Online Lending Circles Hit Circuit Breaker: What Will Possible SEC Regulation Mean for P-to-P Lenders, a Rising Bank Competitor-And Potential Partner?

[ILLUSTRATION OMITTED] Websites that help individuals make loans to other individuals online suddenly have been stopped in their meteoric rise, calling into question whether such sites are the easy antidote to the current credit crisis. Collectively, site operators such as Prosper, Zopa, Virgin Money, GlobeFunder, and Lending Club tend to be termed "pto-p lenders," for person-to-person lending. However, some reject that label, partly, it seems, to distance themselves from "subprime," and now a regulatory tarnish coming over the pto-p lending niche. "Micro lending" is another term for the practice, although that term has more often been used in reference to loans made to the poor in developing countries. We know what happened to peer-to-peer music sites, like Napster, which enjoyed explosive growth at the start of this decade: Lawmakers shut them down. While p-to-p lenders may not be facing something so drastic, April's announcement by Lending Club that it was ceasing to take lender applications pending "a process to register with the appropriate securities authorities" begs the question what the future of p-to-p lending will be. With the music sites, record companies were hemorrhaging revenues from songs that would have been sold, instead being shared for free online. By contrast, with p-to-p loans, the upstarts have taken maybe just $250 million of the $400 billion now funded by credit cards. However, with the initial p-to-p defaults running in one case near 20% in a market generally jittery about bad loans; with unsophisticated financial players (consumers) involved; and with uncertainty about where the buck stops, greater scrutiny now is not too surprising. A "regulatory minefield" At the heart of the regulatory knot is whether p-to-p sites issue loans or securities. Typically, loans made on these sites are subdivided between many parties, so the $20,000 a borrower gets has been advanced by ten individual lenders, each with a $2,000 stake. The subdividing or syndication makes it less like simple loan and more like a structured debt instrument, or security. "The U.S. securities law is very clear on this: if you have a segment of a consumer loan, then it is a security," says Doug Dolton, chief executive of Zopa, which operates differently in the U.S. than in the U.K., precisely for that reason. "The whole world of p-to-p lending, we're finding, is not simple," Dolton notes. A Canadian site and a Dutch site have been shut down, he adds, and "in the U.K., we had to carve out a new category [with regulators]." Asheesh Advani, chief executive of Virgin Money, which operates similarly on both sides of the Atlantic--servicing pre-arranged private loans that are not subdivided--says, "By design, we've avoided the regulatory minefield from the beginning." Lending Club could not take press calls during its mandatory "quiet period" with the SEC. Prosper, the biggest, true p-to-p lender (both Zopa and Virgin say they are not in that category) said it filed an SI with the SEC last October and referred ABA BJ to a statement issued after Lending Club's hiatus, noting that Prosper believes it is, "structured... in compliance with applicable state and federal laws." Banking law specialist Walt Moeling, a partner in Powell Goldstein LLP, Atlanta, says, "If the SEC said 'you have to register as a securities broker,' I don't think these sites could function." It is possible for bona fide loans, even when they are shared, to be distinguished from securities, he says, but factors considered include the financial sophistication of the parties involved and how tailored the offers are. "The more it looks like 'take it or leave it' the more it looks like a security," Moeling says Asked whether SEC regulation would kill the p-to-p model, Jim Bruene, a former banker who is now editor and publisher of the "e-zine" NetBanker, said, "Certainly, it's a huge barrier to entry but my speculation is that it won't kill it. …