Peer-to-Peer Loans May Be Classified As Securities

In April, LendingClub.com, a peer-to-peer lending site, announced that it had temporarily stopped accepting new lender registrations and new commitments from existing lenders. The reason for the website’s …

In April, LendingClub.com, a peer-to-peer lending site, announced that it had temporarily stopped accepting new lender registrations and new commitments from existing lenders. The reason for the website’s hiatus, dubbed a “quiet period,” was to allow the site to register with the SEC so it could offer up to $600 million in Member Payment Dependent Notes through the site, according to an official press release. It is possible that Lending Club and other peer-to-peer (also known as P2P) lending sites may have to adjust their business models in order to comply with relevant securities laws.

Lending Club is not taking press inquiries during this quiet period and has not disclosed further details regarding the changes taking place or the cause behind them. The registration statement is similar to one filed by Prosper, a competing peer-to-peer lending company, in October 2007.

The basic idea behind peer-to-peer lending is that borrowers create a listing on the site looking for funding and third-party lenders “bid” on the listing until adequate funding has been achieved. The peer-to-peer lending company manages and services the loan, dealing with missed payments and other issues that may come up. But it isn’t necessarily as straightforward as it sounds; the problems with loan classification may be arising because of issues surrounding loan ownership and transfers.

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Securities encompass a wide range of investments including but not limited to stocks, bonds, notes and “investment contracts.” An investment contract is essentially an agreement through which investors contribute money to a particular enterprise with the expectation of receiving a return as a result of the managerial efforts of someone other than themselves. The people who conduct these transactions need to be properly licensed by the SEC in order to do so. Because of the way in which peer-to-peer lending companies structure and distribute their loans, they now need to receive this licensure.

Investors who choose to lend money through Prosper, a top peer-to-peer lending company, are not technically direct lenders at all but are instead loan purchasers. “[Lending members] are not actually lending [their] money directly to Prosper borrowers, but are, instead, making loan purchase commitments and purchasing promissory notes from Prosper, representing loans made by WebBank, a Utah-chartered Industrial Bank (‘WebBank’) to borrowers and subsequently assigned to Prosper,” according to Prosper’s Lender Registration Agreement. WebBank actually makes the loans and then third-party “lenders” can purchase the notes via Prosper. This means that peer-to-peer lending companies operating in this manner are selling and managing promissory notes for existing loans and, as such, the loans are technically securities.

As part of the restructuring, once the quiet period is over Lending Club will be offering up to $600 million in Member Payment Dependent Notes. The Notes will be issued in series corresponding to individual consumer loans issued to Lending Club borrowers. “Lender members will direct Lending Club to apply the proceeds Lending Club receives from the sale of each series of Notes to fund a particular consumer loan selected by the lender member and originated through the Lending Club platform,” according to a Lending Club press release. Notes will be issued once the member loan has been fully funded and Lending Club will manage the loan and make payments to the loan purchasers as long as the borrower continues to make payments. But for now the site remains on hiatus from accepting new lender commitments, and it is not specified anywhere how long this quiet period is expected to continue. RateLadder, a blog dedicated to various aspects of peer-to-peer lending, predicted that the quiet period could last anywhere from seven months to 18 months. The site will continue to make new loans to borrowers during this time.

Whether or not this will have a drastic effect on investors involved with peer-to-peer lending companies remains to be seen. It’s possible that extra expenses could be passed on to third-party lenders, which could cut into potential returns, according to ThickenMyWallet.com, a finance and investment blog. The blog post on the subject states that registering with the SEC can cost anywhere from $250,000 to $1 million or more per year for filing fees, legal fees and other associated expenses, depending on the size of the registrant. If these extra expenses do wind up getting passed along to members, investors who put their money into peer-to-peer loans may find their returns somewhat reduced in the future.

Investors who actively use or are interested in sites such as Lending Club or Prosper should keep a watchful eye on changes that may be introduced to the companies’ processes and fee structures as a result of these registrations. For those who are interested in looking into the official legal documentation, both peer-to-peer lending companies’ SEC registration statements can be viewed on the SEC website.

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