September 26th, 2018
In Crowdfunding, Who is Responsible for Preventing Fraud?
Who is responsible in the case that an investor loses his or her money to a fraudster in equity crowdfunding? That is the question that is at the root of much of the debate over how to regulate this new financial tool.
On the last day that public comments for proposed regulation for equity crowdfunding were accepted by the Securities and Exchange Commission, almost fifty letters were submitted with recommendations on how to change the rules. (Let’s be honest, we don’t stop procrastinating after college.)
The comment letters came from a wide variety of sources, from small-business advocacy groups to equity-crowdfunding portals to various members of the legal, regulating community to professional crowdfunding trade organizations. But many of the letters brought up one common concern: that the websites administering equity crowdfunding (or the “portals”) will be saddled with so much responsibility, they won’t be able to effectively function.
The SEC, which was assigned to write rules to regulate this newly legalized equity crowdfunding, released a preliminary set of rules on Oct. 23. That initiated a 90-day comment period which ended on Monday of this week. Regulatory issues brought up earlier in the comment period included appropriate investor caps, how an investor’s wealth ought to be determined and calculated, and the appropriate amounts of financial disclosure paperwork that ought to be required.
Here is a breakdown of the latest hot-button issue: how to regulate the portals.
The regulation squeeze: The proposed SEC rules consider crowdfunding portals “issuers,” and that means that the portals are held liable for the entrepreneurs raising money on their sites. If an entrepreneur’s campaign to raise money is fraudulent, then the portal would be held responsible. At the same time, portals are not allowed to give “investment advice.” That means portals are responsible for investors losing money, but can’t give any advice. “The proposed rules put funding portals between a rock and a hard place,” said Kiran Lingam, general counsel for Seed Invest, an equity crowdfunding platform which currently deals only with accredited investors, in a letter to the SEC.
As a result, only a few portals would survive the regulatory environment: The combination of regulatory burdens will result in a very limited pool of portals, according to letter submitted to the SEC by the Small Business and Entrepreneurship Council, an advocacy group with over 100,000 members. “The combined regulatory and liability risks are far too great under current proposed regulations to expect a vibrant funding portal marketplace. That means less choice for issuers, as well as higher costs. Fixing the proposed regulations to provide clarity when it comes to liability and discretion on the funding portal’s part will allow for innovation, competition and accountability in the portal space,” said Karen Kerrigan, president and CEO of the SBE Council in her letter to the SEC. Having fewer portals is a negative for the industry. “Greater choices of funding portals will benefit investors and the entrepreneurs who will be using these platforms,” Kerrigan says.
Kerrigan says the SEC has estimated that it could cost as much as $400,000 just to meet required regulatory hurdles to open an equity crowdfunding portal. That’s a lot of money for financial platforms whose revenue streams are built by taking a cut of relatively small investments.
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