Prosper.com - SEC Cease & Desist Order

Well... As I predicted in my last writeup, the SEC has found Prosper.com to be in violation of the securities act of 1933. The SEC made this finding public yesterday.

The SEC's public statement can be found here:
SEC Prosper Cease & Desist Order

This SEC release explains why prosper.com has ceased operation.

From the SEC Order. . .
The loan notes issued by Prosper pursuant to this platform are securities and Prosper, from approximately January 2006 through October 14, 2008, violated Sections 5(a) and (c) of the Securities Act, which prohibit the offer or sale of securities without an effective registration statement or a valid exemption from registration.

The details are a fun read, and cover much of the territory that has been discussed here in the past.

Prosper.com - quiet period my ass

It has now been more than one year since Prosper.com'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, Prosper.com 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 Prosper.com 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...
http://invest-faq.com/cbc/warn-unreg-secur.html

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 Prosper.com?

If you read the prospectuses filed by Prosper.com 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 Prosper.com 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 Prosper.com, not obligations of the borrowers. This changes the risk profile for investors (who prosper calls lenders). When considering the purchase of an obligation of Prosper.com, we need to know something about the financial situation of Prosper.com. 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 http://www.quantumonline.com/search.cfm?tickersymbol=JZD*&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.

Lendingclub - Late Loan Stats

Lendingclub has been around for more than a year now, so I figured maybe there was finally enough data to allow one to understand the default rate behavior of Lendingclub loans. I have prepared charts of the behavior of Lendingclub loans that are similar to the ones I've been making for Prosper.

These charts show statistics for the performance of all Lendingclub.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Lendingclub's performance web page.


The curves are "noisy" (ie they jump up and down a lot) and are not as orderly as the curves on the prosper chart. That's because the volume of loans at Lendingclub is still too low to get good stats. We can see that Oct'07 was a really horrible month. Those loans are now 1 year old, and 15% of them have gone bad! That's about as bad as prosper!

After Oct'07 they must have fixed something, because the later curves all seem to have a lower slope. We'll never know. Lets slide these curves over to a common origin, so we can visualize how common their shapes are...


Just look at where these curves crossed the 390 day line, (ie 30 days after the 360 day line, because it takes 30 days for a loan to become 1 month late) or visualize where they might cross the 390 day line as they extend, and that tells you what fraction of loans went bad in the first year. This is then an estimate of the annual default rate for Lendingclub loans.

There is a little problem. Although the data is still quite noisy becase there aren't enough loans, we can see that various groups of loans fall between 5% and 15% bad after 1 year.

Lendingclub has given us estimates of the annual default rate for their loans. This used to be on the web site, but is now found in the prospectus. For their best grade, "A1" they predict a 0.16%/year default rate. (Yes, that's really zero point one six percent!) For their worst grade, "G5" they predict a 5.25%/year default rate.

Ideally we would gather statistics for each credit grade and compare them to these default rates that Lengingclub assumed. Unfortunately, if we split the monthly pools of loans into all the different credit grades, there would be very few loans in each group, and the stats would be horribly noisy.

What we can do however is look at all the Lendingclub loans together. If Lendingclub's numbers were right, the default rate would be something between 0.16%/year and 5.25%/year, so it might come out something like say... 2.5%. However, looking at the picture, you can see they're way off. No month is anywhere near 2.5% at the 390 day line. The curves show us that the average might be more like 8%/year. Hard to be precise with such a small amount of data.

If Lendingclub has used faulty estimates of default rate, then the interest rates on Lendingclub loans are all too low. Seems likely.

In the beginning, Prosper.com gave their lenders default rate estimates that came from Experian (their data supplier), showing their experience with a large number of credit card accounts. Many lenders initially used those estimates to determine the rates they bid. Unfortunately, actual Prosper loans turned out to behave very differently than the Experian credit card statistics. Anonymous internet P2P loans apparently don't behave like historical credit card accounts. Sorry. Later, Prosper deleted the hilarously low Experian numbers from their web site, and showed lenders only their own historical performance data. This was a landmark improvement.

Likewise, Lendingclub obtained estimates from historical account data at Transunion (their credit data supplier) and naively used these to calculate the interest rates they offer on their loans. The assumptions aren't holding, so the rates are too low.

Luckily, Lendingclub added a term in the interest rate formula that they call "adjustment for risk and volatility". They set this term equal to 2x the expected default rate, and added it into the interest rate. (There's a good theoretical basis for doing something like this, which I won't bore you with.) The effect is that interest rates end up adjusted for 3x the assumed (bogus) default rate. That provides a little wiggle room, especially for the lower credit grades. For the high credit grades (ie A) however, I suspect they're just way off.

Lendingclub has originated between 100 and 400 loans in each of the months shown above. Unfortunately, the recent months have very low numbers of loans originated, because Lendingclub was not taking in lender money while they fought some regulatory battles. They're only now ramping back up. We really need them to get over 500 loans/month and then accumulate data for several months (a year?) before we can understand Lengingclub loan performance in a more seriously quantitative way.

Best discussion among P2P lenders occurs at www.prospers.org.

Prosper.com - 11/01/08 late loan stats update

Here's the November 1, 2008 update to to my Prosper.com late loan statistics charts.

These charts show statistics for the performance of all prosper.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Prosper.com's performance web page.

A larger, more readable version of that chart can be found here

Here's a chart of the same data in which each curve has been slid to the left to a common origin. The horizontal axis is now days since loan origination month.

Explanation of methodology can be found in my prior postings in this blog, and in forum discussions on the old prosper forum, now archived at www.prosperreport.com

PS: Best discussion among Prosper.com lenders can be found at http://prospers.org/

Prosper.com - Google says Site Not Available

This just struck me as funny. Every now and then Prosper takes their web site down to update software. During this time, they put up a "site not available" page.

For several weeks now I have noticed that google has been indexing this "site not available" page. If you did a google search for prosper, "site not available" would be one of the pages listed. That was funny. The google robot must have wandered thru a few times while the site not available page was up.

Yesterday Google decided that "Site Not Available" is the name of Prosper's main page! Oops.

I decided to capture this for posterity.

I checked again today and note that it is already back to normal. Google is quick. Could happen again any day tho.

Note to Prosper webmasters: Consider adding a META command with NAME="robots", CONTENT="noindex", to the site-not-available version of the main page.

Prosper.com - the lawsuits are not going well

In January of this year, Prosper initiated a test program to bring suit against a small set of nonpaying borrowers. 66 very late loans were selected, and Prosper turned these loans over to the law firm of Hunt & Henriques to go after the nonpayers, and try to recover some funds.

Almost 10 months have passed, so it is reasonable to ask the status of the cases in this test program. Unfortunately and amazingly, Prosper does not report any of this status to the lenders whose money is invested in these loans. (They told us they would report to lenders monthly, but they have not.)

I wrote about this earlier here.

Lets review the timeline:

01/15/08 -- Prosper sent many lenders an email message asking them to "opt in" to this project to allow Prosper to sue borrowers on the lenders behalf. I opted in.

02/17/08 -- Prosper repurchased the loans from lenders, to simplify court proceedings. Prosper didn't pay anything to the folks who opted in. Payment will come later, depending on success in the lawsuits.

02/25/08 -- First suit filed. In Riverside county. Prosper vs Cline
04/08 -- Lots more suits filed.

So its now >6 months after the suits were filed. Its time to see what happened.

Although Prosper doesn't tell us anything about the status of these cases, we can look some of them up on the public web sites of various courts. All 66 cases were in California, and several large California counties have excellent web sites that provide status of civil cases. I've visited these court websites, and retrieved status of each case I can see. I've simplified the legal language. If you want to see the details you can visit the court web sites and retrieve the same information directly from the source.

Los Angeles Superior Court
Case Number: 08C00921
PROSPER MARKETPLACE, INC. VS. BROWN, HOLLY
Case filed 2/25/08.
Proof that summons was served on Holly Brown filed on 4/25/08.
Case dismissed 5/12/08. Prosper lost.

Case Number: 08C01750
PROSPER MARKETPLACE, INC. VS. RABOTEAUX, VALENTINO
Case filed 4/21/08.
Summons was apparently never served.
Case dismissed 10/10/08. Prosper lost.

Case Number: 08E04908
PROSPER MARKETPLACE INC. VS WEST, JAMES
Case filed 4/28/08.
Summons was apparently never served.
Case dismissed 10/16/08. Prosper lost.

Case Number: 08C01411
PROSPER MARKETPLACE, INC. VS. BARBOZA, RICARDO
Case filed 4/01/08.
No indication that summons was ever served.
Case dismissed 9/24/08. Prosper lost.

Case Number: 08C01437
PROSPER MARKETPLACE INC. VS. MOFFETT, CRYSTAL
Case filed 4/01/08.
Summons served on Robert Moffett. Proof of service filed 5/8/08.
On 8/11/08 the court clerk rejected Prosper's request for summary judgement. Sounds like some piece of documentation was missing from Prosper's request. I presume they'll try again.
In process.

Case Number: BC388361
PROSPER MARKETPLACE INC VS SHI LI PARK
Case filed 4/02/08.
Summons served and proof of service filed 6/19/08.
Plaintiff (prosper) asked for default judgement on 7/16/08.
Proceeding held on 10/29/08, and "continued" to some future date.
In process.

Case Number: 08K08483
PROSPER MARKETPLACE INC VS COLLET, LOUIS
Case filed 4/02/08.
No indication summons ever served on defendant.
Case dismissed 10/27/08. Prosper lost.


Case Number: 08K08484
PROSPER MARKETPLACE INC VS RIVERA, ROBERT
Case filed 4/02/08.
Summons served and proof of service filed on 7/07/08.
Court clerk rejected Prosper's request for default judgement 9/23/08. Doesn't say why. I presume this is another documentation problem, and that Prosper will resubmit, although a month has gone by and they have apparently not yet done so. In process.

Case Number: 08C01110
PROSPER MARKETPLACE, INC VS. CARR, CHRISTOPHER
Case filed 4/01/08.
Proof of service filed 7/07/08.
Court entered judgement against Carr for PRINCIPAL $ 13478.11 . ATTORNEY FEES $00.00 . INTEREST $ 2692.39 . COSTS $ 350.00 . TOTAL $16,520.50 .
Writ of execution issued to Los Angeles County on behalf of Prosper 9/12/08. (Legal thing telling law enforcement that you can take assets.) Prosper won!

Case Number: 08C01456
PROSPER MARKETPLACE VS. WOKE, CHINYERE
Case filed 4/01/08.
Proof of service filed 10/7/08.
In process.

Case Number: 08C01458
PROSPER MARKETPLACE VS. DELGADO, CARLOS
Case filed 4/01/08.
Proof of service filed 5/19/08.
The court clerk rejected prosper's paperwork on 9/08/08. The clerk's writing is terse, and best I can figure it seems that he believes that prosper filled out the paperwork wrong, asking for more interest than they were due.
The court clerk again rejected prosper's paperwork on 10/30/08, this time he seems to be complainng that some declaration was missing.
In process.

Case Number: 08C01457
PROSPER MARKETPLACE VS. DAVIS, DIANA
Case filed 4/01/08.
Proof of service filed 7/02/08.
Prosper asked for default judgement on 8/11/08.
Court clerk rejected prosper's paperwork on 9/08/08, complaining about wrong interest rate.
Prosper filed again on 10/01/08.
Status conference 10/06/08, continued to 4/14/09. I don't quite understand that, but there are no details available.
In process (I think).

Orange County Court
30-2008-00065226-CL-CL-NJC PROSPER MARKETPLACE, INC. vs Mario Villanueva
Case filed 4/24/08.
Prosper filed proof of service of summons on 7/29/08.
Prosper requested dismissal of the case on 8/12/08.
Case dismissed 8/12/08. Prosper lost.

30-2008-00058684-CL-CL-HLH PROSPER MARKETPLACE, INC. vs Brandi Fitzgerald
Case filed 04/01/08.
No proof of service yet. If they haven't been able to serve the summons in 7 months, that's lookin' bad. Means they can't find the person. In process, but lookin' bad.

30-2008-00058438-CL-CL-NJC PROSPER MARKETPLACE, INC. vs Josephine Sharaba
Case filed 4/01/08.
No proof of service yet.
In process, but lookin' bad.

30-2008-00058436-CL-CL-NJC PROSPER MARKETPLACE, INC. vs Jermaine Massey
Case filed 4/01/08.
Summons served and proof of service filed 7/11/08.
Prosper requested default judgement on 8/12/08.
Court clerk rejected Prosper's paperwork on 8/19/08. Didn't give a reason.
In process.

30-2008-00058426-CL-CL-HLH PROSPER MARKETPLACE INC vs Teresita Spreen
Case filed 4/01/08.
No proof of service yet.
In process, but lookin' bad.

30-2008-00050023-CL-CL-NJC PROSPER MARKETPLACE, INC. vs Karen Rozier
Case filed 2/26/08.
Prosper filed proof of service "substitute" on 5/6/08. I don't know what that is.
Karen Rozier filed requests for waiver of fees and an answer to complaint on 5/14/08.
Prosper filed proof of service on 5/27/08.
In process.

So here are the totals, interpreting the facts that have been made public, of the cases that are easily visible:

Prosper won: 1 case
In process: 8 cases
In process, but lookin' bad: 3 cases
Prosper lost: 6 cases

Now it is entirely possible some of those "case dismissed" are not actually losses, but cases where the borrower coughed up money and got prosper to drop the case. However note that none of them say they were "settled". They just say "dismissed". It is just as likely that these are cases where Prosper discovered they were going after the wrong person, perhaps discovering that there was identity theft involved. Lenders have great interest in the possibility of identity theft, because Prosper has guaranteed our investments against identity theft, and in such cases, must pay off. Note that in several cases Prosper has been unable to serve summons. In other words they couldn't find the borrower to hand him a summons. Might mean that the borrower skipped town, but it might also indicate identity theft. We just don't know.

We just don't know, because Prosper has not made any of this transparent .

Not only has Prosper not told us investors/lenders the status or given us any information about these cases. Nine months after promising lenders a monthly financial accounting for these cases, it has delivered none.

I propose a more communicative approach. Prosper should keep Investors/lenders appraised of the status of their investments, and the actions prosper is taking on investors/lenders behalf.

The best discussion among prosper lenders is found at www.prospers.org . See you there.

Prosper.com - 10/15/08 late loan stats update

Here's the october 15th, 2008 update to to my Prosper.com late loan statistics charts.

These charts show statistics for the performance of all prosper.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Prosper.com's performance web page.

A larger, more readable version of that chart can be found here

Here's a chart of the same data in which each curve has been slid to the left to a common origin. The horizontal axis is now days since loan origination month.

Explanation of methodology can be found in my prior postings in this blog.

These curves show loans that are >1 month late, however, you can read them as "default curves" because almost all Prosper.com loans that go 1 month late move on to default. See my discussion of Prosper's collections performance in earlier blog entries.

We continue to see horribly misleading newspaper and magazine articles saying that the default rate on Prosper loans is 3% or 4% or something like that. Investors can only make reasonable investment decisions after understanding the default behavior of Prosper.com loans. Prosper loans default at about 20% per year. You can clearly see this from the charts. Pick your favorite month. Look how high the curve has gone after the first year. About 20%, eh? Prosper loans default at about 20% per year, on the average, considering all Prosper loans. There is considerable variation from month to month. Look at the final chart, where the curves are slid to a common origin. Just look at the vertical line labelled 390 days. (That's 30 days after 360 days, because loan payments can't be 1 month late until you wait 30 days after.) You will see curves cross that line anywhere from 18% to 26%. (Some of the more recent months look like they will come in a little lower.) That's how many loans went bad in the first year. Pretty simple really. Journalists seem to get it wrong time after time. Somebody must be feedin' them bad info, eh? Perhaps they just copy bad data from each other .

At the time of this writing, prosper.com has shut down due to some not fully specified regulatory problem. Meanwhile, the ongoing loans still evolve, and the data is still available, so I will continue to update this charts .

PS: The best discussion among Prosper.com lenders can be found at http://prospers.org/

Prosper.com - You got some 'splainin' to do

Be careful what you say to the judge. It can get you into lots of trouble.

On July 25, 2007, prosper.com issued a loan to "Oakland Gaerke" for $25,000. (We know this from public bankrutpcy court records.) A couple of payments were made, but then payments stopped, and the loan is now long overdue (by something like 9 months).

Six months later, on Jan 23, 2008 Mr. Gaerke entered a chapter 13 bankruptcy proceeding in the Northern district of Ohio bankruptcy court. As part of that proceeding he filed complaints with the court claiming identity theft. (Gaerke's amended complaint of Apr 29, 2008.) He says his wife "Ashley Gaerke" took out the prosper loan (as well as a lot of other credit) without his knowledge. He says he's not responsible for these loans, and he wants the court to let him off the hook. (He wants the court to tell Prosper.com to go pound sand.) There's also a divorce in process. In short, this is now a complex mess.

Whether this is or is not identity theft is of great interest to prosper's lenders, because of prosper's identity theft guarantee. Prosper guarantees that it will repurchase loans from lenders in cases of verified identity theft. If this is identity theft, then lenders must be made whole. If this is not identity theft, then maybe lenders get nothing.

Prosper essentially stopped buying back such loans about a year ago. Lenders wonder whether there has magically been no identity theft in the past year, or the cases are simply hidden in the obscurity of non-public facts and ignored by prosper. There are very few cases where the facts become public. This is a case where facts are public, so lenders are watching closely.

I don't know whether identity theft occurred or not. I wasn't there. I don't know who's telling the truth. However I do want to delve into one small aspect of this mess: How prosper has chosen to respond.

As part of Mr. Gaerke's claim that the Prosper loan was identity theft, he says that Prosper never contacted him, and never verified his identity prior to originating the loan. I would have expected Prosper to defend itself against this charge, producing or at least offering to produce records showing how and when the fellow was contacted and his identity verified prior to loan origination. This verification is Prosper's duty, so I figured maybe they kept records, and could produce them. Maybe sworn statements from the verifier person, or recordings of phone calls. They didn't produce any of these things. Here's what they did...

Prosper chose to deny that Prosper ever made a loan!

Prosper's answer was filed with the court on May 30, 2008, by Prosper's lawyers Patricia Fugee and Gregory Nuti. The meat of the document says:

Loans in a total amount of $25,000.00 were extended to the Plaintiff by individual bidders using Prosper’s website (“Lenders”) and the funds were disbursed to the Plaintiff by Prosper through direct deposit to the joint checking account of Defendant, Ashley Gaerke, and the Plaintiff. Prosper acted as the Plaintiff’s authorized agent to procure loans in the total amount of $25,000.00 from various Lenders on behalf of the Plaintiff.

By way of further answer, it is denied that Prosper loaned any money directly to the Plaintiff or Defendant, Ashley Gaerke.

They're claiming that Prosper never loaned money to Gaerke! They're claiming that the Prosper members who bid on the loan (those folks Prosper calls "lenders") actually loaned the money to Gaerke, and Prosper only acted as an agent to procure these loans from "lenders". In other words, they're effectively saying to the judge, "Hey, this guy has named the wrong defendant in this action. We're not the right guys. This guy should have named the 50 lenders as defendants, not poor little us. We're just the middleman."

I guess you'd call that a "technical defense". Lawyer's soft shoe. Instead of engaging on the issues, you find some techncal point that the plaintiff got wrong, like "He hasn't proved that I'm the guy who should answer for that." There are several problems with this position that Prosper thru its lawyers Patricia Fugee and Gregory Nuti have taken. The most blatant problem is that it isn't true. This position is the exact opposite of rather clear language in written legal agreements between Prosper and its lender members.

Lets examine some of those legal agreements, so we'll know how Prosper actually works. We can then compare that with Fugee and Nuti's statement above.

The most important agreement is called the Lender Registration Agreement (LRA). It defines how Prosper's "lender" members and Prosper interact, and each parties roles. Prosper has changed this agreement many times, but with a little digging, I believe I've found the version of the agreement that was in use mid-2007.

We don't have to look far to find wha the LRA has to say about this issue. It is so important that it is discussed in the very first paragraph at the top of page 1.

Note: Your role as a Prosper "lender" is that of a loan purchaser, and your rights and obligations as a purchaser or prospective purchaser of Prosper loans are set forth below. Although you are referred to in this Agreement and on the Prosper website as a "lender," you are not actually lending your money directly to Prosper borrowers, but are, instead, purchasing loans from Prosper.

Well that's pretty darn clear. Prosper "lender" members buy the loans. We don't lend the money to the borrower directly. Us "lenders" just purchase them. In case there's any ambiguity, they go on and explain who does the lending, and who sells the loans to us.

All loans originated through Prosper are made by Prosper Marketplace, Inc. from its own funds, and then sold by Prosper to the winning bidder or bidders on the listing.

Explicit. Prosper makes the loans from its own funds, then sells 'em to us. If that weren't explicit enough, they go on to tell us why it is done this way.

Prosper is the originating lender for licensing and regulatory reasons and is licensed in all states where licensing is required. Prosper uses the term "lender" instead of "loan purchaser" for the sake of brevity and simplicity, and for the convenience of Prosper users who appropriately view Prosper as a marketplace for connecting individuals who wish to borrow money, with people who have money and the desire to fund loans to other individuals.

Ok, so not only is it done this way, but it has to be done this way, because of lending regulations. It couldn't get much clearer than this.

The next agreement of interest is the "promissory note". Several of these are drafted for every loan that Prosper makes. One contains the name of each "lender" member. Prosper also changes the form of these documents from time to time, so I examined one from mid-2007. The first three llines of the document tell the story. Prosper writes:

Promissory Note
Borrower: xxxxxxx (Real name and address not displayed)
Lender: Prosper Marketplace, Inc. (Assigned to: xxxxxxx)

The Promissory note clearly identifies "Prosper Marketplace" as the lender, and goes on to say that the note has been assigned (ie sold) to the lender member. (I've x'd out the names of the actual borrower and lender members.) Prosper has issued many thousands of these documents, and they all identify Prosper Marketplace as the lender. This could not be more clear.

With these facts clear, how can it be that Prosper's lawyers have told the court the exact opposite?

If Prosper's statement to the court is truthful, then Prosper loans would appear to be in violation of various lending regulations, and Prosper would have acted in violation of its legal agreement with its "lender" members. If on the other hand, Prosper's statement to the court is not truthful, then ... What's that word for when you lie to the judge?

In summary (and with apologies to Ricky Ricardo) :
Prosper, you got some 'splainin' to do!

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Reference materials:
Documents that were filed with the bankruptcy court are available to the public via www.pacer.gov I have copied here a few documents relevant to this discussion for your convenience..

Mr Gaerke's amended complaint
Prosper's response to Gaerke's amended complaint
Ms Gaerke's response to Gaerke's amended complaint
Prosper LRA, circa mid-2007

Prosper also filed an 'S1' with the Securities and Exchange commission on Oct 1, 2007, disclosing the Prosper loan process in great detail. I haven't quoted it here, but on the matter at hand it is consistent with the LRA. You can find the Prosper 'S1' at www.sec.gov .

Notes:
I have avoided mentioning the Prosper listing# or loan# or the borrower's Prosper screen name here, to comply with Prosper's wishes that borrower's screen names remain anonymous, in other words not be associated with the borrower's name.

PS: I don't take credit for finding this. I learned about it in an active online discussion about this loan among prosper lenders .

Prosper.com - lender statements now 7 months late

In early 2008, $735,000 of late prosper loans disappeared from lender's statements. On 01/15/08, prosper promised monthly "supplementary statements" to lenders covering these loans. Hasn't happened. No statements have been produced. By my count, Prosper.com is now 7 months late on delivery of these statements to lenders, on the status of OUR loans.

This is simply one example of a much larger problem. Prosper management refuses to accept their responsibility to lenders. Once loans go late, they don't lift a finger. In this case, that includes not even telling lenders the status of collection efforts on these loans.

Shame. Over and over again. Shame.

For a more detailed explanation, see http://www.prospers.org/blogs/Fred93/2008/08/03/prosper_com_lender_statements_6_months_l

Prosper told us they would take legal action against the 68 late borrowers in this "legal test" group of loans. Today, eight months after they started the "legal test", many of the defendants have not even been served (with legal papers initiating a suit). We can tell that by observing the county court web sites, some of which display this information. Judging from the filings we can observe, it looks like about half of the suits haven't been served yet, eight months after the program began. You could never tell this by looking at statements provided by prosper, of course, because there are no statements, even tho they promised them! There aren't even excuses!

Shame. What a way to run a company.

Where do they get the chutzpah to act this way?

PS: The best discussion among Prosper.com lenders can be found at http://prospers.org

Prosper.com - lender statements 6 months late

Supplemental statements tracking $735,000 of loans were promised monthly, and are now 6 months overdue.

On 01/15/2008, Prosper.com sent an email message to many lenders, explaining that 68 very late loans were being moved to a new category, a "legal test". In this test, Prosper would try taking legal action against very late borrowers, instead of just doing nothing. I thought at the time that it was a good move.

Prosper's 01/15/2008 email promised ...

Since this is a test, we have not yet designed the system to track these revenues within the normal statement process. As such, the loans will be defaulted at zero value and the accounting provided on a monthly basis in a supplementary statement.

However, Prosper has never bothered to send lenders any of these promised supplemental statements! $735,000 of loans have simply disappeared from lender's view.

That's right. No statements. No reporting. Prosper has kept lenders completely in the dark on the status of these loans. I figure January's promise of monthly statements should have produced one in February, and another in March, April, May, June, and July. That makes them now 6 months late.

Fact is, with great effort lenders can track the status of some of these lawsuits. This happens because many courts make some lawsuit status details public via their web sites. (Not all courts make status available online, so we can't see the status of all of them, without travelling around to the various county courts, and checking the records manually.) The visible status isn't pretty. Most of the suits weren't filed until April. Four months later, many of these suits have not even been served against the borrowers. Among the suits that have been served, it appears that none has yet come to trial.

It looks like the entire legal test has been horribly underfunded by Prosper. Now seems more likely that it will be aborted rather than serve as a symbol of Prosper's strength and a deterrent to deadbeat borrowers.

PS: The best discussion among Prosper.com lenders can be found at
http://prospers.org

Prosper.com - 08/01/08 late loan stats update

Here's the August 1st update to to my Prosper.com late loan statistics charts.

These charts show statistics for the performance of all prosper.com loans. Each curve represents the set of loans that were created in one calendar month. The vertical axis is the fraction of those loans that have "gone bad", in other words are 1 month late or worse (up to and including default). The horizontal axis is the observation date. All data comes from Prosper.com's performance web page.

A larger, more readable version of that chart can be found here

Here's a chart of the same data in which each curve has been slid to the left to a common origin. The horizontal axis is now days since loan origination month.

Explanation of methodology can be found in my prior postings in this blog.

These curves show loans that are >1 month late, however, you can read them as "default curves" because almost all Prosper.com loans that go 1 month late move on to default. See my discussion of Prosper's collections performance in earlier blog entries.

PS: The best discussion among Prosper.com lenders can be found at http://prospers.org/

Prosper.com - collections - you have forsaken lenders

Collections on late prosper.com loans are getting worse. Prosper simply doesn't take their responsibility to lenders seriously. Along the way there have been words from Prosper saying they were going to improve this or that, but they've all been hollow. Ding ding .. nobody's home.

Here's the latest data on collections performance, direct from prosper.com. Most late Prosper loans are sent to the collection agency Amsher. To keep things simple, I've graphed only Amsher's performance here. I've shown the fraction of loans sent to Amsher that have been cured. These numbers come directly from Prosper's web site, with no manipulation whatsoever. Prosper breaks this statistic down into three categories, according to credit grade, and that's what you see in the graph.

Prosper switched to Amsher, and dumped a bunch of loans on them, on 2/23/08, so of course the fraction of those loans that Amsher had cured on that date was zero. It took a couple of months for the stats to recover from that initial impulse, and to climb the learning curve, in other words learning how to collect Prosper loans. Well, according to this data, the honymoon is over. Since 6/1/08 Amsher's stats have been going down.

It wouldn't be so bad if there had ever been any good performance here, but Amsher never did anything good (according to the stats Prosper.com has published).

In fact, according to Prosper's stats, Amsher has never done as good as Penncro, the collection agency it replaced. Now how the heck can that be? In some of my earlier posts on this subject I've included a graph showing combined Penncro+Amsher performance. This is the all-time performance of loans worked on by either or both. This representation eliminates the startup impulse problem in the above graph. However, it involves some manipulation of the data, which confuses some folk. Here's an update on that graph:

This curve changes from blue to red when the handoff from Penncro to Amsher occurred. As you can see, Penncro got up to over 17% cured, and Amsher has been mostly downhill from there. As the number of loans handled by Amsher has increased, their lower cure rate has started really pulling down the combined curve. The explanation of how the data is combined can be found here.

How (expletive deleted) could things be this bad? Prosper management has made comments over the past few months about how collection statistics are improving. The stats Prosper.com gives us, on the other hand, are getting worse. What's the deal?

I put this question to Prosper management in mid-June. They said they'd have to look into the numbers and get back to me. I'm sure they ment to do just that, but no answers have been forthcoming. Perhaps higher priorities intervened. Ain't it always the way.

One possibility is that the numbers Prosper displays on the web site may be faulty. It wouldn't be the first time. Prosper used to display a statistic they called "net collected". There's still a row with this label on the web site, but they no longer fill in the numbers. I used to graph this statistic vs time, and as a result, I knew it was ... well ... I suppose the polite word is "bogus". This was discussed at length in the old prosper.com forum. Here's a chart I made about a year ago:

The red curve jerked up and down faster than was physically possible. From that I knew it was bogus. Prosper never did admit there was a problem. They just deleted the statistic from their web site. Well maybe that is an admission.

With that precedent in mind, is it possible that the collection statistics they provide for us now are just wrong? I don't know. I look forward to some feedback from inside Prosper.

If the numbers correctly reflect collection activity, then how the hell could it be that they are so horrible? When a loan goes 1 month late, I'd expect it to recover a significant fraction of the time. Amsher's 6% is not my idea of a significant fraction of the time. In fact, I'd expect more than 6% of 1-month-late loans to recover all by themselves, without any collection activity at all.

Something is horribly wrong.

Nobody seems to be doing anything about it. Seems like nobody cares.

Prosper, you have forsaken us (lenders).

See my prior writings on this subject, including:
Written 05/06/07: Collections is broken
Written 05/04/08: Collections is not improving

Update 08/08/2008: Just got a note from Prosper saying they have found and corrected a major bug in the way they were calculating the collection statistics they present on the web site, and believe that there is an additional problem, for which they are continuing to search. So... It looks like the data they were giving us was indeed faulty.