The returns investors can earn from marketplace lending sometimes sound too good to be true. In the case of fintech company Prosper, they were.
On Friday, the Securities and Exchange Commission announced that San Francisco-based Prosper Funding LLC had miscalculated and materially overstated annualized net returns (ANRs) to retail and other investors for nearly two years.
Through its website, Prosper offers and sells securities linked to the performance of its consumer loans. According to the SEC’s order, from approximately July 2015 until May 2017, Prosper excluded certain non-performing charged-off loans from the calculation of ANRs that it reported to investors. Prosper reported to some of these investors that their portfolios had earned up to double the returns they actually had earned, and “many investors decided to make additional investments based on the overstated [ANRs],” the SEC order says.
The ANRs excluded non-performing, charged-off loans linked to Prosper securities that had been sold to third-party debt purchasers. Prosper’s automated system incorrectly treated the charged-off loans as having changed ownership for servicing purposes. As a result, for investors whose securities were linked to loans sold through the debt sale program, Prosper reported an ANR that excluded the impact of the worst-performing securities in their portfolios.
The SEC order also found that Prosper failed to identify and correct the error in its system’s code, despite the knowledge that “it no longer understood how annualized net returns were calculated and despite investor complaints about the calculation.”
Prosper identified the error only after receiving a complaint from a large institutional investor in April 2017, the SEC says.
Without admitting or denying the findings, Prosper consented to the entry of an SEC order finding that it violated the antifraud provision of the Securities Act of 1933. It will pay a $3 million penalty.
Since discovering the code error, Prosper has instituted controls designed to prevent and detect similar errors in the future, including management supervision of the ANR calculation and semi-annual testing of the ANR calculation, the SEC says.
“As this case shows, we are committed to holding fintech companies to the same standards applicable to other participants in the securities markets,” said Daniel Michael, chief of the SEC enforcement division’s complex financial instruments unit.
Prosper reported net revenue of $104 million in 2018, down from $116 million in 2017. Its net loss fell, to $39 million from $115 million in 2017.
The bulk of Prosper loans are no longer funded by individual investors. In the past two years, the company has landed $500 million in warehouse facility commitments to invest in the personal loans it originates.