The growing peer-to-peer lending business recently suffered a major blow as the SEC shut down one of the businesses’ major players, Prosper. Matching private loaners with borrowers, Prosper has initiated $174 million in loans since January 2006. The SEC ordered Prosper to cease-and-desist, charging that the web service’s loans are actually securities, which are illegal to sell without SEC registration. "Prosper operates an online lending platform connecting borrowers with lenders. The loan notes issued by Prosper pursuant to this platform are securities and Prosper, from approximately January 2006 through October 14, 2008, violated Sections 5(a) and (c) of the Securities Act, which prohibit the offer or sale of securities without an effective registration statement or a valid exemption from registration," says cease-and-desist order.

Under the SEC’s definition, lenders, who expect a return profit in interest, are actually investors. “Lenders expect a profit on their investments in the form of interest, which is at a rate generally higher than that available from depository accounts at financial institutions,” says the filing.

The company stopped facilitating loans in October and began registering with the SEC, which could take months. Existing loans and repayments are still in effect. Much of Prosper’s site has gone quiet until registration is approved.

"Until this process is complete, we're required to be in a quiet period and will be unable to respond to press, blogger or other inquiries about Prosper or the registration filing until it becomes effective," says a note on Prosper's site.

P2P lending has been a fast growing market, and much has been written about it, especially after the implosion of the financial market. It’s yet to be seen how registration with the SEC will change Prosper and the market. Hopefully this is just a temporary setback for the nascent industry.

By Mark Alvarez