SEC, Private Firm Settle Charges Tied to Faulty Systems
The importance of firm support systems such as computer programs has repeatedly been highlighted by Commission enforcement actions. The agency has periodically initiated actions charging market participants such as brokerage firms and others with violations of the federal securities laws based on errors stemming from firm systems and computers even when those involved were unaware of the difficulty. The Commission’s most recent case of this type centers on a privately held firm that failed to even understand certain computations made by its computer system. That failure resulted in significant pricing errors tied to the sale of certain securities. In the Matter of Prosper Funding LLC, Adm. Proc. File No. 3-19148 (April 19, 2019).
Prosper Funding is a privately held firm based in San Francisco. The firm is a marketplace lender that arranges consumer loans through its website. Prosper sells securities linked to the performance of those consumer loans to investors.
When investors open an account, Prosper gives them access to individual account pages on its website through which they can invest in the firm’s securities. The pages investors can access provided information on the consumer loans and the performance of each of Prosper’s securities. That information includes the annualized net returns or ANR.
ANR was calculated by a computer program that traced to 2009. At that time ANR was calculated in a manner that excluded securities sold in the secondary market, a point that was disclosed by the parent company that set-up the program. In late 2014 Prosper rewrote the legacy code after discovering that many employees did not understand it. In the rewrite the firm prioritized the borrower-facing platform which did not include the code for the ANR calculation. No steps were taken to monitor the operation of the ANR code to ensure it performed properly.
The next year Prosper began a debt sale program. In that program the company charged–off consumer loans linked to securities sold to third party debt purchasers. While the this program was not related to the secondary market for Prosper securities, the computer code treated debt transactions as sales, a change of ownership. Accordingly, when calculating ANR the program excluded the charged-off consumer loans. This altered the ANR calculation.
By August 2015 some investors questioned the accuracy of the ANR calculations. When Prosper conducted a review later in the year the firm again learned that certain employees did not understand the calculation. What it did not learn was about the error created in calculating ANR. Investors continued to purchase the securities using the incorrect ANR calculations.
In April 2017 Prosper discovered the error following complaints lodged by a large institutional investor. Subsequently, the firm notified investors and provided corrected calculations. The firm has now revamped its processes. The Order alleges violations of Securities Act Section 17(a)(3).
To resolve the proceedings the firm cooperated with the staff and consented to the entry of a cease and desist order based on the section cited in the Order. Prosper also agreed to pay a $3 million penalty.