LendingClub's fall from grace from rock star status

LendingClub

Not long ago LendingClub was the brightest star in the rapidly-growing world of online lending. Now it's embroiled in turmoil that is shaking confidence in the emerging industry.

Shares of LendingClub (LC), the world's largest peer-to-peer lender, plunged 12% to record lows on Tuesday after saying it received a grand jury subpoena from the U.S. Department of Justice. The company said it has also proactively contacted the Securities and Exchange Commission.

LendingClub said it is "fully cooperating" with the investigation. LendingClub admitted to "material weakness" in its internal controls over financial reporting -- an issue it said was caused by the "tone at the top" of the company.

The disclosures come just days after LendingClub announced a bombshell: founder and CEO Renaud Laplanche was being forced out amid a series of governance failures, including not disclosing a personal investment.

LendingClub went public in late 2014 amid much fanfare about its innovative business model. As a peer-to-peer online lender, LendingClub matches investors with borrowers on everything from homes and vacations to credit card debt.

But LendingClub shares have collapsed by two-thirds in the past two months. The recent events have raised eyebrows in part because LendingClub has some big-name backers: board members include former Treasury Secretary Larry Summers and former Morgan Stanley (MS) CEO John Mack.

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It's also surprising because LendingClub's entire business model requires investors to have faith that the company is being honest and trustworthy. Without that trust, banks and institutions that fund LendingClub loans to regular people and small businesses could walk away.

"It's a new industry that prided themselves on transparency and being investor-friendly. A lot of that trust and goodwill evaporated, almost overnight," said Michael Tarkan, an analyst at Compass Point Research who now has a "sell" rating on LendingClub.

Already, Goldman Sachs (GS) and a group of community banks known as BancAlliance have paused their purchases of LendingClub loans, according to The Wall Street Journal. Goldman Sachs and BancAlliance declined to comment to CNNMoney.

"People have lost faith and trust," said Julianna Balicka, an analyst at Keefe Bruyette & Woods who has a "sell" rating on LendingClub.

Here are the three major developments spooking LendingClub investors and business partners:

1.) Conflict of interest concerns: LendingClub said Laplanche, its former CEO, failed to disclose a personal investment in Cirrix Capital, a firm that invested in LendingClub loans. Additionally, LendingClub said its risk committee approved an investment by LendingClub itself into Cirrix -- without the knowledge of the prior investment by Laplanche.

2.) Improper loan sale: LendingClub said $22.3 million worth of loans were sold to a single institutional investor -- even though those loans didn't meet certain criteria.

3.) Loan manipulation: LendingClub employees also changed the application date on $3 million in loans in an attempt to meet the institutional investor's requirement, LendingClub said.

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LendingClub has sought to reassure investors through a series of moves. The company launched a comprehensive investigation, has hired an acting CEO and has fired or accepted the resignation of the senior managers involved with manipulating loan dates. LendingClub also said no material adjustments or restatements to its financial statements have been required.

"The problems identified this quarter run counter to our values and will never be tolerated. We're working hard to make things right and prove to you that we continue to deserve your trust," LendingClub said in a letter to investors.

But analysts said the turmoil surrounding LendingClub may take time to subside and could dent confidence in online lenders more broadly.

"LendingClub's behavior definitely puts a blemish on the whole industry," said Balicka, the KBW analyst. "It's unfortunate the rest of the industry is going to be hurt by this."

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