When Are State Securities Regulators Going to Get a Clue About P2P Lending?


Today, Lending Club is available to investors in 26 states on their retail platform (they do allow investors in 17 more states to participate on their trading platform). Prosper is available in 30 states (plus Washington D.C.). This leaves a large section of the country out of luck when it comes to investing in p2p lending. What is going on?

The reason for this is that both Lending Club and Prosper have to register with each state separately. And securities regulators in some states are very conservative when it comes to consideration of p2p lending. This was summarized well by a quote from Chris Naylor, Indiana Securities Commissioner, when talking about p2p lending in last week’s article in the Wall Street Journal:

I understand there is a credit crunch and these platforms are providing an alternative. But there are limitations on the financial data that is available, and a chance of default, so we need to protect investors.

This line of thinking is common among many state securities regulators. Now, Naylor did not elaborate exactly what he meant by “limitations on the financial data”. My calls to Naylor’s office have not been returned so one can only guess as to what he means here.

In an interview on CNBC’s Squawk Box last Friday, Lending Club’s CEO Renaud Laplanche was asked about the above quote from Naylor. I completely agree with his response. Lending Club is very transparent, providing detailed information on every borrower and the entire loan history is available to download for analysis by investors. But I would have also added that well-diversified investors are not losing money.

What Are Securities Regulators Protecting Investors From?

Every day I see investors who get excited about p2p lending only to be disappointed when they find out their state doesn’t allow it. I receive more emails about this one issue than any other topic.

It has been well documented on Lending Club that investors with a diversified portfolio of loans have made money. Looking at their latest charts 99.9% of investors with at least 100 loans have enjoyed a positive return. Prosper also talks about the success investors have when diversifying into at least 100 different loans.

Which begs the question: what are these securities regulators so worried about? It is quite legal for any investor to put their entire life savings into a penny stock and lose everything. Or put everything into a “sure thing” real estate deal. Or spend their life savings on Powerball tickets. In fact, there are an almost infinite number of ways in which investors can lose a great deal of money. But a diversified p2p lending portfolio isn’t one of them.

P2P Lending Is Proving Itself

We now know that p2p lending is not a scam or a pyramid scheme as some have previously suggested. Lending Club and Prosper have been regulated by the SEC for over four years now and have been filing publicly available quarterly and annual reports on the state of their business. With every major announcement they have to file an 8-K with the SEC. These companies are under far greater scrutiny than almost any other private company in financial services.

There is a 7-year track record now and no examples of investors being ripped off. However. we know that in Prosper’s early days there were many investors who suffered losses (due to lax underwriting that improved dramatically in 2009) but investors who lose money today do so because of poor diversification. This is something that can be easily avoided by doing a small amount of research on p2p lending best practices.

I scour social media and the internet every day for mentions of p2p lending. The only people who complain on a regular basis are borrowers who have been rejected for a loan. Investors are not complaining about Lending Club or Prosper. P2P lending is coming of age and proving itself month after month with investors.

A Safer Investment Than the Stock Market?

I have been investing in the stock market now for over two decades. I have seen the dot-com bubble and crash of 2000-01 and the financial crisis of 2008. One thing every investor knows today is that the stock market can go up as well as down and it can do so quickly. This is one of the reasons why there is not much excitement about the new stock market highs that have been reached recently. We have been burned before.

I look at my p2p lending accounts and I see a different picture. Every month my account totals go up – it happens consistently with remarkably small deviations. So, I ask the question again to securities regulators: what are you afraid of about p2p lending?

What to do if Your State Does Not Allow P2P Lending

The list of securities regulators for every state is provided here on the North American Securities Administrators Association website. Make your voice heard and contact your state regulator. Tell them it is ludicrous that you cannot invest in what is becoming a proven asset class. You should also call your state representatives, particularly those politicians who oversee Finance Committees in your state.

I happen to be lucky. I live in a state (Colorado) that blesses p2p lending as an investment. But if I happened to live in Ohio, Vermont or Kansas then I would have had to chose a different career. Then, of course, there are those states that “kind of allow” p2p lending. These are the states that don’t let you invest in new loans but once the loan has been issued you are free to invest in the secondary market. Don’t get me started on how illogical that situation is.

It is common knowledge that Lending Club is planning an IPO some time next year. One little known fact is the “blue sky exemption” rule which means that once they launch an IPO they will suddenly be open to investors in all 50 states. This means that state securities laws will become irrelevant for Lending Club investors then.

So, be patient. We don’t really have to wait for state securities regulators to get a clue. Soon, every investor will be able to enjoy the excellent returns provided by consumer credit. It is only a matter of time.


  1. RawRaw says

    A lot of bold claims in this piece. I’m sure many of the same claims could have been made in the Madoff ponzi scheme. I’m a LC investor. . . but this doesn’t come off as particularly unbiased.

    • says

      I never claimed this was an unbiased piece. I am a firm believer in p2p lending as an asset class so as such I am most definitely biased. But the securities regulator in question, whose quote prompted this article, never mentioned a Ponzi scheme – he was saying there was not enough financial data available and there was a chance of default. This article is trying to address both those issues.

    • Dan B says

      Rawraw………….. Most journalists claim that “unbiased” is their default position & that they try their best to stay true to that ideal. Of course the degree of their success varies widely & they are often raked over the coals over these perceived failings.

      Peter, on the other hand, avoids all this by cleverly & openly stating that when it comes to p2p, his default position is “biased”. In this reality the word “biased” is freed from its derogatory connotation. Of course the end result of this position is that we are therefore forced to assume that everything Peter writes is biased unless he specifically states otherwise. Did I get that right? :)

    • says

      Amen. Peter being industry cheerleader, I never assume that he is unbiased and take everything he writes with a grain of salt.

      I think both Renaud and industry cheerleaders are ignoring the P2P risk. Sure financial data is available but the main issue is risk assessment and management capabilities of the investors in P2P. How many P2P investors know how to asses and manage risk? Everyone, from bloggers to LA forum participants, are focusing on returns and not enough on risk.

      Sooner or later this industry is going to unravel like junk bonds, mortgage backed securities, Russian and Thai debt, and so on …

      • says

        Anil, That is a pretty broad statement that everyone is ignoring the p2p risk. While I am not a risk management expert I have spoken to many people who have decades of this exact kind of experience in consumer credit. Most think that LC and Prosper are doing a mediocre to ok job pricing risk. But they are getting better. As investors without risk assessment capabilities we rely on the platforms to do this for us and we mitigate risk by diversifying into a broad cross section of loans.

        So, I am curious to know exactly how you expect p2p lending could “unravel like junk bonds and mortgage backed securities”. Care to share your thoughts?

        • Dan B says

          Anil…………..To say that this whole thing will “unravel like junk bonds, mortgage backed securities, Russian and Thai debt”, is imo, more than a bit over the top. I know nothing about Thai debt, but in the other cases you cited, it was in one way or another, all about mis-pricing, was it not?

          I agree with you in that most retail p2p investors aren’t focusing enough on “risk”. I’ve also stated on numerous occasions these last 3 + years that the return numbers that were at one time or other stated, inferred, suggested etc etc. by LC & Prosper were not going to be achieved by the vast majority of investors (retail or institutional).

          The companies have already proved that I was correct by substantially raising default projections & by deleting references to 9% & 10% type return numbers. I have also said many other things around here that gained me few cheerleader friends. So yes, most people aren’t going to hit the numbers they aim for, yes there will be more defaults than expected & yes, longer term retail investors will hit the exits (& not even come in the door) if/when medium term CD rates hit 5-6%. I’ve run through 10 other negative scenarios & though the results weren’t pretty, none of them led to the “unraveling” scenario of the Russian debt market, or junk bonds et al that you’ve compared this to. I’m sorry I just don’t see how p2p unravels on that scale or in that fashion.

      • Hippo387 says

        I think Anil makes a good point, if overstated. Personally I don’t foresee a big “unravel”, but I do think high risk loans (yielding15-20%+) may disappoint investors during certain periods of time. Those loans get snapped up immediately and the LA forum complains about it (rather than being happy with a decent selection paying 7-12%). I would not be surprised if, over 10-15 years, more conservative loans outperform. We’ll see. The point is, P2P investors are probably not focusing enough on “risk-adjusted returns” and the platforms could do a better job of emphasizing the concept.

        • says

          Hippo, You bring up an excellent point and one that should be emphasized more. The higher interest loans have high interest for a reason – these people are more economically fragile. If we get another 2008-2009 then I agree with you, I think the B and C grade loans will outperform all other grades. But I wouldn’t state with confidence that they will outperform all loans over long periods in good economic conditions.

  2. says

    Its almost as if critics are waiting for that day when p2p lending has an overall negative return. Peter, how many years of positive earnings do you think regulators need to see before they would be convinced? How much positive national noteriety will this take? I am curious if this same lag was experienced in any previous introduced avenues.

    • says

      I am not sure what time horizon would be adequate for the regulators – maybe 10 or 20 years of positive returns would be sufficient. The trouble is that these new asset classes often bring out unscrupulous players (think Michael Milken and junk bonds) so regulators are sometimes overly cautious.

      • Rob l says

        You may think this bizarre (and off topic), but I don’t think Michael Milken was unscrupulous. Guess that puts me in the nut case column, but that’s what I think. He was, in a word, “lynched” and took a plea bargain rather than face possible life imprisonment. You will find many people on both sides of this argument, but most agree his philanthropy since then has been remarkably generous. In the interest of full disclosure I was a DBL client back then (stocks, not bonds). Milken’s concept of returns from a diversified portfolio of junk bonds and P2P investors in small portions of junk loans are essentially the same, and possibly why regulators are hesitant. Clearly their view of Milken and mine are 90 degrees apart. Let’s pick another bad guy we can all agree upon (Madoff?).

        • says

          Rob, I really don’t know much about Michael Milken but I think people like him (and of course Madoff) are why many securities regulators look at anything new with a great deal of suspicion.

  3. Dennis says

    “But I would have also added that well-diversified investors are not losing money.”

    “I look at my p2p lending accounts and I see a different picture. Every month my account totals go up – it happens consistently with remarkably small deviations.”

    I will back up your claims Peter, 100%. I’ve been at this exactly 2 years now, and have experienced only 1 month at Lending Club with a negative return, but even at that it was very minuscule. I’ve never had a negative month at Prosper. I have about 1,900 loans and in spite of having routine defaults because of my high risk tolerance, I’m earning a very decent return (15+% between 3 P2P Accounts).

    I see those state regulators who have not yet approved P2P as stodgy, at best. At some point though they must understand that P2P is becoming (or already is?) a mainstream avenue of investment, and is every bit as legitimate as the stock market or any other state approved investment stream. While there is indeed risk, certainly commodities trading or currency trading (both with high leveraging attributes) carries far greater risk than P2P. I hope regulators will soon understand that.


    You mention the 100+ loan success rate being positive for 99%+ of investors, while I can’t specifically comment on that, I can say that anyone who understands the importance of balance and diversification will do well with P2P. Diversity is KEY to success, particularly for high risk tolerant investors. Maybe the concern from regulators is for the idiots who would bet it all at the casino on a single number (clueless and reckless). While anyone in P2P can bet it all on a single loan, stupid as that may sound, that same reckless behavior is certainly available in the stock market, commodity market, currency market, etc., all of them state approved. And on all those platforms, there will always be failures among the foolish, no amount of regulation will ever stop that from happening.

    P2P is here to stay, and it’s time for ALL states to get on board with it.

    • says

      Thanks Dennis. State securities regulators claim that their main purpose is to protect investors from fraud, not from their own stupidity. I probably should have added that point to the main article because there is just no evidence to support fraud going on at the p2p lenders. As I say, there are so many bad choices investors can make that it would be virtually impossible in the capitalist system to protect investors from their own stupidity.

  4. storm says

    I wonder how many state regulators are in the pockets of big banks, and have been lobbied by the big banks to prevent P2P lending from competing on their turf. Most conspicuous to me is North Carolina which is where Bank of America is based. I can’t wait for LC’s IPO to make it all irrelevant.

    • says

      To be honest I don’t think any large bank is lobbying state regulators about p2p lending. It is barely on their radar so I doubt they would put any lobbying resources into it. One day this may change but by then I expect it will be too late….

  5. Neal S says

    There is human psychology at work here. Opinions are formed and hardened, and people are loathe to change their minds even in the presence of overwhelming evidence. No one likes to admit a mistake.

    State regulators aren’t immune from these human tendencies. They aren’t likely to even revisit past decisions without significant pressure.

    • says

      Good point. These state commissioners have already made their decision – what is their motivation for changing it? It is not like they are up for election in November.

  6. Chris says

    Glad to hear about the “blue sky law” implying that LC may be available in my state (Oregon) sooner rather than later. I’m able to use Prosper here, but not Lending Club, two companies with basically the same business model; how ridiculous is that? I’d love to be able to diversify into LC.

  7. Robert Circle says

    I also believe that one thing it consider is Crony State is not protecting you they are protecting those that contribute to their campaigns. I recall a George Carlin quote “When are people going to realize that those in Government don’t give a f**ck about you they just care about how to increase their little empire.”

  8. JamesBWood says

    I’m going to come out and say it: Has it occurred to anyone that what is being protected here is not individual investors or the free market, but traditional banking and credit institutions? The traditional financial industry makes rather large donations to both political parties.

    Peer to peer is a small but rapidly growing segment of the financial industry and has the potential to become a disruptive innovation.

    • says

      I believe it WILL be disruptive to the big banks…but we are nowhere near that point yet. So, I think it is very unlikely that traditional bankers are taking so much notice that they are actively lobbying to curtail the expansion of p2p lending. I just don’t see it.

  9. Long Tail says


    I am thinking about starting my own P2P lending business (and why not?). Are you able to summarize the barriers to entry, in particular, the rules and regs that might preclude this from happening?

    • says

      Starting a p2p lending company is not as easy as it looks. There are three areas you have to get right to have any chance of success:
      1. IT – you need a robust website with excellent security.
      2. Underwriting – you need people on your team who have a great deal of experience underwriting consumer credit.
      3. Marketing – you need to be able to find a steady stream of borrowers at low cost. This is difficult given the competitive environment for good borrowers.

      You also need to be able to raise money – both Prosper and Lending Club raised over $100 million in VC money. If you can’t raise at least $5 million (preferable $10 million) you will have very little chance at making a serious go at it.

  10. says

    P2P lending is the best. I live in OK so I can’t use Prosper and have to use the trading platform for Lending Club. Nevertheless, after probably 8 months of investing, my return is at 6-7%, after accounting for defaults. I haven’t come up with anything with this amount of liquidity that comes close to that return.

  11. Scott says

    Hey Peter and group. I am a fan of P2P. I have an account with LC and hope to open up one with Prosper in the near future. Being a fan, I have cautious optimism because in my eyes, it is possible that this is another Madoff, I hope not but it is possible, correct? Just this month Gowex (Wifi for public spaces in Spain) filed for voluntary insolvency after a 3rd party report of their business practices surfaced. http://www.businessinsider.com/lets-gowex-insolvent-after-gotham-report-2014-7 That was a huge public company with regulators watching them, and their numbers were bogus. I respect the fact that my example is Spain and not USA but it is the most recent example that I can find.

    I believe that the concept of P2P is great. I believe that if the loans are priced right, a healthy return is viable with a diversified account. My worry is, and I dont know how to shake it, is how do we know that all of this is real. For me, it is a website that I log into and I see my nar at 16%. So I smile and I feel good. But like any ponzi or any company that could potentially be cooking the books and the regulators do not realize it, it would start with many proponents like P2P has now and then one day (who knows when) it would come to a crashing halt.You mention that they are highly regulated. Do you know of good resources or have any thoughts as to that these companies have good business practices?

    • says

      Hi Scott, With highly trafficked websites and hundreds of thousands of borrowers and investors it would be next to impossible for Lending Club or Prosper to operate a Ponzi scheme. Reports would soon surface online about people who were promised a loan but didn’t get it. I have personally obtained loans from both companies and have been an investor for many years and everything I have experienced is completely above board.

      While p2p lending is clearly not a Ponzi scheme there is always the possibility of small scale fraud. I have asked the same question to LC and Prosper management about this and they are acutely aware of the potential for fraud. This is why they have many checks and balances internally with several people from multiple divisions in each company verifying the loans. Then, they have regular outside audits to make sure everything balances.

      While fraud is certainly possible at these platforms I am comfortable they are doing all they can to combat potential problems. I am happy to continue to put more money to work at each company.

  12. Rob says

    When a borrower take out a loan and defaults on it I assume I will take a capital loss on the loan on my taxes. Shouldn’t the borrower who defaults be required to report a capital gain on their taxes since these notes are considered securities? This is probably why P2P firms cant issue a 1099-c to the IRS. Also how can a P2P issue a negative / or positive feedback to a credit union if these are really governed a securities? They are not credit cards, or traditional loans from banks. I would think any intelligent borrower who defaults would challenge any dings on their credit report due to this classification that the loans are really securities govern by the SEC. Any insight is appreciated thanks.

    • says

      Rob, My understanding is that from the borrowers perspective these loans are not securities, they are just a loan in the same was a mortgage loan from a bank is just a loan even though it may be packaged up and sold as a security.

      Now, you bring up an interesting point about taxes – I am not sure what, if anything, a borrower should report on their taxes when they default on a loan. Any CPA’s out there want to chime in on that one?

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