3c hapter - Index of

Pennies from Many 133
the company was complying with regulations. In Larsen’s view,
Prosper was dealing with a banking product, pure and simple—
although some securities experts say it clearly meets the defi nition
of a security, with its promise of a profi t. 6 “They basically said, ‘We
trust your attorney’s interpretation of this so go ahead, we haven’t
made a decision on this space but we’ll watch it,’” recalls Larsen.
“That was as much of a green light as you’re going to get from
the SEC.”
With the company’s fate in the balance, Larsen and his team
worked with the SEC for months on a solution, with the commission
demanding that the site shut down fi rst before it would negotiate.
Prosper argued that shutting down would irreparably harm
its business. In the meantime, it tried to get a bank charter, which
would give it legal cover to offer securities, but new charters were
not being issued. Having no other choice, the company stopped
making new loans in November 2008. A week later, it received
a cease- and- desist order from the SEC. The letter, dated November
24, 2008, stated that Prosper had violated sections 5(a) and (c) of
the Securities Act, which prohibits the offer or sale of securities
without registration or a valid exemption from registration.
It took Prosper nine months and $4 million to register its securities
with the SEC as well as with each state’s regulators. Today,
the company is regulated like a public company issuing securities,
although it is privately held. It must fi le a prospectus with the SEC
for every $25 loan. “We’re going to have more Edgar fi lings than
any company in America at this rate,” sighs Larsen, referring to
the SEC database. “They have morphed this thing from a direct,
people- to- people lending thing to basically a Wall Street special
interest entity.”
The SEC wasn’t Prosper’s only problem. As the economy deteriorated,
so did many of its loans. Like the broader credit market,
Prosper’s risk model turned out to understate risk. Default rates,
particularly among borrowers with lower credit scores, skyrocketed
to as high as 36 percent on some loan types, according to
one report. 7 From 2006 to 2008, investors averaged a negative
4 percent return, Larsen says. So he took advantage of the downtime
to make some changes to the service. Larsen concedes that