Prosper.com - SEC Offer of Settlement

Back on 11/24/08 the Securities and Exchange Commission issued a Cease & Desist order which told us that Prosper.com had violated the securities act. That SEC order mentioned that the SEC had accepted Prosper's "offer of settlement", but the offer was not made pubic at that time. Prosper's offer has now been released by the SEC, and we bring it to you here and now.

I've transcribed Prosper's offer letter below, and provided a link to a scanned version. The transcribed text differs in formatting, but is identical in word.

---

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION

ADMINISTRATIVE PROCEEDING
File No.
In the Matter of
Prosper Marketplace, Inc.
Respondent.

OFFER OF SETTLEMENT
OF PROSPER MARKETPLACE, INC.

I. Prosper Marketplace, Inc. ("Prosper" or "Respondent"), pursuant to Rule 240(a) of the Rules of Practice of the Securities and Exchange Commission ("Commission") [17 C.F.R. § 201.240(a)], submits this Offer of Settlement ("Offer") in anticipation of cease-and-desist proceedings to be instituted against it by the Commission, pursuant to Section 8A of the Securities Act of 1933 ("Securities Act").

II. This Offer is submitted solely for the purpose of settling these proceedings, with the express understanding that it will not be used in any way in these or any other proceedings, unless the Offer is accepted by the Commission. If the Offer is not accepted by the Commission, the Offer is withdrawn without prejudice to the Respondent and shall not become a part of the record in these or any other proceedings, except for the waiver expressed in Section IV with respect to Rule 240(c)(5) of the Commission's Rules of Practice [17 C.F.R. § 201.240(c)(5)].

III. On the basis of the foregoing, the Respondent hereby:

A. Admits the jurisdiction of the Commission over it and over the matters set forth in the Order Instituting Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing a Cease-and-Desist Order ("Order").

B. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. § 201.100 et seq., and without admitting or denying the findings contained in that Order, except as to the Commission's jurisdiction over Prosper and the subject matter of these proceedings, which are admitted, Prosper consents to the entry of an Order by the Commission containing the following findings:

1. that Prosper violated Sections 5(a) and (c) of the Securities Act; and

2. ordering that, pursuant to Section 8A of the Securities Act, Prosper cease and desist from committing or causing any violations of, and committing or causing any future violations of, Sections 5(a) and (c) of the Securities Act.

IV. By submitting this Offer, Respondent hereby acknowledges its waiver of those rights specified in Rules 240(c)(4) and (5) [17 C.F.R. § 240(c)(4) and (5)] of the Commission's Rules of Practice. respondent also hereby waives service of the Order.

V. Respondent understands and agrees to comply with the Commission's policy "not to permit a defendant or respondent to consent to a judgment or order that imposes a sanction while denying the allegations in the complaint or order for proceedings" (17 C.F.R. § 202.5(e)). In compliance with this policy, Respondent agrees: (i) not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any finding in the Order or creating the impression that the Order is without factual basis; and (ii) that upon the filing of this Offer of Settlement, Respondent hereby withdraws any papers previously filed in this proceeding to the extent that they deny, directly or indirectly, any finding in the Order. If Respondent breaches this agreement, the Division of Enforcement may petition the Commission to vacate the Order and restore this proceeding to its active docket. Nothing in this provision affects Respondent's: (i) testimonial obligations; or (ii) right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party.

VI. Consistent with the provisions of 17 C.F.R. § 202.5(f), Respondent waives any claim of Double Jeopardy based upon the settlement of this proceeding, including the imposition of any remedy or civil penalty herein.

VII. Respondent hereby waives any rights under the Equal Access to Justice Act, the Small Business Regulatory Enforcement Fairness Act of 1996, or any other provision of the law to seek from the United States, or any agency, or any official of the United States acting in his or her official capacity, directly or indirectly, reimbursement of attorney's fees or other fees, expenses, or costs expended by Respondent to defend against this action. For these purposes, Respondent agrees that Respondent is not the prevailing party in this action since the parties have reached a good faith settlement.

VIII. Prosper states that it has read and understands the foregoing Offer, that this Offer is made voluntarily, and that no promises, offers, threats, or inducements of any kind or nature whatsoever have been made by the Commission or any member, officer, employee, agent, or representative of the Commission in consideration of this Offer or otherwise to induce it to submit to this Offer.

10th day of November {2008}
Prosper Marketplace Inc
By: {signature}
Print Name: Christian A. Larsen
Title: CEO & Chairman

---

Here's a scanned version of Prosper's Offer of Settlement.

Doesn't make for very exciting reading, does it?

When I read the SEC Cease & Desist order, and saw that it said the SEC had accepted Prosper's offer of settlement, I wondered whether the offer (and therefore the acceptance by the SEC) had contained some elements not found in the SEC's public Cease & Desist order. For example I wondered whether Prosper had agreed to any specific actions that had not been made public. Turns out, there aren't any such agreements in the offer. Most of the words in the offer simply say that if the SEC agrees to end the matter by issuing the Cease & Desist, then Prosper won't argue about it. It looks to be all boilerplate. Its like something from a sci fi horror flick: Sign here so the shock treatments can begin. Then we can set you free.

Thank you to the SEC for releasing this document to the public.

For those of you who have read the above and are completely baffled, be advised that the SEC Cease & Desist order makes much better reading. It actually sets the stage by explaining the context of the SEC's action.

The best discussion among peer-to-peer lenders takes place at prospers.org
See you there!

Prosper.com - one of your loans was charged off

It is so sad. Day after day, lenders see loan after loan go in the toilet. "Charged off" in prosper lingo. Here's my Prosper.com in-box...



I've written extensively about the lack of moxy in Prosper's collections department. (and that's the most polite way I can say it) In May 2007 I wrote an open letter to Prosper.com .

May 2007 - collections is broken

A year later I wrote another appeal to prosper to get their collections act together.

May 2008 - here's what you should do with the lawyers

They never listen.

They never respond, except to say "One of your loans was charged off".

PS: The best discussion among P2P lenders occurs on prospers.org

lendingclub - 02/01/09 late loan stats update

These charts show statistics for the performance of all Lendingclub.com loans. (If you were looking for prosper.com stats, find them here.)

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 really good stats.

Something odd is happening in the last month. Looks like lendingclub must have goosed up their collections activity. Bravo!

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.

The best discussion among P2P lenders occurs at www.prospers.org. See you there!

Prosper.com - 02/01/09 late loan stats update

Here's the February 1, 2009 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.

Click on the chart to see a larger clearer version.

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

I attempted to update my lendingclub late loan charts this month, but the stats page on the lendingclub web site is displaying bad data. They promise to fix it soon.

The best discussion among prosper.com lenders takes place on prospers.org.

Prosper.com - best architecture part two

In the last episode, I told you about the building containing Prosper.com's offices. We will now give you the details.

"The only building in San Francisco with both Romanesque and French Chateau ornamentation." Yea yea. Lets go look up close.

I walk down the south side of Sutter Street, lookin' for Prosper headquarters, 111 Sutter, also known as the Hunter-Dulin building. Suddenly I'm confronted by a bare breasted woman giving me the finger.

Those of you familiar with San Francisco will know that this sort of thing is not particularly unusual. Those stories about San Fran are all true. But this woman isn't just stoned. She is cast in stone.

Can you imagine erecting an office building today festooned with scupture of naked women? In the 20's there was a different style.


Hey, this could be our building.



Here's an address. Yea. This is the place.

Dig those columns! Carved columns and naked ladies. That's what they mean by romanesque!

Let your eye follow those columns up, and you see (photo credit: Flickr/frankfarm)...

Those gargoyles looking down at you are alternating birds and lion heads. They don't make 'em like this any more.

Looking down again, we see the main entrance. That's a sculpture of Mercury in the middle. Outstanding!

Go thru those doors now, and step into the lobby.

Not like any office building I ever worked in. Look at that ceiling! Hand painted. That's just incredible.

Don't linger too long. There are some security folks behind you. They don't yet know we're up to no good. They seem like very nice people. Smile.

Now walk past 'em like you know where you're goin'. We gotta check the building directory.

Yea. There it is. Prosper, on the 22nd floor. Lift the collar of your trenchcoat. We're goin' stealthy. Quickly now, into the elevator. As we enter the elevator, look down.

That brass floor inlay has been there 82 years now. The guts of the elevator system was replaced during the 2002 remodel, but some parts of the original elevator cars remain. Those fuzzy words in the center say "The Hunter Dulin Building". Hunter, Dulin & Company was a west coast investment bank who had this building built. I've failed to trace their history past 1928, but it isn't too hard to imagine what happened to investment banks during the great depression that followed soon after the Hunter Dulin Building was finished.

Don't push the 22 just yet. We're gonna pay a short visit to the 5th floor..

111 Sutter was the (story) location of Sam Spade's office in The Maltese Falcon. As we exit the elevator, we find Spade (Humphrey Bogart) hard at work in conference with some dame. That's San Francisco's Bay Bridge in the window. The bridge is somewhat out of scale. Hollywood took dramatic license to make the bridge look like it is right next door. In the real world, its 1 mile away. Today the view is obscured by a giant skyscraper some fool built (in 1964) just to the East of 111 Sutter.

Sam Spade is not the only famous resident of 111 Sutter. In 1948 Jay Ward, who would later create Rocky & Bullwinkle, rented an office at 111 Sutter, where he created, and sold to NBC-TV, a character known as Crusader Rabbit.

I haven't found any physical evidence of Ward's time here anywhere in the building. Seems a shame. Rocky and Bullwinkle are important cultural icons, but they're enshrined in Los Angeles, so lets move on. Back on the elevator. Next stop, 22nd floor.

Did I mention that the elevator is haunted?

Oh, and I've managed to obtain a floor plan of the 22nd floor. Should help us navigate the Prosper offices.

Darn. Right floor, but the plan seems to be from a prior occupant.

The 22nd floor of 111 Sutter was the West Coast headquarters for NBC from 1927 thru 1943. NBC occupied the entire 22nd floor, just as Prosper does now. They had studios, offices, the electronics that amplified the audio and piped it all over the west coast thru phone wires. This was the place that the famous NBC chime sound originated. Note the "pipe organ loft". Not every office building has one of those.

In 1927, electronics was a little bigger than today. Even tho there was no radio transmitter at this site, the generator controls, DC power supplies, and audio amplifiers looked pretty impressive. This is the master control room at the upper right of the floor plan.

Generator controls in the back. DC power supply controls on your right. Audio equipment on your left. Prosper employees today occupy this very same space.

They must have had a great view of the Bay Bridge construction from here. The Bay Bridge was built between 1933 and 1936.

Here's studio A, with the 1941 NBC staff assembled for a group photo. Note that there's a mezzanine above the 22nd floor. I don't know what has become of that space. Catch the fancy inlaid wood balcony!

There's a lot more, but our elevator has arrived, and we step into the present-day 22nd floor elevator lobby.

Its kind of a letdown, isn't it? We can peer thru that little glass window in the door and see the reception lobby of Prosper.com

Doesn't seem to be anyone here to greet us. Hanging above you see a banner from the first ProsperDays convention in 2007 with signatures of attendees. Maybe they just don't notice us. Lets continue our stealth. Open the door and walk on in. Ah, the people are thru that door on the right.

Still nobody notices us. Its just as well. We sneak up behind this CBS news guy while Chris Larsen (CEO of Prosper.com) gives an interview. Notice that the environment is far less exotic here than the lobby. The exterior and the lobby are from a different world. In here its regular ol' office space, and it seems that Prosper has been pretty frugal with the furnishings. (No oil paintings on the walls, no books in the single bookcase.) Over the years this space has been remodeled many times. I can't help wishing that they could have at least left the balcony and the pipe organ.

Around the corner we can sneak into Prosper's executive offices. Ought to be some good stuff here.

Goldmine! On the whiteboard you can see Prosper's plans for new features. One feature described here looks like it will save lenders the need to wait 3 years to find out if their borrowers are going to pay them back. After the lender wins a participating position in a loan, three windows appear on his screen. They whirr around, and then a picture of a different fruit is displayed in each window. Its implementation quite complex, but the design is right there on the board.

Its getting late in the day, and there's so much more I want to see. I looped around the floor several times, but haven't found any area labelled "collections department". I did want to talk with those folks. Maybe next time.

I do see what could be a door leading to a roof hatch. Unfortunately, this familiar lookin' guy is hangin' around the area, and we have to wait awhile for him to leave. Wouldn't want to give ourselves away.

Finally he leaves, and we go thru the door and climb out onto the roof. It is amazing that we got this far. The security guard is strangely absent during our visit.

That amazing thing in the center is one of the 20 copper spires that adorn the roof of 111 Sutter. They were part of the original design, and can be seen in photographs taken in the 30's, but sometime during the 50's they disappeared. During renovation in 2001, the original plans for the spires were found in the basement, and they were recreated and installed. These contraptions and the leftover wiring from NBC's studios create the ectoplasmic resonance that will bring back Gozer the Destroyer. Just you wait and see.

One more picture. Don't look while I climb out to get this, and whatever you do, don't look down.

There's a lot more material on the Hunter Dulin building available on the web. Google is your friend.

By the way, I just noticed that on 01/16/2009 Prosper filed another amended S1 with the Securities and Exchange Commission. This is the first amendment of the complete rewrite. That probably means approval is close at hand. Folks don't usually file amendments unless they are responsive to SEC comments, and thus likely to result in approval.

PS: For photo credits, click on the photos. Some photographs may not depict current events. Nothing in this article is intended as an offer to buy or sell securities. Your investments may lose value. This blog is not FDIC insured. No animals were harmed during the writing of this blog. And finally, don't believe everything you read on the internet.

Prosper.com - the best architecture

As prosper.com passes 90 days of "quiet period", I thought it was a good time to compare Prosper's innovative architecture with the competition. That's the famous Ghostbusters building on the left, where Sigourney Weaver helped Gozer the Destroyer visit Earth. The building on the right contains Prosper.com headquarters, where... Lets just say I'm developing a theory.

Thus begins the study of comparative modern gothic horrors.


These buildings look a lot alike, at least from a distance. Similar construction, color, height, age. Each is square until about floor 15 where some sort of Art Deco thing begins to happen. The architectural detail, however, is entirely different.

The ghostbusters building, 55 Central Park West, New York, was built in 1929. It is famous, thanks to the movie and the famous real people who live there. But it is ugly and flat when viewed close up. At street level it looks like an old warehouse. Looking up you see what appear to be air conditioners hanging out of windows. New Yorker's pardon me... Its a dump.

The Hunter-Dulin building, 111 Sutter St, San Francisco, was built in 1927. It is a gothic palace with beautiful and amazing architectural detail. The books all say "It is San Francisco's only building with Romanesque and French Chateau ornamentation." I didn't know what that meant either, but I do now, and I'm gonna show you.

Oh, and it is home to Prosper.com . And Prosper's not just on just any floor. They're on the top floor. The famous top floor. Just below 20 gothic spires tuned to the fifth resonance of the ectoplasmic membrane. (You can see two of 'em in the picture above.) But I digress.

In a future installment, we'll go inside 111 Sutter for a behind-the-scenes tour. You'll meet some of the inhabitants, learn what really goes on there, and why Gozer picked the wrong building.

I'm gonna take you right up to the top floor where Prosper.com lives. We might even venture onto the roof, if the guard's not lookin'. Stay tuned .

PS: For photo credits, click on the photos.

Prosper.com - 01/01/09 late loan stats update

Here's the January 1, 2009 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.

Click on the chart to see a larger clearer version.

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

While the press bemoans the credit crisis, there is no such event visible in this data. There's simply nothing special about the last few months. Prosper.com loans continue to go bad at about the same rate as in earlier months. "Credit crisis" is no excuse. These loans simply form a very low quality portfolio, going bad at around 20% per year.

Loans originated after late 2007 look a little better, because Prosper raised the credit score cutoff, chopping off the worst borrowers, and thereby raising the average quality of the portfolio.

Meanwhile, there has been no improvement Prosper.com's collections activities. This appears to be a competely dead area, with no effort being expended on lender's behalf. In fact, Prosper has removed the collection statistics of their main collection agency Amsher from the Prosper web site. Lenders can no longer directly observe how bad collections are.

I'm sorry to notice that Prosper has removed the ROI calculation from their performance stats web page. Unfortunate, because it was the best ROI calculation around for these loans. It actually used the cash flows, instead of doing a hack calculation using "average loan age" as the 3rd party web sites do. My guess is that Prosper's damn lawyers once again advised them to provide even less service to their customer base (of lenders). Its a shame.

The best discussion among prosper.com lenders takes place on prospers.org.

Prosper.com - new prospectus good, but...

The new prospectus that prosper.com filed with the SEC recently (12/5/08) will be approved. It is well written and covers all the bases. The only thing that will hold it up is the ordinary inclination of any regulator to look very very carefully at anything that follows a legal brouhaha.

As I predicted, they dumped the lawyers who wrote the first prospectus a year ago. The new prospectus is authored by a completely new legal team.

As I predicted, they've adoped a business model where the instruments sold to investors are obligations of prosper itself, ie derivatives whose payments are based on the payments (or lack thereof) on the underlying consumer loan. In other words, they copied Lendingclub.

The new prospectus is very thorough. Because the new instruments will be obligations of Prosper, all Prosper's financial detail is in the prospectus. Exactly the same stuff you'd see in a prospectus for a company that was issuing an IPO of common stock. How much cash they have, how fast they're burnin' it, salaries... a voyeur's paradise.

By the way, the filing is actually 6 documents. Serious investors should try to read at least the first two of these. Won't be easy. Nearly 4 megabytes of text here.

1. The Prospectus (S1)
   
2. The Indenture
   
3. Borrower Registration Agreement
   
4. Lender Registration Agreement
   
5. WebBank/Prosper Loan Account Agreement
   
6. WebBank/Prosper Loan Sale Agreement
   

I know you're probably thinkin' hey some of that stuff used to just be on the web site. Now its part of a prospectus? Exactly. We're moving into the regulated world. Prosper's statements about these investments are now cast in concrete (in the SEC's vault), instead of appearing only in fluid web documents changable at a whim, tracked only by a few lenders who frantically archived copies as unannounced changes whizzed by. Sometimes regulation is a good thing.

While this new prospectus probably satisfies all the SEC issues, it does damn little for lenders. The fundamental problems remain. I'll give you a few examples.

We all know that Prosper's lame efforts at collections are a very serious problem. I described it as a symptom of the more general "principal/agent" problem in my ancient open letter to prosper. Have they made any effort to do something about this? No. In fact, they have instead institutionalized the idea that doing almost nothing is ok, by explicitly saying in the S1 that they will do almost nothing!

We are obligated to use commercially reasonable efforts to service and collect the borrower loans, in good faith, accurately and in accordance with industry standards customary for servicing loans such as the borrower loans.

"We are obligated" .. I like that start. But what are those "commercially reasonable efforts" exactly? Don't have to wonder long. They define it pronto.

If we refer a delinquent borrower loan to a collection agency on or after the 31st day of its delinquency, that referral shall be deemed to constitute commercially reasonable servicing and collection efforts.

Whoa! Just the act of sending the loan to a collection agency satisfies their entire obligation with regard to collections! How conveeeenient. (Quarterbacks around the world rejoice! You can now just throw, without worrying about whether anyone receives!) Prosper explicitly takes no responsibility for selecting, checking up on, managing the collection agency, helping them, providing them with good information, or otherwise ensuring that anything at all is actually done. I imagine this cross-examination at some time in the future:

Lawyer: So after sending the package of loans, to the collection agency, you didn't check up to see if it had been received?

Prosper guy: Nope.

Lawyer: You didn't check to see whether the collection agency was working on them?

Prosper guy: Nope.

Lawyer: You didn't know that AmSher had ceased collection operations and become a beauty salon?

Prosper guy: Nope.

Lawyer: And were your actions in this matter reasonable?

Prosper guy: "Hey, we referred that loan to a collection agency. If they didn't do anything, like they didn't call the borrower or anything, hey that's not our fault. We satisfied our obligation as specified in the prospectus."

That's really weak.

Prosper is continuing their longstanding policy of shirking responsibility for the management and servicing of these loans. In one way, the new scheme is worse for lenders. Under the old prosper scheme, lenders owned the loans, so we could argue that prosper, our servicing agent, had a responsibility to us to service those loans competently. Under the new scheme, prosper owns the loans. Its more indirect. Lender's rights are more tenuous. It will be more difficult for lenders to force prosper to act appropriately.

But wait, there's more. Lenders have been concerned about the quality of Prosper's checks of borrower's identity and income since the beginning. In the prospectus, for the first time, prosper gives us some numbers:

For example between September 1, 2007 and August 31, 2008, we verified employment and income for only approximately 22.6% of borrowers. When we perform these verifications, we contact borrowers by email or telephone to request additional information.

If the borrowers fail to provide satisfactory information in response to an income or employment verification inquiry, we may request additional information from the borrowers or cancel the borrower’s listing or refuse to proceed with the funding of the borrower loan.

Of the borrowers undergoing income verification for the period from September 1, 2007 to August 31, 2008:

• approximately 56.7% provided us with satisfactory responses and received a borrower loan;
  
• approximately 37.7% did not provide satisfactory responses, or did not respond, and their listings were canceled; and
  
• approximately 5.9% either withdrew their listings, or failed to receive bids totaling the amount of their requested loan.

Oh my. Depending on how you count that last category, something between 1/3 and 1/2 of borrowers failed income and employment verification! That's an awfully high proportion of liars. Of course this is only within the sample of 22.6% of borrowers who Prosper challenged.

We don't know what the results would have been if Prosper had verified income and employment on the remaining 77.4% of borrowers, but the numbers above give us reason to be concerned.

I tried to write an explanation of how to think about these numbers, but I decided that I had used too many words. Prosper member DakotahFury said it well in a recent discussion:

Holy crap...that is an astonishing, shocking, and infuriating figure.
If you were a factory manager, and 45% of the products you QC'd were faulty... how could you justify NOT checking every single product that went out the door? Heck, how could you justify not shutting down the line and looking for ways to structurally change the way you were going about business?

Indeed. It only takes a small percentage of bad loans to sour the mix.

There are lots more tidbits in there for careful readers. I want to hit just one more.

In the prospectus prosper discusses the legal black cloud (contingent liability they call it) associated with the sale of loans while Prosper was operating without SEC registration. There have been many forum discussions in which prosper members speculate that this could mean the end of Prosper. The liability after all seems huge. I don't think so.

Prosper issued $178M of loans prior to registration. Of these there have been $22.3M net chargeoffs. You can imagine some sort of worst case where class action suits might force Prosper to pay back lenders for all the loans that went bad. That $22.3M looks big relative to the approximately $10M Prosper has in the bank. This is too simple a model.

First, $22.3M isn't a worst case at all. If you look at my late loan curves, you can see that Prosper loans are headed toward about 40% of the loans eventually going bad. 40% of $178M is $71M. A super horrible number.

But then there's a one year statute of limitations. The first class action suit was filed 11/26, and if we look at loans originated in the one year prior to that, we find $77.3M of loans. If my prediction is right, about 40% of those may go bad. 40% of $77.3M is $31M. Well that's sounding less bad. There are situations where lawyers could argue that the statute of limitations should not apply, and these issues are complex and beyond my understanding, so who knows if the lawyers can limit the damage in this way.

But lets use that $31M number. It looks large relative to Prosper's cash in the bank, but that's not the right comparison.

Even if Prosper didn't have this risk, they'd need to raise money before the end of 2009. That's easily calculated from numbers in the prospectus. You might think it would be hard to raise money in their present pickle, and indeed be difficult to raise money for a business that is shut down, but Prosper isn't gonna stay shut down.

I predict that the prospectus will be approved, perhaps with minor modifications, and Prosper will be back running within a few months.

Because Prosper will need cash before the end of 2009 they will do another funding round with VCs. The VCs will invest, because they still believe in the concept. Most opportunities they see haven't built a membership of 800,000 people! It is likely that this will be a "down round", where VCs get shares at a price lower than their last investment, thus substantially diluting the founders. Lets say Prosper gets another $20M. (It might be structured to come in in small chunks, or some other magic which prevents Prosper from looking juicy to the plaintiff's lawyer.)

The class action suit will drag on for at least 2 years, unless Prosper takes initiative to settle it sooner.

In the meantime, Prosper will grow its business, and get itself on the road toward an IPO.

Getting ready for an IPO is hard work involving a lot of accountants and lawyers, but in Prosper's strange case, the accounting and legal work is already done. It had to be done to write the prospectus for "borrower payment dependant notes" that they have just filed. You could cut and paste from that baby, and do an IPO any time you like. ...except for the fact that a shut-down business is not the best candidate, and the fact that the stock market isn't in the mood.

One to two years from now all that will have changed.

If the class action suit proceeds, it will settle for 20% of the $31M of bad loans that get in under the statute of limitations wire, ie $6M. The money will likely come from VCs. (It is also possible that the IPO money could be used to pay the damages, but this is risky, because sight of IPO money would make the plaintiff's lawyer salivate.)

The stock market will recover. Prosper will do an IPO.

I should also mention that there will be a 34% chance of rain tomorrow, diminishing into the evening, with a slight chance of thunderstorms during the early morning hours.

Might be fun to sit in the board meetings, just to hear what the VCs think about all of this .

Prosper.com - 12/01/08 late loan stats update

Here's the December 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.

Click on the chart to see a larger clearer version.

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

The best discussion among prosper.com lenders is found at http://www.prospers.org/

Prosper.com - More legal trouble

Many legal developments for prosper.com in the last 48 hours. New lawsuits. New settlements. All are being reported elsewhere. I'll summarize the major links here for completeness.

An association of state securities regulators called NASAA has piled on, and Prosper has settled with them for $1M: NASAA Settlement (Although the name is similar, I don't think these are the same guys who do the space shuttle.)

A new class action suit has been filed against Prosper.com. The complaint has now become public: Prosper Class Action Complaint

A new blog has appeared, which seems intended to keep us up-to-date on that class action suit: Prosper Class Action Blog

A dumbfounded lawyer blogs about Prosper.com: What were they thinking?

With the legal front so well covered, I can now move on to more interesting subjects !

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.