The Risk Retention Rule as a Framework for Marketplace Lending Funding Arrangements
The legal landscape of marketplace lending remains uncertain, with no consensus on what level of bank involvement in a bank partner model is sufficient for courts to consider the arrangement substantive. If this continues, the fraught legal environment will hamper businesses, lead to unpredictable results in litigation, and threaten the survival of a rapidly growing, innovative segment of finance. By implementing a “5% economic interest” test, we can utilize a tried and tested approach seen in the risk retention rule to analyze bank involvement levels and provide clarity to market participants and related litigation. While various other solutions have been proposed, including a special charter for marketplace lenders, they have been criticized as regulatory overreach and do not strike at the core issue: moral hazard by banks that currently bear no risk of loss stemming from portfolio performance under the bank partner model. A 5% economic interest test solves this issue in the same way the risk retention rule has targeted the Asset Backed Securities market, aligning incentives between banks and marketplace lenders. This paper provides a survey of how the bank partner model and marketplace lending industry developed, litigation brought against marketplace lenders and its unpredictable results, the rationale behind the passage of the risk retention rule, and argues for adoption of a risk retention rule analogue to fix moral hazard within the marketplace lending industry.
* J.D. Candidate, (The George Washington University Law School, 2019); B.A., (University of California, Los Angeles (UCLA), 2015). The author would like to thank Professor Walter E. Zalenski (Partner—Buckley Sandler LLP) for his invaluable guidance throughout this process; the BFLR Boards of 2017 & 2018; as well as Bonnie Y. H. Rothell (Partner – Morris, Manning & Martin, LLP) and Woody N. Peterson (Senior Counsel—Zelle LLP) for their feedback.