MNH Report #5
Prior to September 13, 2007, Prosper.com group leaders could opt to receive compensation for each loan funded within their groups. This compensation, which Prosper originally referred to by the inaccurate euphemism of “group rewards” and later called “group leader rewards,” and which users frequently called “group leader fees,” came in two forms: a “Finder’s Match Reward,” which was paid out of the origination fees for the loan once the borrower made the first payment (provided that it was made within 30 days after the due date), and a “Finder’s Payment Reward,” a portion of the interest component of each payment made by the borrower (provided that the payment is no more than 30 days late). Match rewards were eliminated in June 2007, when the referral program was launched.
In a rare gesture toward encouraging accountability among group leaders, Prosper has withheld the payment rewards due to the group leader on each payment made during the first 3 months of the loan, and disbursed them to the group leader only after the loan is paid in full. As a now-deleted help page from May 2007 explained:
Payment rewards are paid after a 3-month withholding period to ensure the loan isn't bad right out of the gate. After 3 months, all current month payment rewards earned for that month are paid. At the end of the loan term, any remaining rewards withheld are paid in full.
If the loan defaults, the withheld payment rewards would be paid to the lenders on the loan, rather than to the group leader:
There is one last benefit to lenders of a group that takes group leader rewards: if one of those borrowers defaults, the lenders will share the first 3 months of earned group leader rewards. Every little bit counts!http://web.archive.org/web/20070504010155/www.prosper.com/help/topics/groups-rewards.aspx
Prosper.com is supposed to issue a statement for group leaders once a month, but the last one I received covers the month of June. For each loan shown on that statement, there is a figure for “Accruals pending payback,” explained in a footnote as “Payment rewards accrued in the first three periods of any loan are deferred until the loan is paid in full.”
Without a more recent statement, it’s hard to calculate an exact figure, but I would estimate that Prosper.com has withheld at least $120 of the payment rewards owed to me as the leader of a small group. For the largest group on Prosper, that amount is likely in the $5000 to $10,000 range. And my quick-and-dirty calculation of the total amount withheld from all group leaders shows that Prosper.com may have withheld $50,000 to $100,000 in accrued payment rewards.
There’s just one problem.
Prosper has no legal authority to do this.
Under Paragraph 3 of the current Group Leader Registration Agreement (dated November 8, 2007), Prosper.com is required to pay group leaders within 30 days after the borrower makes each payment, and there is no provision for deferring or withholding payments accrued during the first 3 months of a loan.
The Finder's Payment Reward will be paid to you monthly, within thirty (30) days after Prosper's receipt of the applicable monthly payment. Finder's Payment Rewards will be paid to you by automated deposit into an FDIC-insured non-interest bearing account at Wells Fargo Bank, N. A. (the "Prosper Funding Account") separate from Prosper's own funds. You will not earn interest on funds in the Prosper Funding Account. You may at any time request that your uncommitted funds in the Prosper Funding Account be returned to you, in which case Prosper will promptly return the remaining funds to your designated deposit account.http://www.prosper.com/account/common/agreement_view.aspx?agreement_type_id=9
The same is true of the Group Leader Registration Agreement which was in effect when I registered as a group leader (June 22, 2006, version):
The Finder's Payment Reward will be paid to you monthly, within thirty (30) days after Prosper's receipt of the applicable monthly payment.
Ditto for the February 12, 2007, version. (Those were the only three that I had access to while writing this report.)
What’s more, none of the three versions of the Group Leader Registration Agreement which I have reviewed contain any provision requiring a group leader to forfeit any compensation when a borrower defaults. In fact, the language makes it quite clear that a group leader has no liability for loans originated within his group. Quoting Paragraph 4 of the current version:
Group leaders do not guarantee payments on any loan, and you are not required or obligated in any way to guarantee any loan obtained through the Prosper website by any member of your group, or by any other person.
Unlike funds belonging to lenders, for which Prosper Marketplace Inc. has a fiduciary responsibility, rewards owed to group leaders appear to be ordinary debts owed to us as independent contractors. As a result of its decision to withhold the first three months of payment rewards, in the absence of contractual authority, Prosper.com is, and has been for some time, 90 days delinquent in the payment of these debts. (Technically, since the amount of payment rewards due to group lenders are larger than the rewards on later payments, these accounts are probably more than 90 days past due.)
Given the lack of any contractual language or clarifying explanations, I have no way of knowing what Prosper has been doing with these funds. It might be crediting them to group leaders’ Prosper accounts (but rendering them invisible and not subject to withdrawal), meaning that the funds are being held in a non-interest-bearing FBO (“for benefit of”) account at Wells Fargo. Or it might be holding them in some other form of trust.
More likely, Prosper Marketplace Inc. is simply carrying the debt as accounts payable on its balance sheet, and using the funds withheld from group leaders to cover its ordinary operating expenses.
Should Prosper Marketplace Inc. cease operations and/or declare bankruptcy (something I am not predicting here, but cannot exclude as a possibility, given its lackluster performance and lack of growth over the past year), lender funds would (we hope) be protected by the FBO account structure; they do not represent debts owed by Prosper to lenders, but funds belonging to the lenders which Prosper is merely holding.
On the other hand, any funds owed by Prosper to group leaders would likely be treated as ordinary debts in a bankruptcy proceeding, and group leaders would be standing in line alongside the rest of the unsecured creditors.
So, it makes a very real difference to me as a group leader whether I get my $120 or so in accrued payment rewards now, as the contract provides, or a few years from now, when Prosper says it will release the funds.
Not to mention that I’d really like a monthly statement which is less than six months out of date, so I know just how much Prosper owes me. According to the Group Leader Registration Agreement (all three versions):
7. Reporting by Prosper. Prosper will administer your account and provide you with online monthly statements reflecting Finder's Payment Rewards that accrue to your account.
If Prosper cannot withhold payment rewards from group leaders, and group leaders do not forfeit their payment rewards if a loan defaults, where does that leave lenders, who were promised that they would receive the first three months of payment rewards if a loan defaulted?
The promise that lenders would receive forfeited payment rewards if a loan defaults appears nowhere in the Lender Registration Agreement.
However, since Prosper made this promise on the website for the specific purpose of inducing lenders to bid on loans in groups whose leaders were compensated, I’d argue that Prosper Marketplace Inc. must honor that promise. Only the funds cannot come from Prosper’s delinquent debt to group leaders, but must be paid out of Prosper’s own pocket. (This is fitting, I think, since it was Prosper Marketplace Inc. which is ultimately responsible for creating a deeply flawed group system and failing to address its flaws long after they became obvious.)
Lenders attempting to reconcile the amount of reimbursement due from Prosper for defaulted loans should note that this promise, as written in the help pages, applied to rewards due on payments which are made
in the first three months of the loan, not to the first three scheduled payments, and that is how Prosper appears to have been interpreting its promise.
(I know this because one of the borrowers in my group just made her fourth scheduled monthly payment a few days early. I was expecting to see a payment reward credited to my account, but it never appeared. My attempt to determine whether Prosper.com’s entitlement to withhold payment rewards applied to the first three payments, or to the first three months, led me to the discovery that Prosper was not entitled to withhold any funds whatsoever.)
Sigh. Another day, another letter to Prosper’s general counsel.
[Previous MNH Reports can be found on my blog: http://blog.traveler505.com
. Each post there includes a link to the corresponding discussion thread on Prospers.org.]