[Priyanka Sunjay is a Fourth year student, B.A., LL.B.(Hons), National Law University, Jodhpur]
Crowdfunding is a means by which an entrepreneur or business raises financing by way of small contributions from a large number of individuals using mass communication through the Internet. It is usually used to raise funds for films, art, business ventures or social causes. There are various types of crowdfunding, namely: reward, donation, peer-to-peer, and equity-based. Equity-based crowdfunding refers to the issuance of equity shares of a company in consideration of funds solicited from investors.
The scope of this post is restricted to four main objectives: first, to examine the regulation of equity based crowdfunding in India; second, to ascertain if equity based crowdfunding qualifies as a “private placement” or “public offer”; third, to determine if the Securities and Exchange Board of India (“SEBI”) has the jurisdiction to regulation equity based crowdfunding in India; and lastly, to compare the mode of regulation of equity based crowdfunding in India and Italy.
1. Equity Based Crowdfunding: The Regulatory Conundrum
The regulation of equity based crowdfunding is a tricky question, since it comes with its own set of advantages and risks. Its advantages include an unconventional funding mechanism and an opportunity for the crowd to invest in securities. However, at the same time, it comes with higher chances of failure and there is information asymmetry. Thus, the regulation of crowdfunding is in a state of flux.
SEBI issued a consultation paper in 2014, in which it asked for proposals and suggestions regarding the regulation of equity based crowdfunding in India. In that paper, SEBI analysed the concept of crowdfunding, its advantages, disadvantages and the risks posed by it. It also leaned in favour of a restricted and highly regulated mechanism for it, inter alia, limited investors to accredited investors; it also imposed a requirement of 5% investment by qualified-institutional buyers and restricted crowdfunding platforms to the ones that qualify the high threshold requirement of Class I, Class II, Class III entities.
Four main aspects of the consultation paper stand out: (i) SEBI did not include retail investors; (ii) only unlisted public companies were stated to be eligible for crowdfunding; (iii) advertisements were not allowed; and (iv) a cumbersome process is imposed on the issuing company. However, the most important takeaway from the consultation paper (at page 59) was SEBI’s observation that: “crowdfunding is intended to facilitate capital raising through online medium by start-ups and SMEs and not for the resale of securities. There is no requirement of listing for trading and no listing obligation on the issuer.”
However, in a press release issued on August 30, 2016, SEBI found that: “The electronic platforms are allegedly facilitating investment in the form of private placement with companies, as the offer is open to all the investors registered with the platform amounting to a contravention of the provisions of Securities Contract (Regulation) Act, 1956 (SCRA) and the Companies Act, 2013.” Thus, it noted that compliance with SCRA, listing of issuing company and recognition of the crowdfunding platform are mandatory. After enquiring with a few angel investors about their mode of fundraising in August this year, SEBI instructed them to issue a disclaimer that their activities are not authorised by SEBI.
Thus, there is an absence of a robust structure of law regulating equity of crowdfunding in India, and the inconsistent approach taken by SEBI has led to confusion amongst investors and fund-raisers alike.
2. Crowdfunding: Private placement or Public Offer?
Recently, LinkedIn was asked by SEBI to clarify if it provides a fundraising platform to the public in contravention of Section 42 of the Companies Act, 2013. Section 42 enables companies to make private placement through issue of a private placement offer letter; through these private placements, the company may issue shares to up to fifty persons. Notably, a company may only make an offer for the issue and allotment of shares to up to two hundred persons in a financial year, excluding qualified institutional buyers and employees.
In case a company issues securities in contravention of the above rules, irrespective of whether it is a listed or unlisted company, whether it intends to list its securities or not on any recognized stock exchange in or outside India, or whether payment for the securities has been received or not, it will be deemed to be a public offer. This is provided for under explanation I to section 42(2), Companies Act, 2013 which was inserted after the Sahara case.
Likewise, the process for a public offer is mentioned under Part I of Chapter III of the Companies Act, 2013 and the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations 2009. A public offer of shares or convertible debt securities involves a cumbersome process of appointment of one or more merchant bankers, a registrar to the issue, filing of a draft offer document with SEBI, eligibility requirements such as previous track record, minimum promoter’s contribution, as well as detailed disclosure requirements.
The question is: whether equity based crowdfunding would qualify as a private placement or public offer? SEBI’s argument rests on the reasoning that when a company calls for investment through a crowdfunding platform, it puts itself in a position to issue shares to more than 50 persons (and 200 persons in a financial year). However, a company can approach the public through the crowdfunding platform, but still manage to limit the investors to 200 persons. In such a scenario, the crowdfunding mechanism would not strictly qualify as a public offer.
3. The Question of Jurisdiction: SEBI or MCA?
It is questionable whether SEBI has jurisdiction for the following reasons: first, participation in crowdfunding is not limited to listed public companies, but also extends to unlisted public companies and private companies; second, and more importantly, crowdfunding can take place through a private placement. Private placement through electronic means is not prohibited under the Companies Act, 2013 and it also recognises maintenance of statutory registers in electronic form.
The jurisdiction of SEBI was laid down in the Sahara case, where it was held that under section 55A of the Companies Act, on matters relating to issue and transfer of securities and failure to pay dividends, SEBI has the power to administer the case of listed public companies and in the case of those public companies who anticipate that their securities will be listed on a recognized stock exchange in India. The Ministry of Corporate Affairs (“MCA”) regulates private placements, and under section 24 of the Companies Act, 2013 it enjoys residual rule-making power on matters that are specifically provided under the Companies Act (which includes private placements as well).
In its note, SEBI had concluded that equity securities can be listed only on recognised stock exchanges and any issue of equity securities is in contravention of section 19 of the SCRA. It is doubtful whether SEBI considers crowdfunding platform to qualify as a stock exchange under Section 2(j) of SCRA. This leaves the question of private placement on electronic platforms unclear. Further, since crowdfunding is not strictly a public offer or a private placement, SEBI’s exercise of jurisdiction seems incorrect.
4. A Note on the Regulation of Crowdfunding in Other Jurisdictions
The regulation of crowdfunding can be divided into three categories: prohibition of equity crowdfunding in its entirety (Hong Kong, Japan), regulation of crowdfunding under the public offer (United States) of securities and a specific legislation that governs crowdfunding (Italy).
Italy was one of the first jurisdictions to pass a comprehensive regulation on equity crowdfunding. It specifically allows for crowdfunding to support the development of “innovative start-up companies”. The law seeks to provide an incentive to innovative start-ups, and also facilitate the working of enterprises involved in innovation and technology. In furtherance of the same, crowdfunding through online portals is allowed as well. Portals must register themselves with the the securities regulator, CONSOB, and must meet the integrity and professional requirements on a constant basis and ensure protection of shareholders. Their other responsibilities include publishing information on the offer, including information on the issuer and on the financial instruments offered, information on risks and information on any services offered by the portal manager in relation to the offer. The portal is made primarily responsible for information circulated to potential investors and must adequately warn non-professional investors as to the risks of crowdfunding activities. However, the issuer retains the onus for the completeness and truth of the data and information.
Some countries, such as the United States, Australia and Singapore, carve out exemptions for crowdfunding activities. The United States provided a specific exemption to crowdfunding activities in 2012. The Jumpstart Our Business Start-ups Act introduced an exemption to the US securities law and permitted the sale of securities through crowdfunding. Under Title III of the JOBS Act, the CROWDFUND Act amends Section 4 of the Securities Act, 1933 and does away with registration and prospectus requirement. It also includes reduced disclosure, registration and procedural requirements. It sets an upper limit of USD 1 million within a period of 12 months.
It has been observed that are three modes of raising funds on certain online platforms for start-ups. Under the first mode, the profile is visible to all; in the second mode, the basic information about the company is visible to all, but specific details of the company is given only permission; and, under the last mode neither the basic nor detailed profile is visible on any platform. Hence, although the last two modes may not be in violation of private placement norms, the first may potentially constitute an illustration of the types of crowdfunding platform referred to by SEBI in its caution note. It is unlikely that the crowdfunding platforms that adhere to private placements norms violate any law. Yet, SEBI’s observation that: “investors are hereby cautioned that all dealings on such unauthorized electronic platforms would be in contravention of the relevant securities laws,” raises concerns about the validity of crowdfunding and has caused distress among investors and fund-raisers alike.
Therefore, India requires a comprehensive law on equity crowdfunding. At present, the status of cross-border crowdfunding is unclear. A mechanism such as the one present in the Italy which allows a crowdfunding platform to control information asymmetry and protect the interests of the shareholders is welcome. Alternatively, it is suggested that there can be relaxations in procedural, registration, and disclosure requirements as envisaged in the laws of the USA. Such relaxation should be supplemented with a specific legislation on crowdfunding as it has aspects that cannot be strictly categorised into a private placement or a public offer.
– Priyanka Sunjay
 Companies (Prospectus and Allotment of Shares) Rules, 2014.
 Section 120, Companies Act, 2013.
 Section 2(j), Securities Contract (Regulation) Act, 1956.
 Articles 8-11, CONSOB Regulation No. 18592 of 2013.
 Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act, 2012.
 Section 4, Securities Act, 1933 (15 U.S.C 77e).