Prosper’s Brilliant Regulatory Innovation

On Tuesday Prosper filed with the SEC to create a mechanism that will provide a secondary market for trading loans originated through its marketplace. This addresses an important limitation of the current system – the ability of lenders to sell loans they’ve purchased. It also represents a brilliant innovation in U.S. securities markets if approved by the SEC.

Unlike eBay where an item is bought and delivered with no ongoing relationship between buyer and seller (ignoring disputes!), Prosper creates a long-term arrangement between the borrower and their many lenders. While a borrower can repay their loan at any time and terminate the agreement, lenders have been locked in.

So how does the creation of  non-recourse notes enable a secondary market? According to the prospectus filed by Prosper:

The Notes are promissory notes representing three-to-five year, unsecured, fully amortizing credit obligations of individual borrowers. If and when a borrower listing placed on the [Prosper auction] Platform is matched with a bid in, or multiple bids totaling, the amount of a requested borrower loan, Prosper makes the loan to the borrower and evidences the borrower’s obligation by separate Notes in the amount of each individual’s winning bid. Each Note is thereafter sold and assigned by Prosper to each respective winning bidder…

Prior to the date of this prospectus, there has been no trading market for the Notes. As soon as practicable after the offering of the Notes covered by this prospectus commences, Prosper intends to establish a secondary trading market online auction platform, or the Resale Platform, on which the Notes may be resold after three months following the date that they are acquired from Prosper by the winning bidders.

There is a major regulatory innovation here. Prosper is  facilitating the sale of registered debt by individuals. In the equity market context it is commonplace for individuals to register their shares in a given stock for resale. Importantly, this is for a single stock trading at a single price. Here, Prosper is effecting the registration of many, many different pieces of debt:

  • with different terms and face amounts
  • from many individual issuers
  • with no apparent reporting requirements
  • at a reasonable transaction cost.

Undoubtedly the SEC will appreciate the magnitude of this innovation. The question is whether the examiner and the more senior folks at the SEC will play along or force substantial changes to the structure, including ones that effectively kill it.

Tuesday’s filing reflects the impressive innovative drive of Prosper, especially in the regulatory arena. My concern remains that the underlying premise of the platform with its current focus on medium term consumer debt may not be working. See my earlier post – Prosper, Strangely Flat.


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