Regulators sound alarm about latest investment rage

State securities regulators are warning investors to be careful of peer-to-peer lending over the Internet, a trend they say is on the rise as conventional loans have become scarcer and more costly. The National American Securities Administrators Association Inc. has issued an alert advising investors about the risks of online loan “matchmaking,” also called social lending or P2P. Typically, peer-to-peer intermediaries attract investors by promising outsize returns. Such lending can allow individuals or small businesses to get loans that otherwise would be prohibitively expensive or impossible to get, said NASAA president David Massey. According to the website Peer-Lend, P2P borrowers “can receive better interest rates, and investors can yield better returns on invested funds.” That certainly seems to be the selling point for Lending Club and Prosper, two of the better-known online matchmakers. Lending Club claims that its investment notes have thrown off a 6.9% net annualized return as of Dec. 15. Prosper puts the estimated annual return on loans originated from July 15, 2009, to May 31, 2010, at 10.9%. But the firm added: “The calculation requires significant assumptions about the repayment of personal loans,” and “lenders should make their own judgments with respect to the accuracy of these assumptions.” Indeed, Mr. Massey said, when problems arise with P2P loans, it's often due to the fact that an intermediary handles the transactions. “With these cases, the borrower and the lender never have direct contact,” Mr. Massey said. The lender sometimes doesn't even know who the borrower is. Therefore, it may be impossible to verify independently any financial or business information the borrower may have provided. In fact, Prosper's website notes that the firm “does not verify all information provided by borrowers in listings.” And while P2P notes are offered by prospectus filed with the Securities and Exchange Commission, the loans themselves are not secured. That leaves investors with little legal remedy if a loan isn't repaid. In addition, NASAA warns that notes issued to investors are not insured by the Federal Deposit Insurance Corp., or any federal or state agency. In North Carolina, where Mr. Massey is deputy securities administrator, regulators have identified at least five firms that have inquired about the business of providing peer-to-peer lending, he said. Investors should get the background and licensing information about P2P intermediaries from securities, banking and insurance regulators in their state. “If the enterprise is soliciting capital from the public, it's probably going to go into the investment in some form of a security,” Mr. Massey said. These business transactions even could inadvertently be creating securities that should be registered with either state or federal securities regulators. Mr. Massey admits that regulation of “this emerging business model” is murky. In fact, the Dodd-Frank Act mandated a one-year study of the regulatory framework for peer-to-peer lending by the General Accounting Office.