[The following guest post is contributed by Nikunj Agarwal, who is a 3rd
year student pursuing the B. A. LL.B. (Hons.)
course at RML National Law University,
Lucknow. He can be contacted at [email protected].
year student pursuing the B. A. LL.B. (Hons.)
course at RML National Law University,
Lucknow. He can be contacted at [email protected].
In this
post, the author considers the regulation of a specific type of intermediary
involved in crowdfunding, viz. the funding portals. This follows a previous
guest post on a related topic that deals with the overall regulation of
equity crowdfunding in India]
post, the author considers the regulation of a specific type of intermediary
involved in crowdfunding, viz. the funding portals. This follows a previous
guest post on a related topic that deals with the overall regulation of
equity crowdfunding in India]
Intermediaries
are essential to a capital market system. In crowdfunding transactions, the
project, also called “campaign”, is listed on a “funding portal” which acts as
an intermediary to the fundraising process. The portal provides a platform for
the investment or donation of money. But, most importantly, given the concept
of crowdfunding, which involves smaller sums of money pooled from a large
number of people, a funding portal provides access to the potential investment,
lending, or donation.
are essential to a capital market system. In crowdfunding transactions, the
project, also called “campaign”, is listed on a “funding portal” which acts as
an intermediary to the fundraising process. The portal provides a platform for
the investment or donation of money. But, most importantly, given the concept
of crowdfunding, which involves smaller sums of money pooled from a large
number of people, a funding portal provides access to the potential investment,
lending, or donation.
A simple web
search would reveal the emerging crowdfunding-portals in India. Thus, the need
for regulation of crowdfunding portals, the web-based crowdfunding intermediaries,
is necessary. In the absence of regulation, money is being pooled from people
without any statutory protection to these investors or altruists, and without
any accountability of the fund raisers and campaign advertisers.
search would reveal the emerging crowdfunding-portals in India. Thus, the need
for regulation of crowdfunding portals, the web-based crowdfunding intermediaries,
is necessary. In the absence of regulation, money is being pooled from people
without any statutory protection to these investors or altruists, and without
any accountability of the fund raisers and campaign advertisers.
The aim of this post
is to point out the concern areas which the regulation must address. The relevant
issues demand immediate attention of the capital markets regulator
is to point out the concern areas which the regulation must address. The relevant
issues demand immediate attention of the capital markets regulator
Basis
for Regulating Intermediaries
for Regulating Intermediaries
The crowdfunding
regulations, even if premised on long established theories, assumptions and
legal principles, must still be innovative. This is essential given the
Internet based ecosystem of crowdfunding. Such feature may facilitate schemes
like short-term licensing by the capital markets regulator to use a
crowdfunding portal and simultaneous record of such a license with the capital
market regulator. Such record could then be made publicly accessible by
listing it on the SEBI website or any other authorized portal. Such innovation,
as stated earlier, is particularly effective given the Internet based structure
of crowdfunding.
regulations, even if premised on long established theories, assumptions and
legal principles, must still be innovative. This is essential given the
Internet based ecosystem of crowdfunding. Such feature may facilitate schemes
like short-term licensing by the capital markets regulator to use a
crowdfunding portal and simultaneous record of such a license with the capital
market regulator. Such record could then be made publicly accessible by
listing it on the SEBI website or any other authorized portal. Such innovation,
as stated earlier, is particularly effective given the Internet based structure
of crowdfunding.
The
Essence of Regulation
Essence of Regulation
An effective
‘set of obligations’ upon such intermediaries to perform due diligence, background
check, fundamental disclosure requirements and similar matters is the need of
the hour, which demands public regulation. These obligations would ensure that
‘blind listing’ is discouraged and more responsible project-listing takes
place. But, any set of obligations imposed upon these intermediaries would have
to correspond to the fact that start ups raising seed capital may or may not
have a successful, or any, business track record given the early stage of
commercial evolution. Thus, the disclosure obligations would have to be
reasonable and substantially lesser as compared to the disclosure requirements
for the purposes of public issue of equity or debt instruments.
‘set of obligations’ upon such intermediaries to perform due diligence, background
check, fundamental disclosure requirements and similar matters is the need of
the hour, which demands public regulation. These obligations would ensure that
‘blind listing’ is discouraged and more responsible project-listing takes
place. But, any set of obligations imposed upon these intermediaries would have
to correspond to the fact that start ups raising seed capital may or may not
have a successful, or any, business track record given the early stage of
commercial evolution. Thus, the disclosure obligations would have to be
reasonable and substantially lesser as compared to the disclosure requirements
for the purposes of public issue of equity or debt instruments.
A scheme of
registration of crowdfunding portals with the capital market regulator may be
implemented so that an investor can verify the funding portal’s details on the website
of the regulator before entering into a crowdfunding transaction. This may
involve assigning a unique identification number to the intermediary.
registration of crowdfunding portals with the capital market regulator may be
implemented so that an investor can verify the funding portal’s details on the website
of the regulator before entering into a crowdfunding transaction. This may
involve assigning a unique identification number to the intermediary.
Another
obligation could be to introduce a standard of ‘analysis and satisfaction’.
Under this standard, the intermediary could be required to undertake due
diligence of the fund raiser and issue a statement to the effect that the funding
portal has conducted such an assessment. Additional obligation for any
‘misrepresentation ’or ‘fraud’ attributable to wrongful assessment by the
intermediary could also be imposed. Certainly, the burden of this assessment
must be meaningful and more than the paper formality of asking the fund raiser
a set of predetermined questions.
obligation could be to introduce a standard of ‘analysis and satisfaction’.
Under this standard, the intermediary could be required to undertake due
diligence of the fund raiser and issue a statement to the effect that the funding
portal has conducted such an assessment. Additional obligation for any
‘misrepresentation ’or ‘fraud’ attributable to wrongful assessment by the
intermediary could also be imposed. Certainly, the burden of this assessment
must be meaningful and more than the paper formality of asking the fund raiser
a set of predetermined questions.
These would
ensure that the crowdfunding participant, who may not be capable or willing to conduct
an elaborate analysis of the fund raiser, does not suffer due to lack of any
form of scrutiny at any stage. Moreover, since the intermediary-portals possess
the economic incentive of listing a project on their platform, the cost burdens
of such obligation must be borne by the intermediaries. This does not dilute
the liability of the fund raiser to make the disclosure, which obligation may
be created additionally.
ensure that the crowdfunding participant, who may not be capable or willing to conduct
an elaborate analysis of the fund raiser, does not suffer due to lack of any
form of scrutiny at any stage. Moreover, since the intermediary-portals possess
the economic incentive of listing a project on their platform, the cost burdens
of such obligation must be borne by the intermediaries. This does not dilute
the liability of the fund raiser to make the disclosure, which obligation may
be created additionally.
Relationships
and Obligations
and Obligations
It would also be
interesting to explore what kind of relationship exists between the
intermediary and the investor if the intermediary undertakes obligations as to
the averments made upon the portal in relation to the project and the investor
operates upon those representations. Would the relationship change based upon
the nature of the contribution to the fund e.g.: donation, lending or
investment?
interesting to explore what kind of relationship exists between the
intermediary and the investor if the intermediary undertakes obligations as to
the averments made upon the portal in relation to the project and the investor
operates upon those representations. Would the relationship change based upon
the nature of the contribution to the fund e.g.: donation, lending or
investment?
Crowdfunding
regulations must, therefore, establish statutory relationship between the
portal and the fundraiser; and between the portal and the investor, lender or
the donor. Whether the funding portal would be considered an agent of the
fundraiser while making representations in reference to the fund raising
campaign and whether such portal would owe any fiduciary obligations to the
user of such portal are important concern areas.
regulations must, therefore, establish statutory relationship between the
portal and the fundraiser; and between the portal and the investor, lender or
the donor. Whether the funding portal would be considered an agent of the
fundraiser while making representations in reference to the fund raising
campaign and whether such portal would owe any fiduciary obligations to the
user of such portal are important concern areas.
Another
obligation which might be imposed upon the intermediaries is ‘obligation of
honest representation’. The obligation may appear normative and a good conduct
recommendation but given the nature of claims made by the crowdfunding portals,
it is relevant that the regulation discourages untrue statements even if they
were elaborate bluffs. Given that there might be absence of credible benchmark
to reflect the credibility of the intermediary platform, such a ‘fair-play
obligation’ may serve to bridge the gap.
obligation which might be imposed upon the intermediaries is ‘obligation of
honest representation’. The obligation may appear normative and a good conduct
recommendation but given the nature of claims made by the crowdfunding portals,
it is relevant that the regulation discourages untrue statements even if they
were elaborate bluffs. Given that there might be absence of credible benchmark
to reflect the credibility of the intermediary platform, such a ‘fair-play
obligation’ may serve to bridge the gap.
Classification
of Intermediaries
of Intermediaries
The
intermediaries operating in crowdfunding may be classified based upon the
functions they perform. Some funding portals may act only as listing avenues
which inform the potential investor of the investment opportunities. Others
might serve the rating or certification function which might undertake to
‘recommend’ some projects over the others. Such recommendation is to be
differentiated from mere ‘priority listing for consideration’ which then must
not include a statement of credibility or recommendation for the project.
intermediaries operating in crowdfunding may be classified based upon the
functions they perform. Some funding portals may act only as listing avenues
which inform the potential investor of the investment opportunities. Others
might serve the rating or certification function which might undertake to
‘recommend’ some projects over the others. Such recommendation is to be
differentiated from mere ‘priority listing for consideration’ which then must
not include a statement of credibility or recommendation for the project.
Therefore, since
the intermediaries can serve different roles, the regulations must not burden a
portal with the performance of such functions which it would have not taken as
a business activity sans the regulation. Thus, a regulation demanding due
diligence and credibility grading by the portal where such portal is intended
only to be a listing portal can be indirectly establishing a rigid standard
business structure for the intermediaries.
the intermediaries can serve different roles, the regulations must not burden a
portal with the performance of such functions which it would have not taken as
a business activity sans the regulation. Thus, a regulation demanding due
diligence and credibility grading by the portal where such portal is intended
only to be a listing portal can be indirectly establishing a rigid standard
business structure for the intermediaries.
Independence;
Conflicts of Interest
Conflicts of Interest
Independence of
the funding portal from the listed project is a crucial consideration. This would
prevent a funding portal from listing its own campaign thereby leading to a
conflict of interest. It is also relevant to determine whether the start ups
should be allowed to raise money online directly, through their own web
portals. This direct business lending or investment would skip the fund portal
intermediary. Therefore, the definition of “funding portal” would have to
accommodate such portals, failing which the business can skip the regulatory
burden of disclosure etc if they are allowed to raise fund of their own. Alternatively,
use of fund portals could be made mandatory for web based crowdfunding. Also,
restricting regulation to crowdfunding process to Internet based funding and
leaving a regulatory gap for offline fund transfer as crowdfunding can defeat
the purpose of the regulation.
the funding portal from the listed project is a crucial consideration. This would
prevent a funding portal from listing its own campaign thereby leading to a
conflict of interest. It is also relevant to determine whether the start ups
should be allowed to raise money online directly, through their own web
portals. This direct business lending or investment would skip the fund portal
intermediary. Therefore, the definition of “funding portal” would have to
accommodate such portals, failing which the business can skip the regulatory
burden of disclosure etc if they are allowed to raise fund of their own. Alternatively,
use of fund portals could be made mandatory for web based crowdfunding. Also,
restricting regulation to crowdfunding process to Internet based funding and
leaving a regulatory gap for offline fund transfer as crowdfunding can defeat
the purpose of the regulation.
Therefore,
either the regulations must mandate the crowdfunding process to be undertaken
through an independent online funding portal or otherwise regulate the offline
fund campaign. The former method might
bring symmetry in the crowdfunding process whereas the latter would increase
the regulatory burden and monitoring cost. Additionally, there must not be a
substantial difference in offline and online fund raising process otherwise it
may lead to per se defeat of one of the systems. Thus a practical parity would
be required.
either the regulations must mandate the crowdfunding process to be undertaken
through an independent online funding portal or otherwise regulate the offline
fund campaign. The former method might
bring symmetry in the crowdfunding process whereas the latter would increase
the regulatory burden and monitoring cost. Additionally, there must not be a
substantial difference in offline and online fund raising process otherwise it
may lead to per se defeat of one of the systems. Thus a practical parity would
be required.
Foreign
Projects; Jurisdictional Matters
Projects; Jurisdictional Matters
Whether foreign
projects must be allowed to list their campaign on an Indian fund portal i.e.
whether foreign projects should be allowed to run a crowdfunding campaign for
Indian investors is another area of regulation. Indeed, in the absence of any
restriction, the investor, or one who is willing to make a donation, might
access any website and donate money to a foreign campaign. Thus, eligibility
norms to use the intermediary (funding portal) for campaigning are also
essential.
projects must be allowed to list their campaign on an Indian fund portal i.e.
whether foreign projects should be allowed to run a crowdfunding campaign for
Indian investors is another area of regulation. Indeed, in the absence of any
restriction, the investor, or one who is willing to make a donation, might
access any website and donate money to a foreign campaign. Thus, eligibility
norms to use the intermediary (funding portal) for campaigning are also
essential.
The regulations
must also deal with the issue of jurisdiction of the capital markets regulator
over the crowdfunding portals even if the platform only undertakes donation
crowdfunding and does not list or recommend equity or lending crowdfunding.
must also deal with the issue of jurisdiction of the capital markets regulator
over the crowdfunding portals even if the platform only undertakes donation
crowdfunding and does not list or recommend equity or lending crowdfunding.
In United States,
Section 304 of the Jumpstart Our Business Startups Act of 2012 (JOBS Act) gives
powers to the Securities Exchange Commission (SEC) to exempt, either
conditionally or unconditionally, the ‘registered’ funding portals to register
as brokers or dealer. Section 3(a)(80) of the Securities Exchange Act of 1934
defines “funding portal”. This legislation was amended by the JOBS Act. The
provision incorporates a prohibition of ‘holding, managing or possessing
investor funds’ as one of the preconditions to be a qualified funding portal
within the definition of the act. The provision also prohibits the funding
portals from engaging in any activity which the commission deems inappropriate.
It is pertinent to note that in the US detailed regulation with reference to
funding portals is due. It is expected that the regulations would be made
available in October 2015.
Section 304 of the Jumpstart Our Business Startups Act of 2012 (JOBS Act) gives
powers to the Securities Exchange Commission (SEC) to exempt, either
conditionally or unconditionally, the ‘registered’ funding portals to register
as brokers or dealer. Section 3(a)(80) of the Securities Exchange Act of 1934
defines “funding portal”. This legislation was amended by the JOBS Act. The
provision incorporates a prohibition of ‘holding, managing or possessing
investor funds’ as one of the preconditions to be a qualified funding portal
within the definition of the act. The provision also prohibits the funding
portals from engaging in any activity which the commission deems inappropriate.
It is pertinent to note that in the US detailed regulation with reference to
funding portals is due. It is expected that the regulations would be made
available in October 2015.
Thus,
irrespective of what is the final shape of the Indian crowdfunding regulations,
the above mentioned concern areas should find a substantive mention in an
effective regulation for crowdfunding intermediaries: the funding portals.
irrespective of what is the final shape of the Indian crowdfunding regulations,
the above mentioned concern areas should find a substantive mention in an
effective regulation for crowdfunding intermediaries: the funding portals.
– Nikunj Agarwal
Very enlightening article, thanks for the update. However, I'd like to highlight a few points.
Firstly, to my understanding any regulation of intermediaries involved in crowd-funding should be viewed in the light that the concept of "crowd-funding" is by its very nature found in cases where the individual contributor is not at a risk of losing money. That may be so because such contributors tender only a small part in the scheme (knowing well that there will be other contributors) and also because the contributors are not expecting any consideration in return. Thus, the well-understood concept of investor-protection is not very well applicable here.
Secondly, the above two-points are also applicable to donation-based fund-raising which to my view is often undertaken by charitable as well as non-charitable organisations. Just because the same is done through an internet based platform the same does not call for any scrutiny as may be highlighted again that there is no concept of 'investor-protection' involved.
Here I think there should be a highlight also of the circumstances where such crowd-funding is undertaken. Mostly, in profit seeking circumstances a player would seek crowd-funding on the basis of an already functional business idea (like a software or application) which has been made available in public domain under open license. Thus, most contributors would already have utilised the consideration (i.e. the application/ software) in lieu of the contribution.
Further, if we go by the concept of "investor-protection" in donation-based crowd-funding, the same is certain to result in death of charity; as we all know the most basic tenet of charity – 'neki kar aur darya me daal'. Meaning if you donate you do not expect a return out of it.
Thanks
Shreyas