Australian regulators endanger crowdfunding by pushing assessments of project viabiliy

This post was first published on the Getting Results From Crowds book website.

Today the Australian Securities & Investment Commission (ASIC) issued a wide-ranging guidance on crowd funding.

The guidance in essence recognizes crowdfunding and clarifies the current legislation that applies to the area. It notes that if crowdfunding activities “produce financial benefits” then they are regulated under the Corporations Act and will require a disclosure document.

In the case of crowdfunding being effectively “pre-purchase arrangement of a product or a service”, then it will be regulated by the Competition and Consumer Act, that applies to all retail sales.

These points were pretty obvious, so this part of the guidance simply clarifies the relevant legislation for those involved in the space.

Where the guidance gets interesting is on what they expect from crowdfunding platforms in helping to manage risks:

• a risk of fraud being carried out through crowd funding websites. Website operators can help manage this risk by doing background and credentials checks on project creators to help minimise the opportunity for fraud.
• a risk that funded projects are not completed and the project sponsors do not receive the rewards promised. As well as background and credentials checks, the website operators can manage this risk by assessing the viability of the project before it is posted on their website, requiring the project creator to provide more information on how and when they complete the project and consider requiring the project creator to report periodically through the website on their progress in implementing the project.
• a risk that the money collected is lost due to the fraud or bankruptcy of the website operator before the money is passed on to the project creator. The website operator can manage this risk by holding all crowd funding money in a trust account separate from its own assets, avoiding excessive holding periods and implementing appropriate internal controls to ensure withdrawals are appropriate.

Some of this is reasonable: establishing trust accounts would give contributors more confidence, and requiring good disclosure and periodic reporting from project creators is of course sound practice.

However expecting crowdfunding platforms to perform background and credential checks on project creators and assess the viability of projects is not reasonable. Firstly, the cost of doing so would be prohibitive. Secondly, providing an assessment of project viability would in fact significantly increase the legal burden of the platform, as those who were disappointed in the project outcomes could target the advice given. It is possible that forcing viability assessments of projects by platforms could destroy the industry, making the legal risk outweigh the commercial opportunity.

Contributors need to make their own assessment on projects, and of course be given as full information as possible to make that decision. Analogues of the rating agencies such as Moody’s and S&P that provide reputation measures for crowdfunding could arise to provide assessments of crowdfunding projects. However their business model would be completely different from the crowdfunding platforms, and in general it would be better for them to be run as independent and distinct companies.

Of course at this point ASIC is not legislating, but simply encouraging crowdfunding platforms to help manage risks. ASIC says it has written to Australian-based crowdfunding platforms expressing its views on crowdfunding. It would be very interesting to know how strong their language is in expecting them to manage crowdfunding risk, and whether this may foreshadow some heavier-handed moves in the future.

The context for all this is that crowdfunding could be a very powerful enabler of innovation, small business, and the economy in countries around the world. Easier access to funding for those with innovative and worthwhile ideas would be massively helpful.

Of course legislation and protection is required in the crowdfunding arena. However finance regulators around the world are completely focused on risk avoidance, and not on potential social and economic benefits. This dramatically skews how they work, to the point of often stifling value creation.

I dearly hope that ASIC and other regulators around the world will take a balanced approach that will allow the extraordinary potential of crowdfunding to flourish.