New cases in CFA Institute's Ethics in Practice series are published weekly to the
CFA Institute Market Integrity Insights blog and to the CFA member app. Members who engage in the cases via the app can qualify for 0.25 CE credits. This week's case is based on an SEC enforcement action against Prosper Funding and discusses possible violations of the CFA Institute Code of Ethics and Standards of Professional Conduct relating to return calculations that were incorrect due to a coding error. Here is the scenario:
Prosper Funding (Prosper) is a marketplace lender that enables borrowers to obtain unsecured consumer loans and allows investors to purchase securities linked to the performance of those loans. Prosper creates individual account pages for each investor on its website, which provides information on the consumer loans, gives the annualized net return (ANR) performance of each investor’s account, and includes a link through which they can invest in Prosper securities. Prosper calculates the ANR for each investor using an automated process developed some years ago by personnel no longer with the firm. ANR results are reported prominently on each investor’s online account page.
After several years, Prosper implements a “debt sale program” through which eligible nonperforming, charged-off consumer loans linked to Prosper securities are sold. Because of an unforeseen effect of a previous, unrelated change to the original coding in the program, Prosper reports an ANR to its clients that excludes the impact of the worst-performing securities that they previously held but that have since been sold to third-party debt purchasers. Periodically, Prosper reviews all of the computer processes used by the company, and through that review, it becomes clear that current employees lack an understanding of the ANR calculation process. The review is always general and at a high level, and thus Prosper does not identify the error in the ANR calculation. Because of the error, Prosper reports to a majority of its investors that their investments are earning up to double the returns they actually had earned.
When certain affected investors raise questions about the accuracy of the ANR calculations they received, Prosper’s customer service department handles the complaints and confirms the reported figures were calculated erroneously because of a flawed computer program. The customer service employees do not elevate any of these complaints to Prosper’s product, engineering, or compliance departments. Prosper has also solicited new investors for its securities based on the miscalculated ANR by sending hundreds of emails that highlight their ANR performance (albeit erroneous) and has recommended that investors “add funds and build on their solid returns.” Prosper does not identify the error for several years and discovers it only after receiving a complaint from a large institutional investor. Prosper notifies investors that it miscalculated and misstated their ANR and provides a current, correct calculation of the ANR to investors at that time.
Choose one of the following Prosper personnel and explain how that employee may have violated the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards) and why.
- Employee responsible for the computer program that calculates the ANR.
- Customer service employee responding to client complaints about the ANR.
- Marketing employee using the ANR performance calculations to solicit investments.
- Compliance employee responsible for firm policies and procedures.
- CEO of Prosper.
