It is a question the customer service people at Prosper and Lending Club hear all the time. Why doesn’t my state allow me to invest? Now, I am not an attorney but I have been doing some research that I think many readers will find useful. I have found out that unfortunately, there is no one answer to that question.
I spent some time in the past couple of weeks talking with all kinds of people on this topic. I have spoken with people at Lending Club and Prosper and also with the securities regulators in several states. I came away from these discussions feeling somewhat negative about the whole thing.
In some ways I feel sorry for the legal people at Lending Club and Prosper. Every state has different requirements and some states make it so difficult that they are effectively excluding themselves from p2p investors. As laws stand right now it would be virtually impossible for any p2p lender to create a model that would please every state. So, what are the problems with the states that don’t allow p2p lending?
No Investing Allowed in P2P Lending in Ohio
To give an example I will focus first on Ohio where I spoke with Mark Heuerman, Registration Chief Council of the Ohio Securities Division. He has written a report on p2p lending that he presented at last year’s Ohio Securities Conference so he is very familiar with Lending Club and Prosper.
The problem in Ohio is all about potential fraud. Under the Ohio Securities Act, Ohio views the borrower as the actual issuer of the notes – not Lending Club or Prosper. Like any other notes issued to Ohio investors, they need to know that the issuer is not making any fraudulent claims. Because both Lending Club and Prosper do not verify all information entered by borrowers they can make no such claim. How can they? It would be a virtually impossible task to verify the statements of every borrower (not just the financials but anything stated by a borrower) and certainly one that doesn’t scale.
If you want to read an attorney’s take on this then read this short post on the Business Law Prof blog from earlier this month, by University of Akron associate professor, Stefan Padfield. He explains clearly why p2p lending will not be available in Ohio any time soon.
Texas Hold ‘Em
In Texas it is a slightly different story. When I spoke with the securities regulators there they said they have no application on file for Lending Club but Prosper’s application is still pending, as it has been for about three years now. But their issue is slightly different than Ohio. Texas has similar merit review guidelines to Ohio but they focus on who exactly is responsible for the repayment of these loans.
They did not mention a concern about fraud but they wanted to know that the borrower has the ability to repay the loan. The only way they can be assured of that is to verify all the financial information of each borrower individually. Again this is technically unfeasible although not as impossible as Ohio’s demands. Texas did say that there is a potential workaround: if Prosper could issue and guarantee payment of the loans then they would consider approving the application. But obviously that is not going happen.
I also spoke with regulators in Iowa and Vermont. With Iowa they said they have received applications from Lending Club and Prosper; they have made comments on these applications, but have not heard back from either company. Vermont also has merit review guidelines that would require every new loan to be registered with them in a certain way; again this is something that Lending Club and Prosper are likely unwilling to do.
But What About the Secondary Market
The secondary market is interesting. Prosper only allows investing in the secondary market in the same states where the primary market is available, but Lending Club interprets things differently. According to Lending Club’s general counsel there is a different set of laws that govern the secondary market and the primary market. Take Texas for example. Their main problem is around the issuance of loans. Once these loans are issued it seems that they can be traded freely by Texas residents.
Prosper cannot comment on Lending Club’s decision to allow the secondary market in Texas and other states as they don’t allow this. But it seems to me that Prosper is taking a more conservative approach. However, Lending Club’s general counsel was very confident that current laws allow a secondary market in p2p lending notes in Texas and other states.
What Can You Do?
If you are a resident in one of the disallowed states you can take some action that will bring this issue into the spotlight. I would start by calling your state securities regulator. To find out how to contact them you can visit the North American Securities Administrators Association (NASAA) website and click on your state. This will provide a contact number for your state securities regulator. You can find out from them what specific issue prevents investment in p2p lending securities in your state.
It is the job of state securities regulators to enforce state laws. State laws are written by state politicians, so if you really want to take action then this is where you should go next. Find out who chairs the state committees that draft securities law, it is likely a committee that overseas financial institutions. Then contact these committee members and explain the problem. You could also contact your local state member for both the legislature and the senate.
If you can get your spouse, relatives and friends to also call the same state representatives that would also be helpful. We live in a great democracy and you should let your voice be heard. It is unlikely that the laws will change unless state representatives start hearing from a large number of people. For those people in states with particularly onerous laws this is really the best way to try and affect change.
Report Coming from the GAO Next Month
Having said all this, there may be a small ray of hope on the horizon. The Government Accountability Office is scheduled to release their report on peer to peer lending next month. While this will not change any laws it will provide recommendations on how peer to peer lending should be regulated. We can only hope it contains good news for p2p lending investors. But knowing how Congress works we are probably a long time away from any meaningful changes to existing laws.
One final comment I will make about all this. These state laws are designed to protect investors, I understand that. But state laws in Ohio, Texas or anywhere else would have permitted me to put my entire life savings into General Motors stock in 2007 when it was trading at around $30 and still seemed like a relatively safe investment. If I didn’t sell I would have lost my entire investment when GM declared bankruptcy.
Prosper and Lending Club have a track record now of producing great returns for investors while operating in an open and transparent way. They deserve better treatment by some state regulators.