Searching for Regulatory Accommodation and Investor Protection in Fintech Personal Lending
As Chinese authorities crack down on fintech P2P lenders with crushing new regulation, much of Europe remains behind the curve on investor protection in the recent craze of machine-driven, crowdfunded personal lending. A forthcoming book edited by Matilde Cuena Casas (Univ. Complutense Madrid) explores the proper approach to crowdlending regulation and investor protection in Spain, drawing inspiration from other national regimes. One invited contribution lays out the background and current state of the regulatory landscape in the United States, with particular emphasis on the Jumpstart Our Business Startups Acts of 5 April 2012 (JOBS Act).
In that chapter, “Crowdfunding and Crowdlending in the US: Regulations, Exemptions, and Outcomes,” I reveal that crowdlending has collided with the famous behemoth of US securities regulation. As is often the case, however, innovation has found a regulatory niche where it has continued to flourish, though with the surprising consequence that most fintech lending in the US today is funded by a limited number of institutional investors or increasingly by banks themselves, rather than through broad appeals from the cloud to the crowd.
The risks to the ultimate “investors” in crowdlending parallel the risks of classical equity investors, as both involve a business raising money through a broad outcry to the profit-seeking public. As described in the chapter, it has long been settled that both debt and equity investment solicitation falls within the parameters of US securities regulation, but that wall of protection has several gates offering easier passage for those seeking to raise funds. These gates are statutory exemptions from the otherwise quite heavy burdens of regulatory compliance, the focal point of the chapter. Several of these exemptions are either unhelpful or even fundamentally inimical to the core business concept of fintech-driven crowdlending.
One key exemption, however, allows for solicitation of very large investments, though subject to a debilitating limitation: solicitation cannot be made to “the public.” Given that the entire idea behind crowdlending is to democratize person-to-person lending and pool large numbers of small investments from “the public,” this would seem to doom online pooled lending in the US. But it has not. Though the crowd is much smaller, solicitation of lending capital from “accredited investors” has been the primary gate through which US crowdlending has breached the regulatory wall. Wealthy investors such as hedge funds, insurance companies, and pension funds have money to invest and the sophistication to protect themselves in the process, so these have become the primary source of capital behind the online lending market in the US—consequently often referred to as “marketplace” lending rather than “crowdlending.” Indeed, banks have increasingly avoided the third-party outcry altogether, using the fintech platforms simply as marketing devices and retaining loans on their own balance sheets. So much for the crowd.
The machines and their payment-and-default predicting algorithms will remain a crucial new tool in the internet-based lending marketplace, but these loans in the US are fueled by more traditional funding models not involving “the crowd.” As described in the conclusion of my chapter, the JOBS Act has done little if anything to change this, with crowd-based equity financing coming online only in May 2016 and quickly flopping. The JOBS Act exemption is totally inappropriate for crowdlending, given its expense and restrictions, and equity crowdfunding volume fell 57% in 2017 (to just $236 million) as the number of online platform operators contracted in light of persistent regulatory uncertainty. Once again, so much for the crowd. As the chapter concludes, “the internet has lubricated the front-end wheels of this kind of commerce, but the back-end, funding side of the machine still drags along on the old highway of regulations restricting the offer and sale of securities to the public.”
Jason Kilborn, John Marshall Law School