-5 under the Exchange Act prohibit fraud in
connection with the purchase or sale of any security. 15 U.S.C. §
78j(b); 17 C.F.R. § 240.10b-5. SEC staff said that, under these
provisions, a lender may have a remedy for material misstatements in
or omissions from a loan listing if the lender relied on that
information in making his or her investment decision, regardless of
whether that information was contained in the prospectus or
registration statement, if the lender could prove intent to defraud.
Id.
[52] According to Prosper's prospectus and a NASAA announcement,
Prosper and state securities regulators, represented by NASAA, reached
agreement on a settlement in principle in November 2008, the terms of
which were finalized in April 2009. Under the terms of the settlement,
which the states could accept or reject individually, Prosper agreed
not to offer or sell any securities in any jurisdiction until Prosper
was in compliance with that jurisdiction's securities registration
laws. Prosper also agreed to pay a fine of up to a total of $1
million, allocated among the 50 states and the District of Columbia
based on Prosper's loan transaction volume in each state prior to
November 24, 2008. However, the settlement was not binding on any
state, and Prosper was required to pay only the portions of the fine
allocated to states that accepted the settlement. According to
Prosper's May 17, 2011, prospectus, Prosper had paid about $429,000 in
fines to 32 states that agreed to the terms of the settlement as of
December 31, 2010.
[53] 15 U.S.C. § 77r(b)(1).
[54] Twenty-six states had approved both companies' registration
statements or applications; two states and the District of Columbia
had approved only Prosper's registration statement or applications;
and two states had approved only LendingClub's registration statement
or applications.
[55] Idaho, New Hampshire, Oregon, Virginia, and Washington imposed
policies requiring Prosper's lenders to have either (1) an annual
gross income of at least $70,000 and a net worth of $70,000, or (2) a
net worth of at least $250,000. (LendingClub has also voluntarily
adopted this financial suitability standard in all of the states other
than California and Kentucky where it sells notes.) In addition,
California imposed a requirement that, to purchase more than $2,500 of
notes per year from either company, a lender must have a gross income
of at least $85,000 and net worth of at least $85,000, or net worth of
at least $200,000. Kentucky imposed a suitability requirement that
only accredited investors (as determined pursuant to Rule 501(a) of
Regulation D under the Securities Act of 1933) may purchase notes from
LendingClub. Also, lenders in all seven of these states may not
purchase notes in excess of 10 percent of their net worth.
[56] California approved both companies' registration statements with
suitability requirements, as described in the previous footnote.
Kentucky approved LendingClub's registration statement for accredited
investors, and Prosper withdrew its registration statement after
initial consideration by the state regulator, according to company and
state officials. Oregon approved Prosper's registration application
with suitability requirements and denied LendingClub's registration
application by order after LendingClub failed to respond to comments.
Prosper's registration statement was still under Texas' consideration
as of March 2011, and LendingClub withdrew its registration statement
after initial consideration by the state regulator, according to
company and state officials.
[57] Texas has adopted a NASAA Statement of Policy regarding debt
securities. This statement holds that a public offering of debt
securities may be disallowed if the issuer's adjusted cash flow for
the last fiscal year or its average adjusted cash flow for the 3
fiscal years prior to the public offering was insufficient to cover
its fixed charges, meet its debt obligations as they became due, and
service the debt securities being offered. North American Securities
Administrators Association, Statement of Policy Regarding Debt
Securities (1993).
[58] In addition, as in other financial transactions, borrowers and
lenders provide personal financial data to register and complete
transactions with the person-to-person lending companies, which could
be put at risk if the companies' data systems were breached.
[59] In general, staff from FDIC, the Federal Reserve, and FTC, and
CFPB representatives said that whether a federal consumer financial
law and its implementing regulations apply to person-to-person lending
may depend on the nature of the loans and how a particular platform
structures the loans. For example, the Truth in Lending Act and
Regulation Z implementing it generally apply only to extensions of
consumer credit, not to loans made primarily for business purposes.
See Truth in Lending Act, Pub. L. No. 90-321, Title I, 82 Stat. 146
(1968), codified at 15 U.S.C. §§ 1601-1667f; 12 C.F.R. pt. 226.
[60] Federal Deposit Insurance Corporation, Third-Party Risk: Guidance
for Managing Third-Party Risk, FIL-44-2008 (2008). The guidance states
that FDIC evaluates activities that a bank conducts through third-
party relationships using the normal examination processes as though
the activities were performed by the institution itself. The
examination process includes periodic examinations to ensure
compliance with risk management programs and consumer protection and
civil rights laws and regulations.
[61] Relationships between banks and person-to-person lending
platforms would be subject to examination by their federal and state
banking regulators. For instance, NCUA officials said that when the UK
person-to-person lending company, Zopa, briefly operated a platform in
the U.S. through agreements with several credit unions, the credit
unions' oversight of their agreements with Zopa was subject to NCUA or
state regulator examination. Zopa's agreements with credit unions are
no longer in effect.
[62] 15 U.S.C. §§ 6805(a)(7), 6809.
[63] Some entities are exempt from FTC's Section 5 authority because
they are banks or are corporations not carrying on business for their
own profit or the profit of their members. 15 U.S.C. §§ 44, 45(a)(2).
[64] We provided FTC with a list of 13 of the companies we identified
that had operated person-to-person lending platforms in the United
States. FTC reported 29 complaints related to 1 of these companies.
Most of the complaints were filed more than 2 years ago and pertained
mostly to alleged incidents of identity theft in which borrowers
obtained, or attempted to obtain, loans using someone else's personal
information. FTC officials said that the agency had not received any
complaints related to the other 12 companies we identified.
[65] Before LendingClub and Prosper entered into program agreements
with WebBank to originate and disburse their loans beginning in 2007
and 2008, respectively, the companies obtained lending licenses or
other state authorizations to originate loans themselves. Officials
from the companies said that this approach created challenges in
operating nationwide lending platforms, particularly because states
have adopted differing interest rate and fee caps. The officials said
that entering into program agreements with WebBank allowed them to
offer uniform terms across states because, as an industrial bank,
WebBank can "export" its home state's interest rates to customers
residing elsewhere. WebBank officials said that the bank is permitted,
under Utah law, to charge interest rates that may exceed the amounts
permitted under some other states' usury laws.
[66] 12 U.S.C. § 5491.
[67] 12 U.S.C. § 5531.
[68] 12 U.S.C. § 5532.
[69] 12 U.S.C. §§ 5514, 5515.
[70] The term "service provider" means any person who provides a
material service to a "covered person" in connection with the "covered
person's" offering or provision of a consumer financial product or
service. The term "covered person" means any person that engages in
offering or providing a consumer financial product or service, and any
affiliate of such person if such affiliate acts as a service provider
to such person. 12. U.S.C. § 5481.
[71] 12 U.S.C. § 5514.
[72] 12 U.S.C. § 5534.
[73] Kiva loans are made to microfinance partners and repaid in U.S.
dollars, but microfinance partners generally make loans to borrowers
and receive repayments in their local currency. If a foreign currency
suffers a large devaluation against the U.S. dollar, Kiva's
microfinance partners may have problems repaying their loans. For
loans funded since June 2009, Kiva has offered microfinance partners
an optional currency risk-sharing program that passes the loss to
lenders if currency devaluations over 20 percent occur. The loan
listing discloses to lenders before they fund a loan whether the
microfinance partner has opted into the currency risk-sharing program.
[74] Section 501(c)(3) of the Internal Revenue Code and IRS
regulations establish the federal requirements for charitable
organizations. 26 U.S.C. § 501(c)(3). The California Nonprofit
Corporations Law, California Nonprofit Integrity Act of 2004, and
their related regulations establish state requirements to which Kiva
is subject. Cal. Corp. Code §§ 5000-10841; Cal. S.B. 1262 (codified in
scattered sections of the California Business & Professions Code and
the California Government Code).
[75] 26 U.S.C. § 501(c)(3). Kiva officials said they do not treat
amounts solely lent through Kiva as tax-deductible contributions, in
part because Kiva holds lenders' deposited funds in separate lender
accounts held for their benefit to make microloans-i.e., they are not
provided to Kiva to fund its operations. Also, loan repayments are
returned to these lender accounts, and lenders are free to withdraw
their available funds at any time. The officials also said that Kiva
has not obtained a formal legal opinion on the potential deductibility
of foregone interest on funds lent through Kiva's platform.
[76] SEC v. W.J. Howey Co., 328 U.S. 293 (1946). An example similar to
Kiva is Poplogix, a company that operates an online platform in which
lenders may make loans to artists, as long as the lenders receive
repayments of only their principal and no interest. Poplogix requested
a no-action letter from SEC in 2010, which SEC staff provided,
indicating that, if the company acted in the manner described in its
request, the staff would not recommend that SEC take enforcement
action. Poplogix LLC, SEC No-Action Letter, 2010 WL 4472794 (Nov. 5,
2010).
[77] 15 U.S.C. §§ 44, 45(a)(2).
[78] As stated earlier, CFPB is required to establish a unit whose
functions shall include establishing a database or utilizing an
existing database to facilitate the collection of, monitoring of, and
response to consumer complaints about consumer financial products or
services.
[79] Currently, a person-to-person lending company that made loans
without a bank's involvement would not be subject to a federal banking
regulator's oversight or examination. However, we noted earlier that
the Dodd-Frank Act provided CFPB with jurisdiction to supervise
nondepository institutions that engage in residential mortgage
lending, private student education lending, and payday lending and
that it provided CFPB with the authority to define through regulation
how it will determine which nondepository institutions will be subject
to its supervision as "larger participant[s] of a market for other
consumer financial products or services." 12 U.S.C. § 5514. Under the
current regulatory system, then, depending on the types of loan
products nondepository person-to-person lending companies offer and
the outcome of CFPB rulemaking, CFPB could have the authority to
supervise borrower protection for nondepository person-to-person
lending platforms, regardless of whether they partner with a bank to
originate loans.
[80] Alternatively, a consolidated regulatory approach could assign
responsibility to a different federal regulator, such as SEC or one of
the federal banking regulators. However, SEC has not been involved in
regulating, examining, or supervising lending institutions. The
federal banking regulators supervise federally insured depository
lending institutions, which provides the basis for FDIC's oversight of
WebBank's third-party relationships with Prosper and LendingClub.
However, some of the industry observers we interviewed said that,
because the major person-to-person lending companies are not
depository institutions themselves and do not retain the credit risk
associated with their platforms' loans, they do not pose the safety
and soundness concerns that are central to the supervisory activity of
the federal banking regulators. For more information about our scope,
see appendix I.
[81] To help preserve the anonymity of those we interviewed, we use
the term "industry observers" to refer to the 15 current and former
industry participants, researchers, and consumer advocacy
organizations that we interviewed.
[82] [hyperlink, http://www.gao.gov/products/GAO-09-216].
[83] We asked 20 of the regulators, industry participants,
researchers, and consumer advocacy organizations we interviewed to
rate the importance of each element of the framework when assessing
options for regulating person-to-person lending. We received 11
responses from 3 federal agencies, 1 state securities regulator, 3
companies involved in the industry, 3 researchers, and 1 consumer
advocacy organization. Two other federal agencies did not rate the
importance of the elements, but officials generally agreed that the
framework was relevant to our analysis. While we cannot generalize
from the views of this small group of respondents, they informed our
analysis of the regulatory options.
[84] As stated earlier, Prosper and LendingClub use different formulas
to calculate net annualized returns, and they use different criteria
to select the loans to calculate the average net annualized return
statistics that they cite on their home pages. The companies disclose
how they calculate net annualized returns.
[85] SEC staff noted that small loans and small investment increments
are what borrowers and lenders demand on the platforms, not what
federal securities laws require. They also said that, while SEC
required the companies to file prospectus supplements to record
material information that the companies provided to lenders, on their
Web sites, about the notes they offered and sold, SEC staff did not
mandate how the companies should structure the prospectus supplements.
In May 2011, Prosper filed 72 prospectus supplements documenting the
offer and sale of its series of notes and LendingClub filed 126
prospectus supplements. SEC staff said that the companies' filings of
prospectus supplements did not present significant technical
requirements for SEC or its staff, because the receipt of filings by
EDGAR is largely an automated process. Individual prospectus
supplements are operative upon filing, without further staff review.
[86] A. Verstein, "The Misregulation of Person-to-Person Lending,"
(working paper available at [hyperlink,
http://ssrn.com/abstract=1823763}. Accessed May 24, 2011.
[87] NASAA offers its members Statements of Policy that provide
guidelines the states can use when reviewing a securities offering in
their states. The states are not required to adopt NASAA's Statements
of Policy, but often choose to do so, in full or in part. For example,
NASAA officials said that some states promulgate rules which
incorporate portions or all of a statement's text, while others adopt
some or all of the Statements of Policy by reference.
[88] CFPB representatives said that they would work to effectuate any
function assigned to the agency by Congress, consistent with
legislative intent. However, given that the agency is still preparing
to begin transferring functions on July 21, 2011, implementation team
members had not had an opportunity to engage in broad policy analysis
of lender protection issues and therefore could not comment in detail
on how CFPB might implement a consolidated approach to regulating
person-to-person lending, if it was given authority to do so. Our
description of how a consolidated approach could be developed is based
primarily on proposed legislation and suggestions from those we
interviewed.
[89] See, for example, K.E. Davis and A. Gelpern, "Peer-to-Peer
Financing for Development: Regulating the Intermediaries," New York
University Journal of International Law and Politics, vol. 42, no. 4
(2010): 1209. The authors suggest that lenders should have access to a
threshold quantity of information to help them decide whether their
expectation of being repaid is justified, but they note that scaling
financial regulation to avoid excessive costs of compliance for
nonprofit organizations could present a challenge.
[90] The Dodd-Frank Act excludes certain individuals and firms from
CFPB jurisdiction to the extent that they are engaged in an enumerated
SEC-regulated function (e.g., acting as registered broker-dealers and
investment advisers). However, CFPB representatives noted that merely
issuing securities requiring registration under the Securities Act of
1933 is not enough to qualify an entity as a "person regulated by the
Commission." 12 U.S.C. §§ 5481(21), 5517(i). Persons regulated by
state securities commissions are also excluded from CFPB's
jurisdiction, but not to the extent that they offer or provide
consumer financial products or services or are "otherwise subject to
any enumerated consumer law or any law for which authorities are
transferred under subtitles F or H" of Title X of the Dodd-Frank Act.
12 U.S.C. § 5517(h).
[91] For example, on "crowdfunding" Web sites, an entrepreneur can
seek to raise capital for a business venture, and investors can pledge
money toward the entrepeneur's goal in exchange for token
compensation, such as coupons or free samples. The companies that
operate such Web sites may not verify the legitimacy of the business
or ensure that supporters receive their promised gifts. "Crowdfunding"
could raise new regulatory concerns, such as whether securities
registration requirements should apply if such Web sites permitted
investors to profit.
[92] The Investment Advisers Act of 1940 generally defines an
investment adviser as any person (i.e., individual or firm) who is in
the business of providing advice, or issuing reports or analysis on
securities for compensation. 15 U.S.C. § 80b-2(a)(11). Investment
adviser firms generally register with SEC or state securities
regulators as registered investment advisers subject to examination
for compliance with applicable laws and regulations. See GAO, Consumer
Finance: Regulatory Coverage Generally Exists for Financial Planners,
but Consumer Protection Issues Remain, GAO-11-235 (Washington, D.C.:
Jan. 18, 2011).
[93] The most relevant studies that we identified in our literature
search were K. Davis and A. Gelpern, "Peer-to-Peer Financing for
Development: Regulating the Intermediaries," New York University
Journal of International Law and Politics vol. 42, no. 4 (2010); I.
Galloway, "Peer-to-Peer Lending and Community Development Finance,"
Federal Reserve Bank of San Francisco Working Paper 2009-06 (2009);
and A. Verstein, "Peer-to-Peer Lending Update and Regulatory
Considerations," Filene Research Institute (2008).
[94] Securities Act of 1933, 48 Stat. 74, codified at 15 U.S.C. §§ 77a-
77aa.; Truth in Lending Act, Pub. L. No. 90-321, Title I, 82 Stat. 146
(1968), codified at 15 U.S.C. §§ 1601-1667f; Federal Trade Commission
Act, § 5, 38 Stat. 719 (1914), codified at 15 U.S.C. § 45; Gramm-Leach-
Bliley Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999) (codified in
scattered sections of 12 U.S.C. and 15 U.S.C.).
[95] H.R. 4137, § 4315.
[96] GAO, Financial Regulation: A Framework for Crafting and Assessing
Proposals to Modernize the Outdated U.S. Financial Regulatory System,
[hyperlink, http://www.gao.gov/products/GAO-09-216] (Washington, D.C.:
Jan. 8, 2009).
[97] We did not assess SEC's policies, procedures, practices, and
standards for information security with respect to the EDGAR database
for this study. In 2009, we reported on SEC's progress toward
correcting information security control weaknesses that we previously
identified and recommended that SEC fully implement its information
security program. GAO, Information Security: Securities and Exchange
Commission Needs to Consistently Implement Effective Controls,
[hyperlink, http://www.gao.gov/products/GAO-09-203] (Washington, D.C.:
Mar. 16, 2009).
[98] The companies also filed prospectus supplements listing the notes
offered (i.e., notes offered that corresponded to loan requests
available on their platform Web sites). We focused our analysis only
on the prospectus supplements listing notes sold, because those
include the most complete record of information supplied by borrowers
with respect to their loan requests, including their online responses
to questions posed by lenders.
[99] During and after the time period covered by our analysis,
Prosper's loan listings included fields for the borrower's state,
general occupation, and employment status but not for more specific
information on the city of residence or employer name. Borrowers could
include such information, as well as their job titles, in optional
narrative responses (e.g., loan description or responses to lender
questions). However, Prosper officials said that the company uses
manual and automated procedures to screen these borrower responses for
personally identifiable information.
[End of section]
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