Wednesday, November 19, 2008 - quiet period my ass

It has now been more than one year since's ill-fated SEC filing which attempted to create a secondary market, and apparently failed. In the meantime, Lendingclub filed, got approval, and began operating such a market. Prosper at the very least has lost its first mover advantage.

What happened? And what the hell is this thing they're calling a "quiet period"?

On 10/30/2007, a little more than a year ago, filed a prospectus with the SEC to allow them to sell "notes" from one lender to another. This is what Prosper calls the "resale market". I remember reading the prospectus at the time and thinking how strange it was. If these things are securities, requiring SEC registration when they're traded from one lender to another, then why aren't they securities requiring SEC registration when they're sold to the first lender? And if they are (illegal) unregistered securities when sold to the first lender, then has been selling illegal unregistered securities to thousands of lenders for two years. It seems likely that the SEC had similar concerns, because the prospectus was never approved. It could not possibly be approved now, because there have been material changes since it was written (Co-founder John Witchel left Prosper for example). Prosper's year-old filing therefore is dead. Can't be approved as is. They would need to file again.

For background on selling unregistered securities...

In the time since Prosper filed, Lendingclub came along and did the same thing. Lendingclub filed with the SEC on 06/20/08, and was approved on 10/14/08, just 116 days later.

So what's the hangup with

If you read the prospectuses filed by and Lendingclub, you will see that they are quite different. Lendingclub admitted up front that the thing they are selling lenders is a derivative. It is an obligation of Lendingclub, which pays amounts that depend on what borrowers pay to Lendingclub. This is a pretty standard sort of thing, which the SEC has approved many times. Lendingclub structured the thing so that the SEC could easily recognize this as a kind of thing it had approved before. There existed a precedent.

From the LendingClub prospectus: "The Notes will be unsecured special, limited obligations of Lending Club."

From the prospectus: "The Notes represent unsecured fully-amortizing credit obligations of individual Borrowers on the Platform." and later "All Notes issued on the Platform are unsecured credit obligations of individual Borrowers."

So while Lendingclub admitted to creating derivatives, Prosper tried to step to the side and argue that the securities they were registering were actually the obligations of somebody else. This has no precedent. This is unlikely to be approved by the SEC. That I believe is one fundamental problem.

But there's another problem. If the SEC read the prospectus the way I did, they would have the same question I had about the elephant in the room. If these things Prosper sells require registration, then perhaps they require registration the first time they are sold, not just upon resale.

If the SEC believes that then Prosper is in a pickle. The securities act of 1933 considers the sale of unregistered securities a felony subject to punishment by a 5 year prison term. Its pretty much the SEC who decides what is an unregistered security. It is this consideration that gives the SEC much of its authority!

So now lets go back to the question of Prosper's "quiet period", and what the heck it means. They've called it a quiet period, but that's not what it is.

The term "quiet period" refers to a period of time around the issuance of a new stock when the issuing company is supposed to take careful precautions to avoid any appearance that they are hyping the new issue. This generally means they shouldn't give interviews hyping how great the company is, for example. It just means be quiet. It does not imply that the company should cease operation. Companies do not stop selling shoes, or refrigerators, or whatever they normally sell, during a quiet period.

Prosper has not just gone "quiet". They've stopped issuing new loans. I believe they did this because they believe they are in substantial risk of being charged by the SEC with selling unregistered securities for the last two years. We always knew there was regulatory risk associated with this new kind of business model. Well here it is.

Getting out of this pickle will require either convincing the SEC that they should go back to sleep ... everything is ok, or else filing a new prospectus and getting it approved. Until one of those two things happens, Prosper would be operating at considerable risk if they continued to sell these allegedly unregistered securities. Therefore, they had to cease.

This isn't a 'quiet period'.

Its a 'Shut the doors, turn off the lights, hide in the back, and hope the policeman won't knock down the door period'.

No one knows how long this will take. Prosper hasn't even filed yet. Prosper needs to hire a new law firm (I wish whoever wrote that last prospectus should go work for my competitor.), then write a shiny new prospectus, file it, and get it approved.

In the one month that has passed since the shutdown, I would guess that they have hired the new firm. They obviously haven't filed a new prospectus. That puts them somewhere between step 1 and 2.

When that prospectus is eventually filed, I'm betting it will say, (much like the Lendingclub prospectus does), that the notes investors purchase are obligations of, not obligations of the borrowers. This changes the risk profile for investors (who prosper calls lenders). When considering the purchase of an obligation of, we need to know something about the financial situation of We need to see a balance sheet! We need to know what other obligations may be senior to ours. Will Prosper understand this and step up and do what's right in the new environment? I don't know. If I were to judge from their past "To heck with the lender" management perspective, I'd have to say no.

Derivatives such as I describe here are commonplace. Awhile back I invested in a NYSE traded floating-rate note of Daimler-Chrysler. Symbol JZD. (You can read about it at*&sopt=symbol )

Looked great, but it kept going down. Finally I realized that this is actually a derivative. It was an obligation of Lehman, who would pass thru the payments made by Daimler Chrysler, just as Lendingclub or Prosper will pass thru the payments made by borrowers. As Lehman's financial situation became less clear, these derivatives sold off. You've gotta understand the financial condition of the middleman! I was a bit naive. Now I am a bit smarter.

There could be other significant changes in the way the whole thing works too. Prosper has lost its mojo. Although they were first, they no longer act like a frontrunner.

When Lendingclub opened up with a blog full of personal finance drivel, Prosper immediately added a to their site blog full of personal finance drivel. It is as if someone at Prosper said "Oh, of course, Web 2.0, you gotta have a blog! What were we thinking?" Most recently the Prosper blog tells consumers that they should go out and borrow more, at a time when the whole world is deleveraging from the excess borrowing of the last decade. Drivel. Hey Prosper, you were a leader. You don't need to be a copycat. Personal finance drivel advice is not the answer.

I hope they don't continue with this me-to approach. For exampe, I hope they don't adopt Lendingclub's non-auction approach for setting interest rates. I think that's a disaster.

Here's some evidence that Prosper may be thinking about major changes in the platform before they reopen: Several months ago, software development slowed to a trickle.

I've written before about how back in January we were promised monthly statements on the legal-test loans. (Loans where prosper has filed suits against badly delinquent borrowers.) Its November, and no monthly statements have been produced. A lot of months have gone by.

I've written many times about the statistics on collections of late loans. I never could understand how the numbers were so bad. I've written several times about the fact that some of the numbers jumped around faster than was possible, indicating bogosity. Something was wrong, and Prosper kept ignoring it. In August, prosper admitted that the stats they'd been giving us for collection performance at Amsher were wrong, due to a bug in the software interface with Amsher. I figured they'd fix it. Instead, they simply removed the Amsher stats from their web site. August, September, October, November. Nobody fixes the bug. Nobody cares? Lenders figure this is just another sign that Prosper thinks lenders are crap, and don't deserve the data.

How can a company be run this way? It could be rationally run this way if they figured that much of the existing platform was gonna be thrown away soon.

That's just a theory of course.

I'm sure it will all be revealed at ProsperDays 2009! See 'ya there.


  1. "I would guess that they have hired the new (law) firm."
    Based on what?

  2. From bamalucky's blog:
    "The PD 2009 will be an auction of the remaining furniture & leftover pencils."

    I know nothing of the details of securitizing loans on a P2P website . . . but everyone knows you don't mess around with the SEC and financial instruments. It's like knowingly infringing on a patent and just hoping you don't get caught. I'm with you fred, if they knew resale needed SEC filing, why wouldn't the first sale require it?

  3. Fred - this might be of interest:

    (Also posted to


    Dave (Formerly Zopa Dave!)

  4. Fred, sounds like you were right on the money (no pun intended. :) Too bad SEC filed against Prosper because the idea of P2P lending makes so much sense. It really does seem to me that the old securities rules shouldn't apply to this type of lending. But then what do I know?

  5. Thanks so much for finding all this information! I didn't bother to read the prospectuses myself so I'm glad someone did. And the way Prosper shut down was quite suspicious to me as well...

    But anyhow, I don't quite agree with you on the assertion that the new notes will be derivatives. I'm not an expert on these things, but I do have some experience.

    My understanding is that the notes Prosper makes should be placed into a trust, and the trust then issues securities, which will be traded amongst investors. Prosper may or may not be the Trustee, or the servicer of the assets held in the trust. But the notes issued should not be general unsecured obligations belonging to Prosper.

    In the Daimler Chrysler notes example. I don't feel like reading the prospectus of that particular issue, but in general, exchanged traded notes/third party trust preferred/etc, are usually carved out pieces of a larger debt issuance. (call it Chrysler 2020 8% Junior Debt). This piece of debt is then placed into a trust by Lehman (or whatever bank), and securities are issued by the Trust to the public. Lehman, being the packager, takes a fee upfront. And a different bank (call it Bank of NY Mellon) is appointed as the trustee, and they get a fee too. The point is that the notes issued by the trust are not general obligations of Bank of NY, or of Lehman. They are solely backed by the assets of the Trust.

    But anyway, sorry for being wordy... but I think we shouldn't worry about the financial health of Prosper, unless they do something really unorthodox. Knowing Prosper, it is definitely worth reading the Prospectus whenever that comes out.

  6. To MikeT... When you talk about notes being placed in trust and then the trust issuing securites whose payments DEPEND ON or are DERIVATIVE of payments on the original notes, then those are derivatives by definition.

  7. We have been trying to establish similar operation in Japan. Japanese authorities could devise similar situation to Prosper.

    They shall enforce ceiling to the loan interest starting 2009. The ceiling would be 18% for less than 100million jpy=10,000 US approx. and 15% any amount over it.

    Can you make profit with this kind of interest? We do not think so.

  8. Call me naive, but why wouldn't you be able to make profit with 18% interest?

  9. Alice and Bob are both "high risk". You loan $1000 to each at 18%. Bob pays you back but Alice pays back $20 and then skips town.

    What is your profit?

    You need higher interest rates to make lending, to certain types of people, statistically viable.