Background

Ensuring adequate consumer protections is one of the broad goals of the  financial regulatory system in the United States, together with ensuring  the integrity and fairness of markets, monitoring the safety and  soundness of institutions, and acting to ensure the stability of the financial  system. U.S. regulators take steps to address information disadvantages  that consumers of and investors in financial products may face, ensure  that consumers and investors have sufficient information to make  appropriate decisions, and oversee business conduct and sales practices  to prevent fraud and abuse.
Responsibilities for helping ensure consumer financial protection and  otherwise overseeing the financial services industry, including person-to- person lending, are shared among various federal and state regulatory  agencies and numerous self-regulatory organizations. The manner in  which these regulators oversee institutions, markets, or products varies  depending upon, among other things, the regulatory approach Congress  has fashioned for different sectors of the financial industry. For example:    Federal banking regulators subject depository institutions (hereafter,  for simplicity, banks) to comprehensive regulation and examination to  ensure their safety and soundness. Until July 2011, the banking  regulators serve as the primary consumer protection enforcers and  supervisors for the banks under their jurisdictions. These regulators  include the Office of the Comptroller of the Currency (OCC) for  national banks; Board of Governors of the Federal Reserve System  (Federal Reserve) for domestic operations of foreign banks and for  state-chartered banks that are members of the Federal Reserve  System; Federal Deposit Insurance Corporation (FDIC) for insured  state-chartered banks that are not members of the Federal Reserve  System; National Credit Union Administration (NCUA) for federally  insured credit unions; and the Office of Thrift Supervision for federal  thrifts. Both FDIC and the Federal Reserve share oversight  responsibilities with the state regulatory authority that chartered the  bank.   The Federal Trade Commission (FTC) is responsible for enforcing  many federal consumer protection laws. Until July 21, 2011, FTC is  the primary enforcer of federal consumer financial laws for nonbank  financial services providers. After that date, FTC will share  responsibility for such enforcement with the Bureau of Consumer  Financial Protection (known as the Consumer Financial Protection  Bureau or CFPB), as discussed later. In addition, FTC investigates  nonbank financial services providers that may be engaged in unfair or  deceptive acts or practices and takes enforcement action. Because it  is a law enforcement agency, and not a supervisory agency, FTC  does not regularly examine nonbank financial services providers or  impose reporting requirements on them, but instead focuses on  enforcement. State regulators have been the primary supervisors of  nonbank financial services providers, and state-level powers and  levels of supervision have varied considerably.   SEC is the primary federal agency responsible for investor protection.
Like FTC, it does not comprehensively regulate and examine  companies that issue securities. Rather, federal securities regulation  is intended to protect investors in specific securities through  disclosure requirements and antifraud provisions that can be used to  hold companies liable for providing false or misleading information to  investors. State securities regulators—represented by the North  American Securities Administrators Association (NASAA)—generally  are responsible for registering certain securities products and, along  with SEC, investigating securities fraud.
As a result of the Dodd-Frank Act, which mandated the creation of CFPB,  federal regulation of consumer financial products and services is in the  process of consolidation. CFPB will serve as the primary supervisor of  federal consumer protection laws over many of the banks and other  financial institutions that offer consumer financial products and services  and will be one of the enforcers of these laws. Upon assuming its full  authorities, CFPB will, among other things    assume rulemaking authority for more than a dozen existing federal  consumer financial laws from other federal agencies, as well as new  rulemaking authorities created by the Dodd-Frank Act itself; supervise compliance with federal consumer financial laws with  respect to certain nondepository financial services providers, including  those involved in residential mortgage lending, private student  lending, payday lending, and “larger participant of a market for  other consumer financial products or services,” to be defined through  CFPB rulemaking; supervise compliance with federal consumer financial laws with  respect to banks holding more than $10 billion in total assets and their  affiliates; and research, monitor, and report on developments in markets for  consumer financial products and services to, among other things,  identify risks to consumers.
The date for transferring consumer protection functions to CFPB is July  21, 2011. Until a director takes office, the Secretary of the Treasury has  the power to perform some of CFPB’s functions, and the Department of  the Treasury (Treasury) has formed an implementation team to start up  the agency.
The Dodd-Frank Act also established the Financial Stability Oversight  Council (FSOC) to convene financial regulatory agencies to identify risks  and respond to emerging threats to the financial stability of the United  States. Chaired by the Secretary of the Treasury, FSOC is comprised of  the heads of CFPB, FDIC, SEC, and other voting and nonvoting  members—including a state banking supervisor and a state securities  commissioner. Among other duties, FSOC is to    monitor the financial services marketplace in order to identify potential  threats to the financial stability of the United States; facilitate information sharing and coordination among federal and  state financial regulatory agencies on developing policies and  regulatory activities for financial services; identify gaps in regulation that could pose risks to the financial stability  of the United States; and   provide a forum for discussion and analysis of emerging market  developments and financial regulatory issues.

	The Major Person-to- Person Lending Platforms Serve as Intermediaries and Facilitate Loans Generally for Consumer Lending and Microfinance

		Two Major For-Profit Platforms Connect Borrowers Seeking Mostly Consumer Loans with Lenders Seeking a Return on Their Investment

Prosper and LendingClub provide two major Internet-based platforms  currently operating in the United States that allow lenders to select and  fund loans to borrowers for consumer and business purposes. Lenders  participate on these two platforms by buying notes that correspond to a  specific loan, or share of a loan, with the goal of being repaid principal  and receiving interest. As shown in figure 1, according to data provided  by the companies, Prosper grew rapidly after launching its platform in  November 2005, facilitating about $176 million in loans by September  2008 (about $5 million per month). After suspending its operations in  October 2008 to register a securities offering with SEC—as we discuss  later—Prosper resumed operation in July 2009 at a lower loan volume  than before (about $2 million per month through December 2010) but  grew more rapidly beginning in 2011 (about $4 million per month from  January 2011 to March 2011). LendingClub facilitated about $15 million in  loans between when it issued its first loan in June 2007 and March 2008  (roughly $1.5 million per month). Between April 2008 and October 2008,  LendingClub suspended its sales of notes to lenders to register a  securities offering, although it continued to make loans to borrowers using  its own funds. LendingClub grew rapidly after resuming operations in  October 2008, facilitating about $7.6 million in loans per month. As of  March 31, 2011, about 60,000 Prosper lenders had funded about $226  million in loans to more than 33,000 borrowers. At the same time, about  20,600 LendingClub lenders had funded about $243 million in loans to  about 25,000 borrowers.
According to industry officials, researchers, and online discussion forums,  individuals participate as lenders in for-profit, person-to-person lending  platforms as an alternative to traditional savings vehicles (e.g., savings  accounts, money market accounts, certificates of deposit) that pay low  interest rates. As of March 31, 2011, Prosper reported that lenders  received average net annualized returns exceeding 11 percent for loans  originated since it completed registration with SEC in July 2009, while  LendingClub reported net annualized platform returns exceeding 9  percent for all loans since it issued its first loan in June 2007. Around the  same time, the annual percentage yields for savings and money market  accounts and 3-year certificates of deposit listed on bankrate.com were  lower, ranging from 0.1 percent to 1.2 percent and 1.3 percent to 2.2  percent, respectively.
Borrowers use person-to-person lending as an alternative source of  credit. Interest rates on these loans may be lower than those on  traditional unsecured bank loans or credit cards. As of March 31, 2011,  the annual percentage rate for a 3-year loan was as low as 6.3 percent  for Prosper and 6.8 percent for LendingClub, depending on the  borrower’s credit ratings or loan grades, while the average annual  percentage rate for credit cards around that time was 14.7 percent.  Nonetheless, the annual percentage rate could be as high as 35.6  percent for Prosper and 25.4 percent for LendingClub. In contrast, one  credit card issuer had an annual percentage rate of 49.9 percent for cash  advances and purchases made using its credit card. Prosper reported  that the average annual percentage rate for all 3-year loans since its  inception was 20.6 percent, and LendingClub reported that the same  average for its loans was 11.4 percent.
Lenders using these platforms generally provide capital in relatively small  amounts for borrowers who are typically seeking fairly small, unsecured  loans for consumer purposes—such as consolidating debts, paying for  home repairs, or financing personal, household, or family purchases—or,  to a lesser extent, for business purposes. Lenders can invest in many  loans and may fund an entire loan request or only a fraction of each loan  request—as little as $25 per loan. As of March 31, 2011, Prosper lenders  invested on average about $3,700, while LendingClub lenders invested  on average about $8,640. Both platforms restrict borrowers’ loan  request amounts to between $1,000 and $25,000 for Prosper and up to  $35,000 for LendingClub, and the average amount borrowed was $5,886  for Prosper and approximately $9,980 for LendingClub. As of March 31,  2011, according to Prosper officials, about 25 percent of its borrowers  since the platform’s inception used the loans to consolidate debt or pay  off credit cards, 4 percent used the loans for home repairs, 10 percent  used the loans for business purposes, and 14 percent used the loans for  other purposes. The corresponding percentages for LendingClub were  approximately 57 percent to consolidate or pay off debt, 7 percent for  home repairs, 10 percent for financing purchases for consumer use, and  5 percent for business purposes.

		The Two Major For-Profit Platforms Have Similar Processes for Facilitating Loans

As shown in figure 2, the lending process is similar for Prosper’s and  LendingClub’s platforms, with the company acting as an intermediary  between borrowers and lenders. To borrow or lend money on one of the  platforms, each participant must register as a member on that company’s  Web site under a screen name (to maintain anonymity) and provide basic  information to determine their eligibility as a borrower or lender. Each  borrower must complete a loan application that is reviewed to determine  creditworthiness. For example, prospective borrowers must have  minimum credit scores to be accepted on either platform—at least 640 for  Prosper and 660 for LendingClub. Prosper and LendingClub assign a  proprietary letter grade to each loan request—based on credit score,  credit history, and other factors (e.g., requested loan amount and past  reported delinquencies)—to help lenders gauge borrowers’  creditworthiness. In comparison, prospective lenders are not evaluated  for creditworthiness. Beyond demonstrating basic eligibility requirements,  including identity verification, lenders may only have to attest that they  meet the minimum income or asset requirements imposed by a number of  state securities regulators or, in the case of LendingClub, by the company  itself (we discuss these requirements later in this report). In aggregate, a  Prosper lender can invest up to $5 million, while a LendingClub lender  can invest no more than 10 percent of that lender’s total net worth.
The companies post approved loan requests, including loan amounts,  interest rates, and assigned letter grades, on their Web sites for lenders  to review and choose to fund. Approved loan requests are for unsecured,  fixed-rate loans with a 1-, 3-, or 5-year maturity (Prosper) and a 3- or 5- year maturity (LendingClub), with interest rates reflecting the assigned  credit rating or loan grade. Lenders may also view information such as  borrowers’ income levels, and the purpose of the loans, to the extent  borrowers provide such data. Lenders may scroll through approved loan  listings manually to select which loans to fund, or they may build a  portfolio based on their preferred criteria, such as loan characteristics  (e.g., amount, term, interest rate) or borrower characteristics (e.g.,  location, number and balance of credit lines, length of employment).  Lenders may also use automated portfolio building tools, offered by both  platforms, that allow lenders to search for loans using criteria defined by  the platforms, such as credit quality, average annual interest rate, or a  combination of these characteristics.
On both platforms, lenders do not make loans directly to borrowers.  Rather, lenders purchase payment-dependent notes that correspond to  the selected borrower loans. Once lenders choose which loans to fund,  WebBank, an FDIC-insured Utah-chartered industrial bank, approves,  originates, funds, and disburses the loan proceeds to the corresponding  borrowers. WebBank then sells and assigns the loans to the respective  platform in exchange for the principal amount that the platform received  from the sale of corresponding notes to the lenders. WebBank officials  said that the bank does not have long-term ownership of the loans and  does not bear the risk of nonpayment. Rather, they noted that, due to the  nature of the platforms, the risk of nonpayment is transferred (through the  notes) to the lenders.
Prosper and LendingClub have exclusive rights to service the loans and  collect monthly payments from borrowers, generally via electronic fund  transfers. After deducting a 1 percent servicing fee and any other fees,  such as insufficient fund fees, the platforms credit each lender’s account  his or her share of the remaining funds. Also, the platforms can attempt to  recover any loans that become delinquent, and they have exclusive rights  to determine whether and when to refer the loans to third-party collection  agencies. As we discuss later, for both companies, 2 percent or less of  the loans in their top three credit grades originated in the first half of 2010  had defaulted as of March 31, 2011.

		A Major Platform Allows Lenders to Support Microloans to Entrepreneurs on a Not- for-Profit Basis

Founded in November 2005, Kiva is the major nonprofit platform in the  United States that offers lenders opportunities to support economic  development and entrepreneurship, mostly in developing countries,  through partnerships with local microfinance institutions. As part of its  efforts to alleviate poverty by connecting people through lending, Kiva  facilitates the collection and transfer of capital for interest-free loans,  funded by its lenders, to approximately 130 microfinance institutions  around the world to fund interest-bearing loans to entrepreneurs in their  communities. Kiva screens, rates, and monitors each microfinance  institution on its platform and assigns it a risk rating for lenders to  consider in their funding decisions. As of March 31, 2011, about  570,000 Kiva lenders had funded approximately $200 million for 273,000  microloans across 59 countries.
Much like the two major for-profit platforms, Kiva is set up to allow lenders  to register for an online account to select and fund loans to borrowers,  primarily in developing countries, who are seeking money to support their  small business (microenterprise) operations. As shown in figure 3, Kiva’s  lending process contains some key differences from the process used by  the major for-profit platforms. Rather than transacting directly with  individual borrowers, Kiva aggregates funds from lenders and forwards  them to microfinance organizations, which make and manage loans to the  borrowers and transmit the borrowers’ repayments to Kiva, which in turn  distributes the lenders’ shares of the funds received back to the lenders.  Individuals are eligible to become lenders on Kiva simply by providing  basic information, including their name and e-mail address. Once  lenders have registered, Kiva automatically generates a profile page, but  lenders may choose to remain anonymous. Through the platform Web  site, lenders can look through the loan requests and select the  microenterprises that they are interested in funding. Lenders can fund as  little as $25 and as much as the entire amount of the loan. Officials said  that requested loan amounts vary geographically, ranging from $1,200 to  $10,000. Kiva relies on the local microfinance institutions to screen and  evaluate borrowers and set loan amounts and terms. Additionally, the  local microfinance institutions work with the borrowers to collect their  entrepreneurial stories, pictures, and loan details and upload the  information to Kiva’s Web site for potential lenders to view.
When lenders select the microenterprises they want to fund on Kiva’s  platform, they do not make loans directly to the borrowers. Rather, the  loan proceeds typically replenish the microfinance institutions for the  loans that they distributed to borrowers when they were needed. Often,  the loans are disbursed before the loan details are posted on Kiva’s Web  site for lenders to view. Even though Kiva lenders provide loan funds  free of interest, the microfinance institutions charge the entrepreneurs  interest on their loans to help cover the institutions’ operating costs. As of  February 2011, the average portfolio yield among Kiva’s microfinance  institution partners was about 37 percent. As the microfinance  institutions collect the scheduled repayments from borrowers, they retain  the interest payments and any other fees they charge to help finance their  operations, and transfer the amount of principal payments to Kiva, which  credits lenders’ accounts for their share of the corresponding loans. If a  borrower fails to make a scheduled payment, the microfinance institution  notifies Kiva and lenders could potentially receive a late or partial  payment or receive no payment. According to Kiva, the repayment rate  for all of its loans from all partners as of March 31, 2011, was  approximately 99 percent.
According to Kiva officials and online discussion forums, many lenders  participate on Kiva’s platform because they are motivated to help  individuals in developing countries escape poverty and improve their  quality of life. Kiva reported that, as of March 31, 2011, each of its lenders  had funded an average of about 11 loans for about $380 per borrower.  Furthermore, Kiva officials said that, based on its market research, the  bulk of its lenders said that they chose to lend to make a difference in  someone’s life without spending a lot of money and that they would be  likely to use any repayments they received to fund more loans to other  entrepreneurs.

		Other Domestic and Foreign Companies Demonstrate the Variety of Person-to-Person Lending Platforms

Several U.S. companies have introduced a variety of other person-to- person lending platforms. For example, some companies have offered,  and at least one continues to offer, a more direct form of person-to- person lending that formalizes lending among friends and families.  Lenders can use such platforms to make loans directly to borrowers they  know by arranging a promissory note that outlines explicit conditions,  such as the loan amount, terms and rate, and repayment terms. Other  companies have offered platforms that, like Prosper and LendingClub,  facilitate interest-bearing loans between individuals who do not know one  another, but these companies have often targeted a more specific lending  market. For example, these platforms may provide financing for small  businesses, mortgages, or private student loans for higher education.
Foreign companies have also offered an array of person-to-person  lending platforms in a number of other countries. For example, Zopa, a  UK company, operates a major for-profit, person-to-person lending  platform similar to Prosper and LendingClub in the United Kingdom and  has begun to franchise its model in other countries. As of March 2011,  Zopa had facilitated more than £125 million (roughly $200 million) in loans  since its launch in 2005. Additionally, other foreign companies in  countries such as Australia, Canada, China, France, Germany, India,  Japan, and Korea have also offered both for-profit, person-to-person  lending platforms and nonprofit platforms that offer lenders opportunities  to fund microfinance loans.

	Although Person-to- Person Lending Offers Potential Benefits to Lenders and Borrowers, It Also Poses Risks Currently Overseen by a Complex Regulatory Structure

Person-to-person lending offers lenders the potential to earn relatively  high returns and may provide borrowers with broader access to credit  than they would otherwise have. In return, lenders face the risk of losing  their principal and the expected interest on their investments on for-profit  platforms. While borrowers using the person-to-person lending platforms  face risks largely similar to those facing borrowers using traditional banks,  including unfair lending and collection practices, borrowers face some  privacy issues unique to the person-to-person lending platforms. The  current regulatory structure for the oversight of person-to-person lending  consists of a complex framework of federal and state laws and the  involvement of numerous regulatory agencies. For the major for-profit  platforms, SEC and state securities regulators enforce lender protections,  mostly through disclosures required under securities laws, and FDIC and  state regulators enforce borrower protections. The Internal Revenue  Service (IRS) and California attorney general have authority to enforce  reporting and other requirements for Kiva as a charitable organization,  while Kiva’s microfinance partners are subject to varying consumer  financial protection requirements that apply in the jurisdictions where they  lend.

		Person-to-Person Lending Poses Risks to Lenders That Have Been Subject to Securities Regulation

The major for-profit, person-to-person lending companies (Prosper and  LendingClub) offer lenders the potential to earn higher returns than they  might through conventional savings vehicles, as the examples of the  companies’ Web sites show (figs. 4 and 5). As we have seen, the  companies have reported average net annualized returns for lenders that  have exceeded recent returns for savings accounts and certificates of  deposit. According to Prosper and LendingClub, lenders can also select  loans that match their appetite for risk and return, something they cannot  do with bank deposits, and diversify their portfolios by investing in  consumer and commercial (i.e., small business) loans as an alternative  asset class to stocks or mutual funds.
Lenders participating on the platforms are also exposed to various risks— particularly credit risk (the possibility that borrowers may default on their  loans) and operational risks associated with relying on the platforms to  screen loan applicants and service and enforce collection of the loans  (see table 1). In contrast with traditional savings vehicles, such as FDIC- insured savings accounts or certificates of deposit with fixed rates of  return, the notes that lenders purchase from Prosper and LendingClub do  not guarantee that they will recover their principal or achieve expected  returns. While the companies take steps to confirm loan applicants’  identities and use information from their credit reports to screen loan  requests and assign credit ratings, they often do not verify information  that borrowers supply, such as their income, debt-to-income ratio, and  employment and homeownership status. Lenders face the risk that  inaccuracies in the platforms’ assigned credit ratings or borrower-supplied  information could result in lower-than-expected returns. Also, lenders  have no direct recourse to the borrowers to obtain loan payments, so their  returns depend on the success of the platforms and their collection  agents in obtaining repayments from borrowers. For all loans originated  between January 1, 2010, and June 30, 2010, about 55 percent of  Prosper’s and more than 70 percent of LendingClub’s loan volume went  to borrowers with the top three credit grades and, of those loans, 1.2  percent (Prosper) and 2 percent (LendingClub) had entered into default or  been charged off by March 31, 2011.
To mitigate some of the credit risk that loans might default, lenders on the  platforms may choose to diversify their investments by funding a broad  portfolio of loans, in the same way that investors might diversify their  investments across and within asset classes to minimize the impact of a  single asset losing value. However, investing in a diverse portfolio of  loans on a given platform does not eliminate other risks, such as those  associated with lenders relying on unverified borrower information and the  companies’ credit rating systems when selecting which loans to fund.
The risks to lenders of participating on person-to-person lending platforms  are currently addressed through securities registration of the notes the  companies sell to lenders. Although officials from Prosper and  LendingClub said that they had initially questioned the applicability of  federal securities registration requirements to person-to-person lending,  both companies ultimately registered securities offerings with SEC.  Prosper and LendingClub launched their platforms in 2005 and 2007,  respectively, without registering securities offerings. Prosper  subsequently filed a registration statement in October 2007 for a  proposed secondary trading platform that its lenders could use to trade  their notes, but it did not seek to register the notes themselves. Prosper  continued to sell notes to lenders until October 2008. In November 2008,  SEC entered a cease-and-desist order against Prosper, in which SEC  found that Prosper violated Section 5 of the Securities Act for engaging in  unregistered offerings of securities. Prosper resumed selling notes to  lenders when its registration statement became effective in July 2009.  LendingClub suspended its sales of notes to lenders from April to October  2008 to register with SEC. This progression of events is illustrated in  figure 6.
SEC’s oversight of person-to-person lending, as with its oversight of other  companies that issue securities, focuses on reviewing the companies’  required disclosures rather than examining or supervising the companies  or their operations, or reviewing the merits of the notes they offer.  Specifically, staff from SEC’s Division of Corporation Finance led the  agency’s review of Prosper’s and LendingClub’s registration statements  and other required filings for compliance with legal requirements for an  issuer to disclose all information that may be material to an investor’s  decision to buy, sell, or hold a security. For example, Prosper’s and  LendingClub’s prospectuses identify, among other things, the general  terms of the notes, the risks to lenders of investing in the notes, and  details about the operations of the platforms. In addition, both Prosper  and LendingClub continually offer new series of notes to investors to fund  corresponding loans and thus are required to update their prospectuses  with supplements containing information about the new notes and their  corresponding loans as they are offered and sold. These supplements  include required information on the terms of each note, such as interest  rate and maturity. Prosper and LendingClub also include other  information concerning the underlying loan that is available to lenders on  their Web sites as part of the loan listing, including anonymous  information from the borrower’s credit report, and anonymous information  supplied by the borrower, such as loan purpose, employment status, and  income.
SEC staff explained that the federal securities laws and rules require that  certain information—including information in the prospectus  supplements—be provided to investors in order to document the final  terms of their investments. Including these disclosures in the prospectus  also ensures that certain protections of the securities laws are available to  investors in the event the information is found to be incorrect or  misleading. For example, SEC staff told us that the borrower and loan  information included in the prospectus supplements established a  permanent record of all material information that the companies provided  to their lenders about the notes offered and purchased. Staff from SEC  and officials from the companies agreed that lenders were unlikely to  consult the prospectus supplements—which are available to the public  online on SEC’s Electronic Data Gathering, Analysis, and Retrieval  (EDGAR) database—at the time they invest, because the same  information is available in real time on the platforms. However, investors  who purchase securities and suffer losses have recovery rights, through  litigation, if they can prove that material information was omitted or stated  untruthfully in the prospectus or prospectus supplements. Information is  only deemed part of a prospectus when it is required to be filed with SEC  under its rules.
In addition to registering with SEC, Prosper and LendingClub have  registered with selected state securities regulators in order to be  permitted to offer and sell notes to state residents. The Securities Act of  1933 exempts certain types of securities, such as those of companies  listed on national exchanges, from state securities registration  requirements. However, because the notes that Prosper and  LendingClub offer do not qualify for such an exemption, the companies  have sought to register the notes on a state-by-state basis. As of April  2011, 30 states and the District of Columbia had approved the registration  statements or applications of one or both companies (fig. 7). Lenders in  the remaining 20 states cannot participate on either platform, but officials  from both companies said that they were continuing to seek approval in  some of the remaining states.
NASAA officials explained that, while some states take a disclosure- based approach similar to SEC’s, other states have a merit-based  approach that, in addition to disclosure, also requires the securities  regulators to determine whether a securities offering is fair, just, and  equitable. These merit-review states may impose financial suitability  standards, such as minimum income or asset requirements and caps on  the percentage of an investor’s assets that can be invested in a security.  Seven merit-review states have required their residents to meet such  suitability standards to participate as lenders on Prosper’s or  LendingClub’s platforms. The state securities regulators do not examine  compliance with these suitability standards, and the companies are not  required to verify that lenders meet them. Rather, the companies require  lenders to attest that they meet the standards. NASAA officials said that a  company could be held liable if it sold notes to a lender without receiving  the proper attestation of suitability or when it knew, or should have  known, that the lender’s attestation of suitability was false. In either event,  the state securities regulator or SEC could bring an enforcement action  against the company.
Officials of the securities regulators in the four merit-review states that we  contacted (California, Kentucky, Oregon, and Texas) identified risk factors  and other considerations that led their agencies to impose financial  suitability requirements for lenders or that have prevented them from  approving one company’s, or both companies’, registration statements.For example, all four of these states cited the risks lenders face,  particularly related to their reliance on the platforms to screen borrowers  and service the loans, the companies’ limited verification of information  supplied by borrowers, and the novelty and untested nature of person-to- person lending. Officials from Kentucky and Oregon said that, by  imposing suitability requirements that restricted lenders’ investments to  10 percent of their net worth, their agencies aimed to protect investors in  their states by limiting their exposure to losses on the notes. They also  said that their states’ minimum income or net worth requirements helped  to ensure that lenders could afford to withstand any losses incurred and  increased the likelihood that they would have the sophistication to  understand the risks of investing in the notes. Officials from Texas said  that the companies’ registration statements had not yet satisfied Texas’  conditions for approving registrations. The officials said that one of the  applicable conditions was a cash flow standard for debt securities—which  holds that a company issuing debt securities should have sufficient cash  flows to service the debt securities being offered—even though Prosper  and LendingClub are not obligated to make payments on the notes if the  borrowers fail to repay the corresponding loans. In contrast, officials  from California said that the financial condition of person-to-person  lending companies has little relevance for lenders compared with the  financial conditions of the borrowers in the underlying transactions.  However, they noted that securities regulators cannot assess borrowers’  financial conditions. These officials said that, in imposing financial  suitability requirements for California residents, the agency sought to  balance the risks to lenders with the overall benefits that person-to- person lending confers on lenders and borrowers.

		Various Regulators Oversee Risks to Borrowers on Person-to- Person Lending Platforms

Person-to-person lending platforms may broaden the supply of unsecured  consumer and commercial loans, and borrowers who obtain loans  through the platforms may be able to obtain better terms than they could  from more conventional lenders. To the extent that lenders invest in  consumer and commercial loans, person-to-person platforms may provide  borrowers with an alternative to traditional sources of unsecured credit  such as credit cards and personal loans from banks. Borrowers may also  be able to obtain lower annual percentage rates through Prosper and  LendingClub than through more traditional credit sources. As with  traditional loans, however, these terms will vary according to the  borrower’s credit score and history, as well as the amount and terms of  the loan.
As with any source of credit, borrowers on the two major for-profit,  person-to-person lending platforms face risks—such as potentially  unclear or misleading lending terms, predatory or discriminatory credit  decisions, and unfair, deceptive, or abusive servicing or collection acts or  practices. The regulators, researchers, and consumer advocacy  organizations we interviewed generally characterized these risks as  similar to the risks borrowers faced in obtaining consumer loans from  banks or other institutions. Borrowers face the risk of unclear or  misleading lending terms, but regulators and consumer advocacy  organizations generally agreed that the major for-profit, person-to-person  lending platforms currently offer loans with fairly straightforward terms  (e.g., fixed-rate, fully amortizing loans). Some of these commentators also  said that, as they would with other types of credit providers, borrowers  could face the risk of predatory or discriminatory credit decisions or other  unfair, deceptive, or abusive acts or practices by the major for-profit  platforms or the third-party collection agencies they hire.
Unlike with traditional lending, borrowers also face the risk of having their  privacy compromised through their participation on the major for-profit  platforms because borrowers may reveal enough information online to  permit the platforms’ members and members of the public to deduce their  identities. Prosper and LendingClub present borrowers’ information  anonymously, including credit report data, and take steps to deter  borrowers from posting personally identifiable information. Nonetheless,  any personally identifiable information borrowers choose to reveal is  available to members online and, because it is included in the prospectus  supplements filed with SEC, publicly through SEC’s EDGAR database.  Our review of selected prospectus supplements filed by Prosper and  LendingClub between August 31, 2010, and November 26, 2010,  identified cases in which borrowers revealed information that potentially  could be pieced together to determine their identities. For example, a few  borrowers listed Web site addresses for their small businesses, while  others revealed their city of residence, employer, and job title or other  specific occupation information. In April 2011, LendingClub implemented  additional controls to help address some of the issues we identified. Also,  in June 2011, Prosper officials said that they intended to modify their  privacy policy to disclose to borrowers that certain information they  provide in their loan listings becomes publicly available through SEC  filings. Appendix II offers a more detailed discussion of our analysis.
A number of federal and state regulators currently play a role in  monitoring and enforcing Prosper and LendingClub’s compliance with  laws that address risks related to consumer lending and Internet  commerce. As shown in table 2, these laws require creditors to disclose  lending terms, prohibit discrimination, and regulate debt collection. The  laws also prohibit unfair or deceptive acts or practices and require  companies to protect personal financial information, adopt anti-money-  laundering procedures, and meet requirements for electronic  transactions. Officials from Prosper and LendingClub identified these laws  as being applicable to the platforms’ lending activities directly or indirectly  through their relationships with WebBank (the FDIC-insured industrial  bank in Utah that originates and disburses the platforms’ loans) and third- party debt collection agencies. Prosper, LendingClub, and WebBank  officials also described the steps that they have taken to ensure  compliance with many of these laws and their regulations. For example,  WebBank officials said that loans are originated based on WebBank- approved credit policies, which Prosper and LendingClub implement. The  officials said that WebBank reviews and approves all materials and  policies related to loan advertising and origination, and also performs  transaction-level testing of the platforms’ credit decisions to, among other  things, help ensure compliance with antidiscrimination provisions of the  Equal Credit Opportunity Act. The officials noted that Prosper and  LendingClub were responsible for providing, on behalf of WebBank as the  lender, disclosures of loan terms for approved loan requests, as required  under the Truth in Lending Act, and of reasons for denying loan  applications for consumer credit, as required under the Equal Credit  Opportunity Act and the Fair Credit Reporting Act. They added that  WebBank’s transaction-level testing validated the companies’ calculations  of annual percentage rates and finance charges and ensured that the  platforms’ disclosures were generated correctly.
Several federal and state regulators, including FDIC, FTC, and the Utah  Department of Financial Institutions (UDFI), either play a role or could  play a role in helping ensure Prosper’s and LendingClub’s compliance  with applicable laws and regulations. First, WebBank’s primary federal  and state regulators—FDIC and UDFI—have the authority to indirectly  oversee Prosper’s and LendingClub’s compliance with applicable lending,  consumer protection, and financial privacy laws, because the bank  originates and disburses the platforms’ loans, and Prosper and  LendingClub are the bank’s servicers for this purpose. FDIC and UDFI  generally evaluate institutions’ risk management programs, including  third-party relationships. These evaluations focus on the institutions’  oversight programs and generally not include direct examination of third- party platforms. Officials from FDIC and UDFI said that they could take  enforcement action against a bank or refer the companies operating  platforms to law enforcement agencies if they identified problems in a  bank’s relationship with the companies, or found evidence that the  companies had violated federal or state laws.
Second, FTC has some enforcement responsibilities related to person-to- person lending. FDIC enforces applicable financial privacy provisions of  the Gramm-Leach-Bliley Financial Modernization Act (Gramm-Leach- Bliley Act) against WebBank. FTC staff said that, while FTC has not  determined whether Prosper or LendingClub are financial institutions as  defined by the act, if the companies were engaged in any of the financial  activities incorporated by reference into the act, they would be subject to  FTC’s jurisdiction if they were not specifically assigned to another  regulator’s jurisdiction. FTC also has the authority to enforce Section 5  of the FTC Act—which prohibits unfair or deceptive acts or practices. FTC  staff said that, unless Prosper and LendingClub were exempt from the  agency’s jurisdiction, FTC could enforce Section 5 against them. FTC  also has primary enforcement responsibility under the Fair Debt  Collection Practices Act—which prohibits abusive, unfair, or deceptive  acts or practices by third-party debt collectors—although banks and  certain other entities are exempt from FTC’s authority. FTC staff said that  FTC could enforce the act against Prosper and LendingClub if they were  not exempt from FTC’s authority and if they were engaged in third-party  debt collection.
However, FTC officials noted that FTC was primarily a law enforcement  agency and did not have examination authority. To identify targets for law  enforcement investigations and prosecutions, FTC staff monitors  consumer complaints, among other sources, for trends and for  information about problematic practices and companies. As of March  2011, FTC reported that it had received 29 consumer complaints related  to person-to-person lending out of more than 6 million complaints it had  received overall in the last 5 years.
Third, some states have lending, servicing, and debt collection laws that  apply to Prosper and LendingClub. Officials from both companies said  that, although WebBank originates and disburses loans on their behalf,  some states require them to be licensed or otherwise authorized to  perform their roles in marketing and servicing the loans. The officials  said that they could be subject to inspection by these states’ licensing  authorities but added that state oversight had generally been limited to  periodic reporting requirements.
The federal regulatory structure for person-to-person lending as related to  borrower protection will be affected as CFPB assumes its new authorities  under the Dodd-Frank Act. For example:    CFPB will assume authority to make rules under many existing  consumer financial protection laws and will have the authority to  prescribe rules defining what acts or practices pertaining to consumer  financial products or services constitute unfair, deceptive, or abusive  acts or practices. Similarly, CFPB will have the authority to prescribe  rules imposing disclosure requirements to help consumers understand  the terms, benefits, costs, and risks of consumer financial products  and services. CFPB representatives noted that many regulations  promulgated by CFPB will generally apply to consumer loans made  through person-to-person lending platforms.   CFPB will assume responsibility for supervising compliance with  federal consumer financial laws for (1) banks with more than $10  billion in assets and their affiliates and (2) certain categories of  nondepository financial services providers including, as discussed  earlier, nondepository entities that are “larger participant of a  market for other consumer financial products or services,” as defined  by CFPB in regulations after consultation with FTC. CFPB will also  have substantial authority to examine “service providers” who provide  material services to depository or nondepository “covered persons”  under the Dodd-Frank Act. CFPB representatives emphasized that  determining the scope of CFPB’s supervision authority with regard to  particular person-to-person lending platforms would be highly fact- dependent, but that, in general, a nondepository institution operating a  person-to-person lending platform could become subject to CFPB’s  supervision authority if it was involved in residential mortgage lending,  private student education lending, or payday lending; if it met the  definition of a “larger participant of a market for other consumer  financial products or services;” or under certain circumstances as a  service provider.   CFPB is required to establish a unit whose functions shall include  establishing a database or utilizing an existing database to facilitate  the centralized collection of, monitoring of, and response to consumer  complaints about consumer financial products or services. CFPB  representatives said that the complaint unit would collect complaints  related to borrowers’ experiences with person-to-person lending  platforms to the extent the complaints relate to consumer loans or  other consumer financial products or services. As a general matter,  CFPB is still defining the scope of its complaint handling function,  including whether it would collect complaints related to lenders’  experiences with person-to-person lending platforms and how it would  coordinate with agencies such as FDIC, FTC, and SEC to route and  respond to such complaints.

		The Major Nonprofit Platform Is Subject to Regulation as a Charitable Organization

The major U.S. nonprofit person-to-person lending platform, Kiva, offers  lenders the opportunity to help alleviate poverty through funding loans  and entrepreneur borrowers the opportunity to benefit from these funds.  As we have seen, Kiva lenders do not earn interest on the loans they  fund. Instead, Kiva emphasizes the potential social and economic  benefits that lenders may help achieve through their support of  microfinance and entrepreneurship, as shown in figure 8. To the extent  that the funds from lenders provide Kiva’s microfinance partners the  capital to finance loans that they would not have otherwise made, the  platform’s activities may increase the supply of credit for individual  entrepreneurs who might not have access to traditional banking services  in their home countries.
Lenders on Kiva’s platform face some risks similar to those facing lenders  on the for-profit, person-to-person lending platforms, principally credit  risk—the possibility that they will lose their principal if borrowers or Kiva’s  microfinance partners fail to repay their loans. Kiva and its microfinance  partners do not guarantee lenders’ loans, so the lenders assume the risk  that borrowers may not repay. In addition, lenders face risks because  they rely on Kiva’s microfinance partners to screen borrowers, service  their loans, and transmit payments to Kiva. As a result, even if borrowers  repay their loans, lenders may not be repaid due to a microfinance  partner’s bankruptcy, fraud, or poor operations. Kiva discloses these risks  on its Web site. Similarly, lenders face operational risks associated with  their reliance on Kiva to screen and monitor its microfinance partners and  effectively maintain its platform for servicing the loans and transmitting  payments to lenders. Kiva also discloses on its Web site that lenders face  potential currency risks and country-specific risks that do not affect  lenders on the major for-profit platforms. For example, Kiva’s  microfinance partners may choose to pass on to lenders a share of the  foreign currency risks associated with their receiving loan payments in  local currency and needing to repay loans to Kiva in U.S. dollars. Also,  broader risks of economic or political disruption or natural disaster in  borrowers’ home countries can affect repayments to lenders.
Borrowers who receive loans funded by lenders on the Kiva platform also  face risks that are similar to those facing borrowers who receive loans  through other types of lenders, based on actions of the microfinance  institutions that actually disburse the funds and service the loans posted  to the Kiva Web site. These risks include the potential for a microfinance  institution to provide unclear or misleading lending terms, make predatory  or discriminatory credit decisions, and use unfair, deceptive, or abusive  servicing or collection acts or practices. For Kiva’s microfinance partners  that lend to borrowers in the United States, the legal standards for lending  terms and practices would depend in part on whether they extend  consumer or commercial credit, but would likely be similar to those for  Prosper and LendingClub and other institutions involved in domestic  lending of the same type, according to CFPB representatives. For Kiva’s  microfinance partners that lend in foreign countries, however, the local  lending regulations may vary.
As a 501(c)(3) nonprofit tax-exempt organization, Kiva is subject to  federal and state charity regulation and IRS financial reporting  requirements. For example, to obtain and maintain its exemptions from  federal and state income taxes and its ability to receive tax-deductible  donations, Kiva must be organized and operated exclusively for charitable  or other exempt purposes and must comply with federal limitations on  lobbying activities. Although Kiva is exempt from income taxation, the  IRS and California’s Franchise Tax Board require charitable organizations  to file annual information returns of their income and expenses. Also,  under California law, Kiva must prepare and have audited annual financial  statements. While Kiva must disclose its annual returns and financial  statements to the public on request, federal and state charities  regulations do not require it to disclose information about its platform or  the risks involved for lenders. IRS can examine Kiva’s returns for  compliance with requirements for federal income tax-exemption, and Kiva  could be subject to enforcement action by the IRS or the California  Attorney General if it is not in compliance with the relevant requirements.  Kiva is not subject to further federal or state supervision or examination of  its operations or activities.
Because Kiva does not offer lenders the opportunity to earn interest, it  has not been subject to federal securities registration requirements. Staff  from SEC’s Division of Corporation Finance said that Kiva had not invited  SEC to take a position on whether its arrangement with lenders was  subject to securities regulation. However, these staff said that based on  Supreme Court precedent, SEC generally considered a security to be  present only where the purchaser expects to make a profit or return that  is the result of a third party’s efforts. Even if a security were present—if,  for example, Kiva or another nonprofit platform offered notes that paid  interest—nonprofit organizations issuing securities can potentially obtain  an exemption from federal and state registration requirements.
FTC cannot enforce Section 5 of the FTC Act’s prohibition against unfair  or deceptive acts or practices against a corporation that does not carry on  business for its profit or the profit of its members. FTC staff said that, if  Kiva is such an entity, the agency would lack the authority to challenge its  conduct under Section 5 of the FTC Act. As of March 2011, FTC reported  that the agency had received no complaints related to Kiva in the last 5  years.
Kiva officials said that, because its microfinance partners make loans to  individuals, the microfinance partners are responsible for compliance with  any applicable consumer financial protection requirements. For example,  Kiva’s microfinance partners that lend in the U.S. could be subject to the  Truth in Lending Act to the extent that they extend consumer credit and  the Fair Debt Collection Practices Act to the extent that they engage in  third-party collections of consumer credit, according to CFPB  representatives. They also said that, because the Equal Credit  Opportunity Act applies to both consumer and commercial credit, it may  apply to the microfinance partners regardless of whether the transactions  involve consumer or commercial credit. FTC staff also noted that the  Gramm-Leach-Bliley Act and the Fair Credit Reporting Act could also  apply, and that the debt collection practices of Kiva’s domestic  microfinance partners and their third-party debt collectors could be  subject to the prohibitions on abusive, unfair, or deceptive acts or  practices under the Fair Debt Collection Practices Act and Section 5 of  the FTC Act. Kiva’s microfinance partners that lend outside the U.S. are  subject to varying national and local borrower protection laws and  regulations in the foreign countries where they lend, according to Kiva  officials. These officials said that Kiva facilitates its microfinance partners’  compliance with some requirements. For example, for microfinance  partners that are subject to prohibitions on publicly identifying borrowers  who are delinquent on their loan payments, Kiva offers a feature that  informs lenders when loans are delinquent but keeps the identity of the  borrowers anonymous to other Kiva members and the public on Kiva’s  Web site.

	Options for Regulating Person-to- Person Lending Have Advantages and Disadvantages Related to Borrower and Lender Protection, Flexibility, and Efficiency

We identified two primary options for regulating person-to-person lending  that differ primarily in their approach to lender protection: (1) continuing  with the current bifurcated federal system—that is, protecting lenders  through securities regulators and borrowers primarily through financial  services regulators, which will include the newly formed CFPB—or (2)  consolidating borrower and lender protection under a single federal  regulator, such as CFPB. We considered the advantages and  disadvantages of these two options primarily in relation to three key  elements—consistent consumer and investor protection, regulatory  flexibility, and efficiency and effectiveness—from a framework that we  had previously developed for evaluating proposals for financial regulatory  reform. The current regulatory system offers borrowers and lenders on  the major for-profit platforms protections consistent with those for other  borrowers and investors, but some industry observers suggested that  using securities regulation to protect lenders on person-to-person lending  platforms lacked flexibility and imposed burdens on companies that  hampered efficiency. Under a consolidated regulatory approach,  borrowers on person-to-person lending platforms would likely continue to  receive the same kinds of protections as other borrowers, and, depending  on how implemented, lender protections could be expanded. Some  industry observers, however, were uncertain about the efficiency and  effectiveness of shifting to a new regulatory regime under an agency that  is still in its formative stages. Finally, new regulatory challenges could  emerge if the person-to-person lending industry introduced new products  or services or if it grew dramatically, making it difficult to predict which  regulatory option would be optimal in the future.

		The Two Options for Regulating Person-to- Person Lending Differ Primarily in Their Approach to Lender Protection

The key distinction between the two primary options for regulating  person-to-person lending is how they would protect lenders using the for- profit platforms. First, as we have seen, under the current regulatory  system, SEC and state securities regulators protect lenders on the major  for-profit platforms primarily through disclosure requirements and the  antifraud and other liability attending those who offer and sell securities,  while, for borrower protection, FDIC and UDFI have authority to oversee  banking institutions and their third-party relationships. In addition, CFPB  will play a role in borrower protection under the current regulatory system  as it assumes rulemaking authority for federal consumer financial laws  and as its database for collecting and routing consumer complaints  becomes operational. Also, CFPB could have a number of potential  bases for conducting direct examinations of person-to-person lending  platforms, as discussed earlier, including, but not limited to,  nondepository platforms that qualify as “larger participant of a market  for other consumer financial products or services,” to be defined by CFPB  rulemaking.
Second, a consolidated regulatory approach for person-to-person lending  would assign primary federal responsibility for borrower and lender  protection to a single regulator, such as CFPB. A consolidated approach  would require exempting person-to-person lending platforms from federal  securities laws. Under such an approach, CFPB could be assigned  responsibility for lender protection, in addition to the roles that it would  play with respect to borrower protection under the current regulatory  system for person-to-person lending. Depending on how a consolidated  regulatory approach was implemented, CFPB might, for example, require  disclosures for lenders as well as borrowers, impose requirements or  restrictions on person-to-person lending companies’ practices in  facilitating loans to borrowers and selling the loans (or corresponding  notes) to lenders, and perform supervisory examinations of person-to- person lending companies. Under a consolidated regulatory approach,  other federal and state regulatory agencies might still be involved in  regulating and overseeing person-to-person lending, unless preempted  by law. For example, even if person-to-person lending was exempt from  federal securities law, person-to-person lending companies could still be  required to register offerings with state securities regulators. Also, bank  regulators could continue to examine third-party relationships of banking  institutions with companies, and states could continue to require person- to-person lending companies to obtain licenses or other authorizations to  perform their role in facilitating loans.
The federal and state regulators, current and former U.S. industry  participants, researchers, and consumer advocacy organizations that we  contacted took different views of these options for regulating person-to- person lending. The staff of federal and state agencies we contacted cited  advantages and disadvantages of each approach but did not take  positions on which would be optimal. Officials from NASAA and some of  the industry observers we contacted favored the current regulatory  system. A few industry observers have supported a consolidated  regulatory approach, albeit it with some reservations about the effects on  the existing companies of shifting to a new regulatory system. A number  of the other industry observers we contacted did not express a preference  between the options, in some cases because they were uncertain how a  consolidated approach would be implemented.
We assessed the advantages and disadvantages of these two regulatory  options in relation to our previously developed framework for evaluating  proposals for financial regulatory reform. The framework consists of nine  elements that are key to developing a successful financial regulatory  system (see table 3). We focused on three of these elements—providing  consistent consumer and investor protection, being flexible and  adaptable, and being efficient and effective. When we asked regulators,  industry participants, consumer advocacy organizations, and researchers  that we contacted to comment on the advantages and disadvantages of  the two regulatory options, they most frequently cited issues related to  these three elements. (For more information on our methodology, see  app. I.)
Federal and state regulators, industry participants, researchers, and a  consumer advocacy organization we contacted generally regarded all of  the elements as somewhat or very important to regulating person-to- person lending. However, they agreed that having a systemwide focus  and minimizing taxpayer exposure were less significant considerations at  present, but some thought that such considerations could become more  significant if the person-to-person lending industry and participating firms  were to grow dramatically.

		While the Current Regulatory System Generally Protects Borrowers and Lenders, Some Industry Observers Questioned Its Flexibility and Efficiency

As we have seen, the current regulatory system provides borrowers and  lenders on for-profit, person-to-person lending platforms with protections  consistent with those afforded to conventional bank borrowers and  investors in registered securities. The current regulatory regime for  person-to-person lending does not have goals and agency responsibilities  that are specific to the industry and its activities. Rather, it applies broader  consumer financial and securities laws, regulations, and agency oversight  and enforcement responsibilities to this new industry.
SEC staff noted that comprehensive protections of the type afforded to  investors under federal securities laws are particularly important  considering that some lenders compare returns on the notes they  purchase from the for-profit platforms to relatively risk-free, federally  insured bank products. They explained that the breadth and scope of  disclosure and attendant liability for false disclosure under these laws are  key to investor protection. However, some industry observers saw  drawbacks to protecting lenders by relying primarily on the disclosures  required under current securities registration requirements. Specifically:    The disclosure-based approach allows LendingClub and Prosper to  report on loan performance and returns on investment differently.  Four industry observers said that this approach increases the difficulty  to lenders of assessing risk and potential returns and comparing  performance across the platforms. Staff from SEC’s Division of  Corporation Finance said that SEC could potentially encourage or  require Prosper and LendingClub to report in the same way, either  through the SEC staff comment process for the companies’ financial  disclosures or by proposing a rule that would require them to use  consistent reporting methods. However, SEC staff pointed out that  there could be trade-offs between the benefit to lenders of  standardized reporting and the additional reporting burden on the  companies. They also noted that proposing a rule would entail a  substantial investment of SEC’s limited staff resources to address an  issue that currently affects only two registered companies.   Three industry observers we interviewed noted some concerns about  the limited role of securities regulators in helping ensure lender  protection if a person-to-person lending company entered bankruptcy.  As we have seen, because lenders who hold notes do not have a  direct security interest in the corresponding borrower loans, their  rights could be uncertain if the platform were to enter bankruptcy.  Prosper and LendingClub’s prospectuses disclose this risk and  describe their back-up plans for servicing loans. However, staff from  SEC’s Division of Corporation Finance said that prescribing steps that  a person-to-person lending company should take to protect lenders in  case of a bankruptcy would be inconsistent with the role of securities  regulation—a role that is intended to ensure adequate disclosures for  investors rather than to regulate companies’ operations.
Four industry observers also raised concerns about the flexibility and  adaptability of securities regulation as it is applied to person-to-person  lending. SEC staff members and three industry observers said that, under  the current regulatory system, issuing securities is central to the business  of person-to-person lending companies, so the companies’ ability to  navigate securities regulation requirements is critical to their success.  However, four industry observers questioned the applicability of securities  regulations to person-to-person lending, in part because securities  regulation treats the platforms as issuers of a debt security, while in  actuality borrowers are responsible for fulfilling the debt obligation. Three  commentators questioned whether securities requirements that preceded  the emergence of the person-to-person lending industry could continue to  be applied to the industry without stifling its innovation and growth—that  is, they questioned whether the current system was adaptable and  flexible enough to respond to this nascent industry. For example, officials  from one company said that the company’s ability to quickly adapt to  changing market conditions or to experiment with changes to its business  model had at times been hampered by the time and cost involved in  amending its prospectus to reflect such changes.
To some extent, some of these concerns have been alleviated or will  likely be addressed in the future. According to officials from Prosper and  LendingClub, SEC staff have developed an understanding of person-to- person lending and have been increasingly receptive to working with the  companies involved to enable them to meet registration requirements in a  way that fits with their business models. For example, officials from  Prosper and LendingClub said that SEC staff were considering the  companies’ proposal to streamline how the companies would disclose  changes to their credit policies and lending terms to reduce the time and  cost involved. Also, SEC staff said that they were willing to continue to  work with the companies through the comment process on their ongoing  filings. But they also noted that their role was primarily to respond to  proposals or analyses of concerns provided by the companies, not to  suggest changes themselves.
Industry observers we interviewed raised other concerns about the  efficiency of using securities regulation to provide lender protection,  noting in particular the burdens that the registration process imposed on  existing firms and potential new entrants. For example, because each  borrower’s loan corresponds to a series of lenders’ notes that can be for  as little as $25, Prosper and LendingClub must register a large volume of  notes with relatively small denominations. Officials from LendingClub  and Prosper said that it was costly to establish their processes to register  these series of notes in their prospectus supplement filings, although they  have reduced their ongoing costs by largely automating the filings. SEC  staff and officials from both companies agreed that lenders were unlikely  to consult these filings, except for litigation purposes. One researcher  also questioned the utility of the prospectus supplement filings and  suggested that their volume could make it difficult for investors to identify  disclosures containing more useful information.
Four industry observers also suggested that new entrants could  effectively be barred from entering the market by the cost and other  burdens associated with securities registration, which two of them said  restricts competition and discourages development of new credit options  for consumers. Whereas Prosper and LendingClub launched their  platforms and had built a base of borrowers and lenders before they  registered with SEC and state securities regulators, new person-to- person lending companies would likely need to register before launching  platforms under the current regulatory system. New entrants could  potentially begin to sell notes without registering with SEC or could meet  reduced registration requirements under existing exemptions—such as  those for small offerings or private offerings that are made available only  to a limited number of sophisticated investors. However, SEC staff noted  that the existing exemptions might not be compatible with the business of  person-to-person lending companies, which have generally been widely  available online and have sought to attract investment from many lenders.  Instead, these staff noted that SEC could use rulemaking to exempt  securities issued for person-to-person lending from certain registration  requirements but only if its commissioners deemed doing so to be in the  public interest.
At least three industry observers also raised concerns about the burdens  associated with meeting varying state securities registration  requirements. Officials from Prosper and LendingClub said that the  registration process at the state level had already been costly and  laborious, and 20 states had yet to approve either of their registration  applications. One former industry executive said that the burden of state  securities requirements, and particularly the states’ ability to impose  varying financial suitability requirements, was a key consideration in his  company’s decision to exit the market rather than pursue federal and  state registration. Officials from the major for-profit platforms suggested  that the notes of person-to-person lending companies should be exempt  from state registration requirements, as the securities of companies listed  on national exchanges are. However, officials from NASAA and selected  state securities regulators said that the states play an important role in  helping ensure investor protection, and those officials generally favored  states’ continued participation in securities regulation of the person-to- person lending industry. Furthermore, to promote greater consistency in  how states reviewed the registration statements of person-to-person  lending companies, NASAA officials said that it was considering two  options: (1) a comprehensive policy statement applicable to person-to- person lending, or (2) particular standards for merit review that states  could use in reviewing applications of person-to-person lending  companies.

		Although a Consolidated Regulatory Approach Could Provide Adequate Protections, Its Flexibility, Efficiency, and Effectiveness Are Uncertain

Depending on how it was implemented, a consolidated approach to  borrower and lender protection could continue to provide borrowers on  person-to-person lending platforms with the protections they currently  receive. But how the protections provided to lenders would compare with  those under the current regulatory system is uncertain. As they do under  the current system, borrowers would presumably continue to receive the  same kinds of protections afforded to borrowers using more traditional  sources for consumer or commercial credit. Also, legislation adopting a  consolidated regulatory approach could create specifically targeted  protections Congress deemed necessary, such as industry-specific  authority to perform supervisory examinations of person-to-person  lending companies’ compliance with requirements for both borrower and  lender protection. While CFPB could also be given the authority to  prescribe lender protections under a consolidated regulatory approach, it  is uncertain whether CFPB would require disclosures for lenders that are  similar in substance to those required under securities regulation, whether  any required disclosures would be more or less extensive, and whether  any required disclosures of borrower and loan information would be made  publicly available. In addition, legislation could authorize liability for false  disclosure. Furthermore, legislation adopting a consolidated regulatory  approach could authorize CFPB to go beyond the current disclosure  requirements by prescribing standardized reporting on loan performance  and returns on investment or requiring companies to take steps related to  the effect on lenders of a company’s bankruptcy. While such steps could  address the concerns about lender protection under the current system  that we noted earlier, the benefits to lenders would need to be weighed  against the burden that such requirements would impose on the  companies involved.
Three of the industry observers we interviewed suggested that a  consolidated regulatory approach might be better suited than the current  system to resolve tensions between borrower and lender protection. Two  of them cited, for example, the tension in person-to-person lending  between lenders’ interests in gaining valid information about the credit  risk they are assuming and borrowers’ privacy interests. Borrowers have  the discretion to determine how much personal information to provide  anonymously with their loan requests, and the platforms could address  any concerns that borrowers raised about their privacy by limiting the data  they request. Nonetheless, these commentators thought that it would be  beneficial to have a consolidated regulator that would be charged with  balancing the need to disclose to lenders material information about  borrowers and loans with borrowers’ concerns about the vulnerability of  such information, when made publicly available, to searching activity that  could result in borrowers being identified by name. However, staff from  SEC cautioned that easing disclosure requirements could reduce lender  protections and suggested that, considering the financial risks facing  lenders who participate in the platforms, it would be important for a  consolidated regulator to seek to ensure at least the same level of lender  protection as the current system provides.
Adopting a consolidated regulatory approach would provide an  opportunity to examine the appropriate level of oversight for nonprofit  platforms, particularly with respect to lender protection. The researchers  we interviewed all questioned whether it was appropriate that a nonprofit  platform that offered no returns to lenders would not be subject to  disclosure requirements, while one that offered minimal returns potentially  would be subject to the full burden of securities registration requirements.  The researchers all suggested that nonprofit platforms should be subject  to financial regulation rather than disclosing risks to lenders only on a  voluntary basis, as they do now. A consolidated regulatory approach to  person-to-person lending could be designed to encompass nonprofit  platforms. However, Kiva officials suggested that the costs of imposing  additional regulatory burden on nonprofit platforms might outweigh the  benefits of regulation to philanthropically motivated lenders.
The flexibility, efficiency, and effectiveness of creating a new regulatory  regime under a new agency are uncertain. Depending on how it was  implemented, a consolidated regulatory approach that vested  responsibility for borrower and lender protections in a single agency could  potentially be more efficient than the current system, and it could  potentially be designed to adapt to changes in the industry. However,  seven of the federal and state regulators and industry observers we  interviewed cited uncertainties about how a consolidated regulatory  approach would be defined in statute and regulation or how CFPB would  carry out its responsibilities, making it difficult to predict how flexible,  adaptable, and efficient CFPB would be were it to become the  consolidated supervisor for person-to-person lending. Three  commentators were uncertain how effective CFPB would be in protecting  lenders on person-to-person lending platforms, in part because the Dodd- Frank Act generally focuses the agency’s mission and jurisdiction on  protection of consumers of financial products and services rather than on  protection of investors. Furthermore, officials from both of the major for- profit platforms raised concerns about the costs of transitioning to a new  regulatory regime, especially considering that they had already invested  substantial costs and time adapting to the current one. Also, officials from  one of the firms raised concerns that, under a consolidated regulatory  approach, lenders who were already familiar with and reliant on the  protections afforded by securities regulation might be less willing to invest  in notes on the platforms and thus could set back the industry’s growth at  least temporarily. Company officials also raised a concern that losing the  precedent set by SEC and the courts in securities-related rulings would  create uncertainty for the industry.
Furthermore, reductions in the regulatory burden on person-to-person  lending companies under a consolidated regulatory approach would likely  be limited if state securities regulations continued to apply. Officials from  NASAA and the state securities regulators we interviewed said that even  if person-to-person lending was exempt from federal securities law, the  notes the companies sold could still be treated as securities under state  law. In that case, person-to-person lending companies might still be  required to register with state securities regulators to allow lenders in  those states to participate.

		Further Changes and Growth in Person-to- Person Lending Could Pose New Regulatory Challenges

The continuing evolution and growth of person-to-person lending could  give rise to new regulatory concerns or challenges, making it difficult to  predict what the optimal regulatory structure will be. For example, while  the major for-profit platforms have focused on providing relatively  straightforward unsecured consumer loans, they and other platforms have  explored or could explore more complex loan products, other forms of  lending—such as auto loans or mortgages—or variants on the concept of  person-to-person lending that could affect regulatory concerns, such as  ensuring the fairness and transparency of lending terms and practices.  Also, the major for-profit platforms have increasingly been attracting  sophisticated individual and institutional investors, and the potential exists  for these and other platforms to offer advisory services to these investors  that could introduce new regulatory issues. For example, LC Advisors,  LLC, a wholly owned subsidiary of LendingClub, has registered with SEC  and state securities regulators as an investment adviser firm that will offer  and manage separately managed accounts and other services for high  net worth and institutional clients to invest through the LendingClub  platform. Furthermore, platforms could develop different features or  products for lenders—such as allowing companies to select loans on a  lender’s behalf or allowing lenders to invest in pools of loans assembled  by the company—that have generally been subject to regulation by SEC.  Such activities could raise new questions about protecting the interests of  lenders and, if a consolidated regulatory approach were adopted, could  introduce challenges in defining and coordinating CFPB’s and SEC’s  regulatory jurisdictions.
In addition, the regulators and industry observers we contacted did not  raise having a systemwide focus and minimizing taxpayer risk as  significant regulatory considerations because of the small size of the  market and the firms involved in person-to-person lending. Further, two  industry observers suggested that, from a systemwide perspective, one of  the potential benefits of person-to-person lending is that it shifts credit risk  from banks and nondepository lenders to individual lenders. Five of the  regulators and industry observers we contacted suggested that  systemwide concerns could increase only if the industry grew dramatically  and were to focus more on attracting large institutional investors.
Regardless of whether the current regulatory system is retained or a  consolidated approach is adopted, mechanisms currently exist for  monitoring the person-to-person lending industry for emerging risks and  regulatory challenges. Staff from SEC’s Divisions of Corporation Finance,  Trading and Markets, and Investment Management said that they  routinely monitor changes in Prosper’s and LendingClub’s business  models through their review of the companies’ securities registration  filings, and they noted that the companies’ growth would be evident  through their required disclosures. Also, as previously discussed, CFPB’s  duties include researching, monitoring, and reporting on developments in  markets for consumer financial products and services to, among other  things, identify risks to consumers. However, CFPB representatives said  that the agency is still in the process of developing this function and that  they had not determined the methods by which the agency would monitor  the industry. Finally, FSOC could come to play a role in monitoring the  industry if person-to-person lending were to grow dramatically.

	Agency Comments and Our Evaluation

We provided a draft of this report for review and comment to FDIC, the  Federal Reserve, FTC, NASAA, NCUA, SEC, and Treasury (including the  CFPB implementation team). We also provided relevant excerpts from the  draft report to UDFI, the four state securities regulators we interviewed,  Kiva, LendingClub, Prosper, WebBank, and Zopa for review and technical  comment. These agencies and companies provided technical comments,  which we incorporated as appropriate. In addition, we received written  comments from the Deputy Associate Director of Research, Markets &  Regulations, CFPB; the Director of the Division of Depositor and  Consumer Protection, FDIC; and the Chairman of SEC, which are  summarized below and reprinted in appendixes III to V.
In its written comments, CFPB said that the person-to-person lending  industry could have significant implications for consumers seeking  alternative sources of credit. CFPB agreed and stated that monitoring the  industry as it evolves would be important and, as the draft report noted,  CFPB will collect and analyze complaints about consumer financial  products and services over time. Additionally, CFPB noted that it expects  to keep abreast of consumers’ experiences with providers of person-to- person lending and developments in the industry.
FDIC in its written comments stated that it agreed with our description of  the types of risks identified related to person-to-person lending as well as  the federal consumer protection laws and regulations that may be  applicable. FDIC said that, as the draft report noted, there is one FDIC- supervised institution currently involved in person-to-person lending.  FDIC noted that its supervisory program examines for these products  from both a risk-management and a consumer-protection perspective,  including a review of third parties involved in the offering of the product as  appropriate. FDIC said that it will continue to monitor this evolving  industry and adjust its supervisory program as warranted.
In its written response, SEC said that the draft report provided a  comprehensive overview of the person-to-person lending industry and an  important contribution to the overall understanding of the regulatory  structure of the industry. SEC stated that for several years, its staff have  been actively involved in working with the two for-profit platform  operators, Prosper and LendingClub, to facilitate ways for them to  conduct their offerings in a manner that realizes their business objectives  and is consistent with the federal securities laws. SEC said that, because  Prosper and LendingClub conduct registered offerings of securities,  investors in these securities are being provided with the information they  need to make informed investment decisions and have the protections of  the liability and antifraud provisions of the Securities Act of 1933 and the  Securities Exchange Act of 1934. SEC also said that Prosper and  LendingClub file prospectus supplements containing the information that  borrowers voluntarily disclose on the companies’ Web sites because that  information—particularly credit report data—is the basis on which  investment decisions are being made. SEC said that, while it remains  concerned about any violation of borrowers’ privacy rights in this  information, it believes that these rights should be addressed within a  framework where investors continue to receive appropriate disclosures  and protections to which they are entitled under the federal securities  laws. SEC stated that, as indicated in the draft report, the person-to- person lending industry is relatively new and that future innovations could  pose new regulatory challenges. SEC said that the Commission and its  staff seek to be vigilant in this regard and that they look forward to helping  address concerns about the adequacy and effectiveness of the current  regulatory structure.
We are sending copies of this report to interested congressional  committees, the Chairman of FDIC, the Chairman of the Federal Reserve,  the Chairman of the FTC, the Executive Director of NASAA, the Chairman  of NCUA, the Chairman of SEC, and the Secretary of the Treasury. This  report will also be available at no charge on the GAO Web site at  http://www.gao.gov.
If you have any questions about this report, please contact me at (202)  512-8678 or sciremj@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO staff who made key contributions to this report are  listed in appendix VI.

Appendix I: Objectives, Scope, and Methodology

Our report objectives were to address (1) how the major person-to-person  lending platforms operate and how consumers use them; (2) the key  benefits, risks, and concerns that person-to-person lending poses for  consumers and how the risks are currently regulated; and (3) advantages  and disadvantages of the current and alternative approaches to regulating  person-to-person lending.
To describe how the major person-to-person lending platforms operate  and how consumers use them, we reviewed existing studies and reports  related to the operation of major person-to-person lending platforms and  the regulatory challenges for both the for-profit and the nonprofit  platforms. We interviewed executives from the three major U.S. firms  operating person-to-person lending platforms—two for-profit companies  (Prosper Marketplace, Inc. (Prosper) and LendingClub Corporation  (LendingClub) and one nonprofit organization (Kiva Microfunds (Kiva))— and the bank (WebBank) that partners with Prosper and LendingClub to  disburse loans made through their platforms. We reviewed materials on  the companies’ Web sites and documents on their operations, in  particular information on how the platforms work for both lenders and  borrowers. For the for-profit companies, we further reviewed offering  documents (i.e., prospectus and prospectus supplements) and quarterly  and annual reports. Additionally, we obtained data from the companies  and their Web sites regarding loan performance and consumer  characteristics. We did not independently verify the data the companies  provided. We assessed the reliability of these data by reviewing relevant  documents, including the for-profit companies’ audited financial  statements filed with the Securities and Exchange Commission (SEC),  and interviewing company officials. We concluded that the data were  sufficiently reliable for our purposes. We also interviewed representatives  of three companies that previously operated platforms in the United  States, and two foreign person-to-person lending companies operating  abroad. Furthermore, we reviewed online discussion forums where  borrowers and lenders on the platforms post their views, to obtain more  direct information on the purposes for which consumers use both the for- profit and nonprofit person-to-person lending platforms.
To identify the key benefits, risks, and concerns that person-to-person  lending poses for consumers and how the risks are currently regulated,  we interviewed executives from the three major U.S. person-to-person  lending platforms and reviewed regulatory filings and relevant documents.  We also reviewed laws that may be applicable to the platforms and their  third-party relationships, including the Securities Act of 1933, the Truth in  Lending Act, Section 5 of the Federal Trade Commission Act, and the  Gramm-Leach-Bliley Financial Modernization Act. Furthermore, we  reviewed relevant regulations and guidance and interviewed officials at  the Bureau of Consumer Financial Protection (known as the Consumer  Financial Protection Bureau or CFPB) implementation team at the  Department of the Treasury (Treasury), Federal Deposit Insurance  Corporation (FDIC), Board of Governors of the Federal Reserve System  (Federal Reserve), Federal Trade Commission (FTC), National Credit  Union Administration (NCUA), SEC, and Treasury officials involved with  the Financial Stability Oversight Council, as well as the Utah Department  of Financial Institutions (UDFI), and the North American Securities  Administrators Association (NASAA). Because state securities regulators  approach person-to-person lending differently, we interviewed four state  securities regulators—California, Kentucky, Oregon, and Texas—to  understand the risks and concerns they have identified. Specifically, we  selected states with merit-review standards (as opposed to less complex  disclosure-review standards similar to the federal securities regulation  system) that had approved both, one, or neither of the securities  registration statements of the two major for-profit U.S. platforms. In  addition, we conducted interviews with three consumer advocacy  organizations—the Center for Financial Services Innovation, Consumer  Federation of America, and Consumers Union. Three organizations that  we contacted declined to participate because the person-to-person  lending industry is beyond the scope of their work. To assess the  potential risk of disclosure of personally identifiable information, we  randomly selected a small sample of prospectus supplements which the  two major for-profit platforms are required to file with SEC, from the  period from August 31, 2010, through November 26, 2010, and  systematically reviewed a sample of the loan listings to identify any  examples of where the borrowers disclosed enough information with their  loan requests to allow them to be potentially identified by name. (See  app. II for more details on this analysis.)
To identify the advantages and disadvantages of the current and  alternative approaches to regulating person-to-person lending, we  reviewed previously proposed legislation and discussed other regulatory  options with relevant federal and state officials, executives and  representatives from person-to-person lending companies, researchers,  and consumer advocacy organizations listed earlier. While other options  may exist for a consolidated regulatory approach including assigning  responsibility to a different federal regulator, such as SEC or one of the  federal banking regulators, we focused on two options most frequently  identified by the entities we interviewed and that were considered in  legislation. First, we considered the current regulatory structure. Second,  we focused on the possibility for a consolidated regulatory approach  under CFPB because it is assuming a role in supervising nondepository  lenders and because the version of the Dodd-Frank Wall Street Reform  and Consumer Protection Act (Dodd-Frank Act) passed by the House of  Representatives included a provision that would have exempted person- to-person lending from federal securities regulatory requirements and  vested primary jurisdiction for regulating person-to-person lending  platforms and their lending activities in the new consumer financial  protection agency, now known as CFPB. The provision would have  created an exemption from federal securities requirements for person-to- person lending in section 3(a) of the Securities Act of 1933 (15 U.S.C. §  77c(a)) and would instead have given CFPB the authority to prescribe  regulations or issue orders pertaining to person-to-person lending,  including disclosure requirements with respect to the sale of loans, or  notes representing an interest in loans, to individuals. However, the  provision was not included in the Senate or enacted versions of the Dodd- Frank Act. We assessed the advantages and disadvantages of these two  primary options we identified using our previously developed framework  for evaluating proposals for financial regulatory reform, which consists of  nine elements that are key to developing a successful financial regulatory  system. We contacted 20 of the entities we interviewed to obtain their  views on the importance of the elements of this framework and received  11 responses, from CFPB representatives, FDIC, SEC, one state  securities regulator, the two major U.S. for-profit platforms and the bank  that they work with to disburse loans, three researchers, and one  consumer advocacy organization. On the basis of their ratings and the  information we obtained through our interviews and other research, we  chose to focus our discussion of the advantages and disadvantages of  the two regulatory options for person-to-person lending on three of the  nine elements from our framework—consistent consumer and investor  protection, regulatory flexibility and adaptability, and efficiency and  effectiveness.
We conducted this performance audit from August 2010 to July 2011 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: Analysis of Prosper and LendingClub’s Prospectus Supplement Filings

Prosper and LendingClub, the two major U.S. for-profit, person-to-person  lending platforms, have registered as securities the series of notes that  they continually offer to investors to fund corresponding loans. The  companies thus are required to update their prospectuses, filed with the  SEC, with supplements containing information about the notes and their  corresponding loans as they are offered and sold. Because certain terms  of the notes sold to lenders—such as maturity date, interest rate, and  amount—depend on the terms of the corresponding loans, Prosper and  LendingClub submit prospectus supplements to disclose information  about the notes they offer and sell. Specifically, the companies submit  prospectus supplements to disclose information about the notes they offer  one or more times per business day, before they post the corresponding  loan requests to their Web sites. They also submit prospectus  supplements on a daily or weekly basis to disclose information about the  notes they have sold. The prospectus supplements include required  information on the terms of each note, such as interest rate and maturity.  Prosper and LendingClub also include other information concerning the  underlying loan that is available to lenders on their Web sites as part of  the loan listing, including anonymous information from the borrower’s  credit report, anonymous information supplied by the borrower, such as  loan purpose, employment status, and income, and (in the case of notes  sold) the borrower’s online responses to questions posted by lenders.  These prospectus supplements are publicly available through SEC’s  online Electronic Data Gathering, Analysis, and Retrieval System  (EDGAR).
Borrowers face the risk that they may reveal enough information as part  of their loan requests to permit the platforms’ members and members of  the public (through EDGAR) to deduce their identities. Lenders could  attempt to identify borrowers by name and contact them (for example,  regarding loan repayment) but such an action would violate the terms of a  lender’s agreement with either platform. Officials from Prosper said that  they were not aware of any incidents of lenders identifying and attempting  to contact borrowers but that they would expel lenders from the platform if  that did occur. Also, some current and former industry participants raised  a concern that EDGAR users could attempt to search LendingClub’s and  Prosper’s prospectus supplements to obtain identifiable information about  borrowers.
To assess the potential for disclosure of information in prospectus  supplements that could be used to identify borrowers by name, we  reviewed selected prospectus supplements describing notes that  LendingClub and Prosper sold, and their corresponding loans.  Specifically, we randomly selected 4 weeks from the period August 31,  2010, through November 26, 2010, and obtained from EDGAR all  prospectus supplements that both companies filed, listing notes sold,  during those weeks. Within the selected prospectus supplements, we  reviewed every fifth loan listing to identify examples of information that  could potentially be pieced together to infer someone’s identity using  additional Internet research or telephone calls.
Of the 275 loan listings that we reviewed in the selected prospectus  supplements, we identified 47 instances where we thought that borrowers  potentially revealed information that could be used to determine their  identities. In nearly all of these cases, borrowers revealed information  about their location, employer, and job title or occupation, often in  combination with personal information—such as their first or last names  or initials, or details about marriages, divorces, bankruptcies, or their  children—that we thought could potentially be used to identify them by  name. However, in many of these cases, substantial effort might be  needed to identify borrowers, such as contacting employers directly to  match a job title with a name or searching for marriage announcements.  In a few remaining cases, borrowers voluntarily provided a business  name or Web site address to support a loan request for small business  purposes. We shared the results of our analysis with officials from  Prosper and LendingClub, who confirmed our assessment that the  information we identified could be used to identify some borrowers.
On April 15, 2011, after the time period covered by our analysis,  LendingClub adopted changes to its question-and-answer process that  company officials said were intended to reduce the likelihood that  borrowers would reveal personally identifiable information. LendingClub’s  loan listings have fields for borrowers to enter their current city and state  of residence and employer name, information that company officials said  its lenders considered important in evaluating borrowers and their  creditworthiness. In addition, prior to April 15, 2011, LendingClub’s  borrowers could voluntarily reveal their job title or occupation in their loan  descriptions or in their optional responses to lenders’ online questions.  LendingClub officials said that, on that date, the company modified its  question-and-answer process to only permit lenders to select from a set  of “pre-screened” questions approved by LendingClub and WebBank.  The officials said that LendingClub also screens each borrower’s answers  and loan descriptions for personally identifiable information or information  that could be reasonably combined to identify the borrower, including the  borrower’s job title or occupation.
We did not assess the extent to which borrowers on the platforms are  aware that the anonymous information they disclose with their loan  requests can be accessed by the general public. LendingClub’s privacy  policy discloses to borrowers that their personal, but not personally  identifiable, and financial information contained in loan listings are filed  with SEC and, as such, are made publicly available. In addition,  LendingClub officials said that, during the loan application process, the  company labels certain information fields that are completed by the  borrower as being publicly available. During the time period covered by  our analysis, Prosper’s privacy policy did not contain a similar disclosure,  nor did its terms of use statement or borrower agreement. However, in  June 2011, Prosper officials said that the company intended to modify its  privacy policy to provide such a disclosure.
While the Gramm-Leach-Bliley Financial Modernization Act restricts the  sharing of nonpublic personal information by financial institutions with  unaffiliated third parties, the act exempts disclosures that are necessary  to effect, administer, or enforce a transaction that the consumer has  requested. Staff at the CFPB, FDIC, and the Federal Reserve indicated  that a detailed legal analysis would be necessary to evaluate any  potential legal concerns related to privacy protection for borrowers on the  platforms.

Appendix III: Comments from the Consumer Financial Protection Bureau

Appendix IV: Comments from the Federal Deposit Insurance Corporation

Appendix V: Comments from the Securities and Exchange Commission

Appendix VI: GAO Contact and Staff Acknowledgments

	GAO Contact

	Staff Acknowledgments

In addition to the individual named above, Harry Medina, Assistant  Director; Emily Chalmers; William Chatlos; Rachel DeMarcus; Julianne  Dieterich; Chir-Jen Huang; Matthew McDonald; Marc Molino; and Patricia  Moye made key contributions to this report.

Summary:
Why GAO Did This Study

Over the last decade, Internet-based platforms have emerged that allow individuals to lend money to other individuals in what has become known as person-to-person lending. These online platforms present a new source of credit for borrowers and a potential investment opportunity for those with capital to lend. Both for-profit and nonprofit options exist, allowing for income-generating and philanthropic lending to a variety of people and groups around the world. The Dodd- Frank Wall Street Reform and Consumer Protection Act directed GAO to conduct a study of person-toperson lending. This report addresses (1) how the major person-to-person lending platforms operate and how lenders and borrowers use them; (2) the key benefits and risks to borrowers and lenders and the current system for overseeing these risks; and (3) the advantages and disadvantages of the current and alternative regulatory approaches. To do this work, GAO reviewed relevant literature, analyzed regulatory proceedings and filings, and interviewed federal and state officials and representatives of the three major person-to-person lending platforms currently operating in the United States. GAO assessed options for regulating person-to-person lending using a framework previously developed for evaluating proposals for financial regulatory reform. The Bureau of Consumer Financial Protection, Federal Deposit Insurance Corporation, and Securities and Exchange Commission provided written comments on the report, and they all noted the need to continue to monitor the development of the industry.

What GAO Found

The three major U.S. person-to-person lending platforms facilitate lending by allowing individuals acting as lenders to invest in loans to individual borrowers. Prosper Marketplace, Inc. (Prosper) and LendingClub Corporation (LendingClub), the two major for-profit platforms, screen and rate the creditworthiness of potential borrowers. Individual lenders (and a growing number of institutional investors) browse the approved loan requests on the companies' Web sites and purchase notes issued by the company that correspond to their selections. Kiva Microfunds (Kiva), the major nonprofit platform, allows individual lenders to indirectly fund loans to entrepreneurs around the world by funding interest-free loans to microfinance institutions. The three platforms have grown rapidly and, as of March 2011, Prosper and LendingClub had made about 63,000 loans totaling approximately $475 million, and Kiva about 273,000 loans totaling about $200 million. The for-profit companies said that borrowers were often consolidating or paying off debts or were seeking alternate sources of credit, while lenders were seeking attractive returns. Kiva said that its lenders were not seeking to generate income and were motivated mostly by charitable interests. Person-to-person lending platforms offer lenders the potential to earn higher returns than traditional savings vehicles and may offer borrowers broader access to credit. Individual lenders and borrowers face risks that are currently overseen by a complex regulatory structure. For example, lenders risk losing their principal and, on the for-profit platforms, the interest on their investments. Borrowers face risks typical of consumer lending, such as unfair lending and collection practices. Currently, the Securities and Exchange Commission and state securities regulators enforce lender protections, mostly through required disclosures. The Federal Deposit Insurance Corporation and state regulators enforce protections for borrowers on the major for-profit platforms, and the newly formed Bureau of Consumer Financial Protection will also play a role in borrower protection as it becomes operational. The Internal Revenue Service and the California attorney general enforce reporting and other requirements for Kiva as a charitable organization. Kiva's microfinance institution partners are subject to varying consumer financial protection requirements that apply where they lend. The two options that GAO identified for regulating person-to-person lending-- maintaining the status quo or consolidating borrower and lender protections under a single federal regulator--both offer advantages and disadvantages. The current system offers protections that are consistent with those for traditional borrowers and investors. Some industry observers suggested that protecting lenders through securities regulation under this system lacked flexibility and imposed inefficient burdens on firms. Under a consolidated regulatory approach, current protections for borrowers would likely continue and, depending on how implemented, lender protections could be expanded. But uncertainty exists about shifting to a new regulatory regime and about the potential benefits. Finally, regardless of the option selected, new regulatory challenges could emerge as the industry continues to evolve or if it were to grow dramatically, particularly if that growth was primarily due to the increased participation of institutional versus individual investors.