The wheels come off LendingClub

▶▶Peer-to-peer lending needed big-time funding to grow. Mistakes were made ▶▶“Events occurred on my watch where we failed to meet our high standards”

Renaud Laplanche started

LendingClub in 2006 and soon emerged as a leading voice for what sounded like a radical new movement. With peer-to-peer finance, people wanting to borrow money and people wanting to lend it could be matched up via a website like LendingClub’s. The company would vet borrowers with its computer models and collect a fee for the service. Never mind going to a bank, or to Wall Street.

By the time LendingClub went public in December 2014, it was looking more pinstriped. John Mack, former chairman of Morgan Stanley, was on the board of directors and stood on the New York Stock Exchange dais with Laplanche for the ringing of the opening bell. Increasingly, the funders of many LendingClub loans weren’t individuals, but money managers, investment funds, and banks. The term “peer-to-peer” eventually fell out of favor in the industry, replaced with “marketplace lending.”

Ties to Wall Street may have been essential to the company’s growth— but Laplanche’s management of those relationships now has him out of a job. LendingClub’s share price is down more than 40 percent since his ouster was announced on May 9, and the company says investors who provided “a significant amount of funding” for loans have set their debt purchases on pause. The company has been subpoenaed by the U.S. Department of Justice, and the Securities and Exchange Commission is examining what happened.

LendingClub’s board asked Laplanche to leave after questioning $3 million in misdated loans that were sold in a bundle to an investment bank. The company also said Laplanche failed to properly disclose his interests in an outside fund before LendingClub invested $10 million in it. That fund’s investors included Mack, who remains on the LendingClub board and hasn’t been accused of impropriety. He declined to comment.

Although these were relatively small issues in dollar terms, they spiraled into a breakdown of trust between Laplanche and his board, say people familiar with the talks. “Trust is a core part of their business, especially for a new industry like this,” says Michael Tarkan, an analyst at Compass Point Research & Trading, speaking generally of peer-to-peer finance.

Tensions had been simmering at the company. In recent months, turbulence in capital markets had prompted investors to cool on Internet loans like those of LendingClub, says a person familiar with the matter. Laplanche began pursuing funding sources he’d shunned, this person says. The CEO had long resisted bundling LendingClub’s consumer debts into securities, but the company recently reversed course, working with Goldman Sachs and Jefferies on bond deals.

No bonds have been issued. Not long after that process began, things went wrong. An employee changed dates on $3 million in loans in response to a request from Matt Wierman, a LendingClub senior vice president, according to one person close to the company who also says the employee later brought up the decision with Laplanche. Wierman has told colleagues he was misunderstood, the

Wall Street Journal reported. He did not respond to messages seeking comment.

The loans were sold to Jefferies. They were among $22 million in loans a LendingClub internal inquiry later found didn’t meet Jefferies’s criteria. LendingClub said on May 9 that it bought back all those loans and sold them to another investor.

Separately, the board had been looking into another matter. Earlier this year, Laplanche asked the board’s risk committee to spend the company’s money on a stake in Cirrix Capital, a fund that specialized in buying loans from LendingClub, according to the people familiar with the matter. Cirrix could bolster funding for loans if other sources temporarily dried up. Laplanche ultimately wrote up the idea and got approval. But he left something out: He had a personal stake in Cirrix.

Andrew Hallowell, a managing director of Cirrix, didn’t respond to messages seeking comment. Laplanche didn’t stand to benefit from LendingClub’s investment with Cirrix, says one person with knowledge of the event.

LendingClub later disclosed Laplanche’s holding to investors in regulatory filings. It also said that Mack held a personal stake in Cirrix. Mack wasn’t involved in the risk committee’s decision to invest in the fund.

Mack joined LendingClub’s board in 2012 and invested $2.5 million that year. He became a public booster of the idea of buying LendingClub loans. “Financial advisers are fascinated by this business and its returns,” he told CNN Money in 2012. “I wouldn’t be surprised if some start putting $10 million to $15 million in this.”

Before long, Mack, who’d retired as Morgan Stanley’s chairman, was helping LendingClub access key sources of funding via customers of Morgan Stanley’s private-client services group, efforts he described to Bloomberg in 2013. Morgan Stanley brokers began offering clients a chance to invest in portfolios of loans created by a LendingClub subsidiary, LC Advisors, says a person familiar with the matter. Morgan Stanley’s private-banking clients probably account for less than 1 percent of all of LendingClub’s outstanding loans, a spokesman for LendingClub says, while declining to give figures for LC Advisors.

Laplanche said in a statement to Bloomberg that he disagreed with the board’s “characterization of facts,” but recognized “that events occurred on my watch where we failed to meet our high standards.”

LendingClub’s troubles are affecting competitors. With Wall Street nervous about peer-to-peer, Prosper

Marketplace, the company’s largest rival, has met with investors including Fortress Investment Group about potential capital injections, a person with knowledge of the matter says.

Robert Waldrop, executive director of the Cambridge Centre for Alternative Finance, says “many people expected the wheels to come off” a peer-to-peer player at some point. “The big surprise, clearly,” he says, “was that this was an event that happened at a top performer.” Noah Buhayar, Hugh Son, and Dakin Campbell, with Jenny Surane, Laura J. Keller, and Matt Scully