Follow-up to MNH Report #1

I originally posted MNH Report #1 ("Misappropriation of lender funds by Prosper Marketplace Inc.) on both the independent discussion forums at Prospers.org and the Prosper.com official forums (which have since been deleted) on October 31, 2007. After six weeks, Prosper.com has still not reimbursed lenders for the thousands of dollars which they took without legal authority.

Here is my follow-up letter to Ed Giedgowd (Chief Compliance Officer and General Counsel), Chris Larsen (Chief Executive Officer and Founder), and John Witchel (Chief Technology Officer and Founder):

[VIA E-MAIL AND U.S. MAIL]

December 18, 2007

Gentlemen:

On October 31, 2007, I posted on the official forums for Prosper Marketplace Inc. (PMI) a complaint that PMI had violated its contractual and fiduciary obligations to loan purchasers (“lenders”) by misappropriating thousands of dollars in servicing fees and group leader fees from payments made by delinquent borrowers to lenders, in the absence of any legal right or authority to do so.

Under Paragraph 5 of the Lender Registration Agreement which was in effect prior to November 8, 2007:

"With respect to each Note you purchase from Prosper, the Servicing Fee is payable only upon Prosper's receipt of the full monthly payment from the borrower on such Loan no later than thirty (30) days after the due date of the payment."

The Lender Registration Agreement, in Paragraph 13, has also provided – and continues to provide -- that group leader fees will only be deducted from borrower payments which are made within 30 days of the due date:

"a. You acknowledge that the group leader on certain loans that resulted from listings that were posted prior to September 13, 2007 may receive a percentage of the interest portion of each monthly loan payment made by each borrower on your Notes, provided that no loan payment is more than thirty (30) days past due. ….

"b. The group leader will not receive any Finder's Payment Reward at a time when any payment on a Note is more than thirty (30) days past due. With respect to loan payments received by Prosper on a Note that is more than thirty (30) days past due, Prosper will pay you, rather than the group leader, the entire amount of principal and interest received on such Note."

For more than one and one-half years, PMI has violated these contractual agreements and misappropriated funds belonging to the lenders for whom it serves as servicing agent, taking those funds for its own use and for distribution to its independent contractors (“group leaders”).

Several days after I posted this complaint in the official PMI forums, Shira Levine, PMI’s Director of Community Marketing, replied. According to Ms. Levine’s explanation, the taking of these funds was a deliberate and intentional act by PMI, while the language in the legal agreements precluding it from doing so was “an unintended drafting error”. On the forum, Ms. Levine promised that:

"Lenders who were charged servicing fees in a manner inconsistent with the language quoted above will receive an appropriate credit in their funding account."

Six weeks have passed since that promise was made, but PMI has not reimbursed lenders for the thousands of dollars which it has taken from their accounts without legal authority to do so.

Indeed, it appears that rather than honoring its contractual and fiduciary responsibilities to the lenders, PMI has devoted its considerable resources to suppressing information about this and other instances of corporate malfeasance, with the goal of depriving lenders of the opportunity to exercise their legal rights. My original post, along with Ms. Levine’s promise, have been deleted, along with all other contents of PMI’s original forum, and my attempts to post regarding this issue on the new official forums have been blocked. PMI has also taken extreme steps to prevent lenders from becoming aware of the existence of an independent forum where this issue and others are freely discussed.

Prosper’s decision to focus its resources on suppressing information rather than making prompt restitution to lenders creates a clear impression that PMI’s continuing misappropriation of lender funds is a deliberate attempt by PMI to enrich itself at the expense of lenders to whom it owes a fiduciary duty, and that PMI has no intention of making lenders whole. It is my understanding that many jurisdictions treat deliberate misappropriation of funds, and failure to promptly return negligently misappropriated funds, by a party acting in the role of fiduciary, as a criminal conversion, i.e. theft.

Accordingly, I am filing formal complaints against PMI with the attorneys general of California and New Mexico, as well as the Federal Trade Commission.

In the event that all Prosper lenders are not reimbursed for the unauthorized servicing fees and group leader fees by the end of this month (two months after the date of my original complaint), I will be filing complaints with the attorneys general for the other 48 states, since each of them almost certainly has constituents who have been adversely affected by this misappropriation of funds.

In addition, I am sending copies of my formal complaint to each of the state agencies which have granted lending licenses to PMI, and to the Massachusetts Division of Banks, where PMI is registered as a loan servicer. While breaches of duties owed to persons other than borrowers are outside of the direct jurisdiction of most of these agencies, it appears to be relevant to the financial responsibility, character, reputation, integrity, and general fitness of PMI, which is typically a prerequisite for licensing. My understanding, however, is that the bond which PMI was required to post with the Massachusetts Division of Banks does protect loan purchasers against such breaches, and affected lenders may wish to file claims against this bond.

Finally, I am providing a copy of my complaint to the Securities and Exchange Commission. Given that PMI is unwilling or unable to honor its existing fiduciary responsibilities, I do not believe that it is appropriate for PMI to expand its activities to include operation of a secondary trading market for securities.

Please be aware that the issues which I raised on October 31 – and which PMI has failed to satisfactorily address – are merely the tip of the iceberg. Since September 13, I have devoted considerable time to reviewing compliance issues related to PMI’s operations.

[Preview of MNH #5 et seq. deleted.]

When I discovered PMI in May 2006, I was excited by the concept of P2P lending, and, despite early skepticism regarding various aspects of PMI’s implementation of that concept, I regarded it as a noble experiment worthy of support, as did many other lenders whose support and goodwill PMI has squandered. I became an active lender, and once I felt that I had an adequate understanding of what was necessary to deliver profitable loans to loan purchasers, I opened a group, and began working on plans to actively promote the Prosper product. (My group, by the way, has yielded a net ROI for “lenders” of over 20%, from loans to the subprime borrowers which PMI now wishes to exclude from its customer base.)

As long as I could believe that PMI was engaged in a noble experiment, I was willing to set aside many of my suspicions and concerns about corporate misconduct in the hopes that these violations were simply the growing pains of a start-up enterprise, and that they would eventually be addressed or ameliorated over time.

Sadly, PMI’s actions over the past ten months, beginning with the March 31 forum suspensions, and continuing through the closure and deletion of the official forum and attacks on independent third-party websites, demonstrate that PMI has chosen the low road of suppressing information about its short-comings and malfeasance, rather than the high road of making a good faith attempt to correct them. They have persuaded me that there is nothing noble about PMI, and I will be proceeding accordingly, as an advocate for the interests of lenders and borrowers who have been victimized by its actions.

Sincerely,
Trav