On Friday (Sept. 30), LendingClub officially closed the door on a two-year chapter in its corporate history that its current board and founding team would probably like to forget. Both the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) have officially ended a two-year investigation of LendingClub, its subsidiary LC Advisors (LCA), its founder and former CEO Renaud Laplanche and its former CFO Carrie Dolan.
The SEC Finding
The SEC charged LCA, LendingClub and Laplanche with fraud connected to improperly using LCA assets to benefit LendingClub Corporation, LCA’s parent company for which Laplanche was both founder and CEO. LCA and Laplanche, along with former CFO Dolan, were also charged with improperly adjusting fund returns.
“Investment advisers have an obligation to put their clients’ interests ahead of their own,” said Daniel Michael, chief of the SEC’s Complex Financial Instruments Unit, about the decision. “By using funds managed by LCA to benefit its parent company, LCA and Laplanche failed to do so.”
The SEC also noted that it will not recommend charges against LendingClub Corporation, because the firm’s board “promptly self-reported its executives’ misconduct following a review initiated by its board of directors.” The SEC also noted that LendingClub has been highly cooperative in the investigation.
LendingClub Chairman Hans Morris expressed satisfaction at the resolution of this issue with the SEC.
The DOJ Finding
The DOJ investigation centered on whether LendingClub had – between January 2009 to September 2010 – misled its FDIC-insured loan originator, WebBank, leading the bank to underwrite over 200 loans that did not conform to the bank’s lending requirements. The DOJ further alleged that LendingClub made the loans to bolster its underwriting figures so that it could make monthly loan volume goals. That, according to the DOJ, put LendingClub in violation of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA).
FIRREA authorizes the federal government to seek civil penalties against companies and individuals that commit various criminal offenses affecting federally insured financial institutions, including bank fraud, wire fraud and false statements to financial institutions. LendingClub has agreed to pay a $2 million civil penalty to settle the matter.
“As technology continues to provide more creative means for financial transactions, so, too, must financial technology companies be careful to abide by the rules that ensure stability and fairness in these emerging markets.” said U.S. Attorney Alex Tse. “We will vigorously investigate wrongful conduct in this industry.”
Last week’s announcements capped off two years of investigation into the P2P lending firm, and its board has expressed some relief that it seems to be time to turn the page on the events of 2016.
“Following an internal review in 2016, LendingClub’s board of directors accepted the resignation of Renaud Laplanche as chairman and CEO of the company,” the board noted. “The findings of the SEC further support the board’s decision to take swift and decisive action. We have full confidence in our new management team and we are a better company today.”
A better company, perhaps – but recovery has been a slow process for LendingClub, and not always smooth. Investors have returned to the platform in larger numbers, but loan volume and revenue have seen sluggish growth until very recently. Earlier this year, LendingClub saw its stock price hit record lows when news broke that the firm was being sued by the FTC for reportedly charging consumers with hidden fees and, in some cases, double-withdrawing payments from consumer accounts.
Those effects, however, were short-lived. LendingClub’s stock has since recovered, bolstered by Q2 earnings results that demonstrated record-breaking revenue and origination counts.
The build-back from the revelations of 2016 was a bit more of a lengthy process.
The Rundown on the Run-up to the Decisions
When LendingClub entered the market in 2006, Laplanche had one idea in mind: disrupt the banks.
“When I founded my first startup, it got me thinking — banks are middlemen,” Laplanche said after having learned from friends and family that they would have bankrolled his first startup for less than the interest he was paying on his credit card balances.
It was an idea slightly ahead of its time, but not by much – and despite the fact that most startups get their start by maxing out their credit cards. By 2008, the economy had lurched into crisis mode, and the world of credit suddenly become a very different place. Banks had lost much of their taste for underwriting personal loans, investors were on the hunt for yield as stimulus efforts dropped interest rates to historical lows, and consumers were deeply overleveraged with credit card debt in an environment where unemployment and underemployment were endemic.
LendingClub’s P2P lending model touted itself as the solution to all three problems: a non-bank source of credit for consumers that offered an opportunity for investors. Borrowers could consolidate their credit debt at a lower rate, debt buyers could purchase loan packages on the hunt for higher yields and LendingClub could enjoy the relatively low-risk middle ground as the platform that underwrote and packaged the loans, but didn’t have to endure the risks involved in holding those loans on a balance sheet.
It was, as Karen Webster noted in February of 2016, a very attractive model for many investors.
“So, without the same capital requirements as banks, without the brick-and-mortar operations to support like banks, without the onerous regulatory and compliance boxes to check like banks and without the credit risk to get in the way of financial performance like the banks, it’s not surprising that VCs were attracted like bees to honey to this innovative lending model,” she pointed out.
And from 2008 on, LendingClub was in many ways the biggest, brightest flower in the garden, largely credited as the platform that set the ships of many P2P/marketplace lending platforms sailing.
After briefly having to suspend new lender registrations to clear up some issues with the SEC, LendingClub was up and running fast by early 2009, when it brought in $12 million in funding led by Morgenthaler Ventures, joined by existing investors Norwest Venture Partners and Canaan Partners.
In 2010, LendingClub added to its war chest with a $24.5 million Series C financing round led by Foundation Capital and joined by Morgenthaler Ventures, Norwest Venture Partners and Canaan Partners. That same year, it was estimated that LendingClub controlled 80 percent of the U.S. lending marketplace. In 2011, LendingClub added another $25 million in Series D funding in a round lead by Union Square Ventures.
By 2012, LendingClub announced it had underwritten $1 billion in loans on its platform and was cash flow positive. In 2013, the lender’s originations count had grown to $2 billion, and Google acquired a minority stake in the company for $125 million.
Riding a wave of market enthusiasm, LendingClub filed and completed its IPO in 2014, raising $900 million, the biggest tech IPO of that year. Its stock popped 56 percent in the first day of trading, leaving the company’s post-IPO valuation at $8.6 billion. Within five days of that IPO, LendingClub’s value had grown to $10 billion.
The Problems and the Reformation
Media accounts of the actions that led to LendingClub’s internal investigation – and the SEC and DOJ’s external investigation – were of a firm going 100 miles an hour before suddenly hitting a brick wall on May 3, 2016, when reports surfaced about irregularities and questionable practices.
The facts were a little more complicated: LendingClub and marketplace lenders in general started to show signs of weakness well ahead of those announcements. Trouble with defaults at higher-than-expected rates in securitized loan packages chilled investor enthusiasm for the model, and LendingClub’s stock price and market cap steadily diminished over the 18 months between the IPO and the resignation of Laplanche in May 2016.
The revelations of early May 2016, however, revealed that LendingClub was a firm with much bigger problems than the profiles of its borrowers.
According to filings with the SEC, in March of 2016, the first domino fell and set the chain of events into motion that eventually saw LendingClub’s founder and founding executive team exit the firm. The inciting event was LendingClub’s agreement with Jefferies Financial Group that involved changes to their borrower agreement.
When building that package of loans for Jefferies, LendingClub found they did not have enough conforming loans to meet the terms of the deal. Dates were changed by employees on some LendingClub loans in order to include them in the package.
The discovery of issues with the loans dating triggered and investigation fist by the firm’s auditor and later by a law firm retained by the board.
Those two things were enough to end Laplanche’s tenure at LendingClub, and he agreed to step down three days after the news emerged. He didn’t leave alone – most of LendingClub’s founding senior management team resigned or exited along with him.
“I recognize that events occurred on my watch where we failed to meet our high standards. While there are disagreements as to the characterization of facts, I accept that the board acted in good faith and did what it believed was right for the company,” Laplanche said in a statement shortly after news broke of his exit from the firm.
The early revelations were also enough to kick off both the SEC and DOJ investigations that, from the SEC’s standpoint, have formally ended as of Friday.
And, it should be noted, LendingClub’s internal auditor wasn’t finished as of May 2016.
A few months later, in August, when LendingClub’s self-investigation was complete, it was found that in 2009, the lender originated 32 loans worth approximately $722,800 in originations and $25,000 in revenue to CEO Laplanche and three of his family members when it was discovered that the firm was not going to hit its predicted loan target for the year. All but three of those loans were paid in full January of 2010.
The investigation found that those loans were then used to help increase that platform’s reported loan volume for December 2009, which was used to support the fundraising pitch that garnered its $24.5 million Series C round in April of 2010.
The investigation also discovered irregularities with asset management arm LC Advisors (LCA), a sub-unit of the company dedicated to using loans to construct funds for investors. As of December 2015, there were six such funds, each with certain loan lengths and qualities that could be included in the fund.
LendingClub’s internal auditors found that when LCA had amassed a glut of five-year loans and not enough investors interested in them, Laplanche authorized the packaging of five-year loans into funds to cover the effect of the inclusion of the longer-term loans. It was reported that in January 2016, Laplanche instructed staff to put a floor in a fund that seemed at risk of throwing off a negative return so as to prevent it from falling below zero.
It was this charge – that LCA and Laplanche caused one of the private funds it managed to purchase interests in certain loans that were at risk of going unfunded to benefit LendingClub, not the fund – that formed the focus of the SEC investigation and subsequent fines.
The SEC found that LCA had breached its fiduciary duty, and that LCA, Laplanche and Dolan improperly adjusted monthly returns for this fund and other LCA-managed funds to improve the returns they reported to fund investors.
“Investors depend on fund advisers to give them the straight scoop on performance so they can make informed investment decisions,” said Jina Choi, director of the SEC’s San Francisco regional office. “Advisers who adjust their valuation processes to boost results are in breach of their duties to investors.”
When all the revelations were out and the smoke started to clear, the effects were staggering. LendingClub saw a mass exodus of investors from the platform, as well as a massive wave of layoffs and a new CEO. By the end of 2016, LendingClub’s stock was trading at half its price.
And LendingClub’s woes weren’t just its own – the shockwaves from the revelations about its irregularities reverberated through the marketplace lending industry. Online lender Prosper Marketplace cut 25 percent of its workforce in 2016 and lost 70 percent of its value in 2017, despite reporting a profit for the first time in its corporate history.
SMB marketplace lending platform OnDeck emerged from 2016 so battered that by early 2017, it was widely speculated that it was about to be snapped up by Kabbage in a fire sale.
All three firms have seen measured improvements in 2018 – but the winning back of consumer and investor trust for this once incredibly hot segment has been slow and steady work.
So, Now What?
For LendingClub, which is under new management with new directives operating throughout the business, today’s release by the DOJ and SEC marks the closing of the book on this chapter of the firm’s history.
The model pioneered by LendingClub in 2006 and expanded and iterated on in the last 12 years does present a value proposition that both consumers and investors seem to like and want to tap into. And LendingClub, under its new management team, is rebuilding its business by rebuilding the trust that it may have lost over the issues that the SEC decision put to rest today.