Crowdfunding and the "Wisdom of the Crowd"
Congress in the JOBS Act provided an exemption from registration for certain crowdfunding offerings. The SEC has a rule proposal pending. The difficulty in this area is balancing the costs of investor protection against the impediments to capital raising. The issues are exacerbated by the limits ($1 million) on the size of any offering relying on the crowdfunding exemption.
In considering the need for shareholder protection, some suggest that the online community is more sophisticated and better able to identify frauds. Indeed, the Commission put considerable emphasis on the "wisdom of the crowd." This has always been a debatable proposition. As we have noted:
- There are many reasons to suspect that the “collective wisdom” of the crowd will not adequately protect investors. Fraudulent offerings may be difficult to expose. Bad actors can hide behind others, obscuring their identity and role. Challenging inaccurate or incomplete statements will be difficult given the dearth of public information associated with non-reporting companies. Nor, in many cases, will the “crowd” be the only, or even the loudest, voice in the debate.
With that in mind, we note an article in the WSJ that discussed some potential changes on the non-equity crowdfunding sites. See Should Crowdfunding Sites Do More to Vet Projects? The article discussed a number of potetial problems with crowdfunding ventures. In one case, a venture, according to the article, "drew flags online from some in the growing crowdfunding community" but continued to raise funds. As the article noted: "The campaign stands as an example to those who say crowdfunding platforms should take a more active role in checking out projects on their sites before allowing the public to contribute money that may never be returned."
Other issues concern missed delays. See Id. ("A study last year of crowdfunded projects by professor Ethan Mollick at the University of Pennsylvania’s Wharton School found that more than three-fourths were delayed."). Delays may arise because of poor planning or unforseen problems. But delay may also be an explanation used for offers that were fraudulent from the outset.
As for litigation, there hasn't apparently been much given the small amounts usually involved. See Id. ("Complaints have also prompted little legal action. With the mean pledge amount at about $64, according to Mr. Mollick’s study, many backers may not think litigation is worth the cost and the hassle.").
Indiegogo has apparently been testing a solution. Rather than collectively imposing the costs of investor protection on the companies making the offerings, Indiegogo has begun offering a product that will allow contributors to buy insurance. See Indiegogo Signals a Blending of Crowdfunding and Commerce ("Indiegogo is testing optional insurance to protect backers against delays and non-delivery. The insurance, if bought, guarantees a refund for the backer if the product misses its deadline by more than three months. Crowdfunding websites don’t provide refunds for funded projects, leaving them to founders and backers to settle directly.").
In other words, if investors want to avoid caveat emptor, they can pay for it. All of this suggests that investors investing up to $100,000 a year in crowdfunding offerings, the maximum amount permitted under the JOBS Act, may not be able to rely on the wisdom of the crowd for protection.