UK Watchdog Criticizes Crowdfunding Platforms for Misleading Investors

Font Size:

UK financial regulatory body finds fault with some crowdfunding promotions.

Font Size:

The age of crowdfunding has arrived. Individuals and businesses increasingly raise small amounts of money from a large number of people through the Internet to fund a project or venture. While people can participate in crowdfunding to give money for charity, another form of crowdfunding has emerged that not only raises money but promises financial returns to investors. But these new types of crowdfunding also raise concerns for protecting potential investors.

In the UK, the Financial Conduct Agency (FCA), which regulates retail and wholesale financial service firms, introduced new rules last year to govern the burgeoning £1bn crowdfunding industry. In a recent audit of financial return crowdfunding platforms, the FCA raised concerns about how these firms operating crowdfunding platforms have conducted financial promotions to investors, thereby not effectively protecting consumers.

The FCA report concentrated on the regulation of business loan-based and investment-based crowdfunding platforms. Business loan-based crowdfunding platforms allow people to lend money to businesses with a prospect of a financial return. Investment-based crowdfunding platforms let people invest in unlisted shares or business-issued debt securities, and may be either debt-based or equity-based. Markets for both of these types of crowdfunding platforms have expanded in the last twelve months. According to a study by Cambridge University and Nesta, a charity organization, business loan-based crowdfunding platforms increased from £193m to £749m between 2013 and 2014, while over the same time period equity-based crowdfunding platforms grew 201%, and debt-based crowdfunding platforms increased by 63% in the area of renewable energy finance.

The FCA report particularly focused on the ways that these platforms disclosed relevant information to enable potential investors to make informed decisions on whether or not to invest. Indeed, pursuant to the FCA rules, promotions must be “fair, clear, and not-misleading,” to allow consumers to assess the risks of the investment and understand who will ultimately be using their money. After reviewing 25 websites against these financial promotion rules, the FCA concluded that investment-based and loan-based crowdfunding platforms have made some problematic financial promotions.

According to the FCA report, the surveyed investment-based crowdfunding platforms presented information in a manner emphasizing the advantages and downplaying the risks, for instance, by claiming “no capital had been lost.” Similarly, the FCA noticed that the platforms omitted important information that could mislead investors, leaving them with an “unrealistically optimistic impression of the investment.”

The FCA found these communication practices to be disconcerting because inexperienced retail investors can participate in investment-based crowdfunding. Although firms are barred from making direct promotions to retail investors who do not meet certain legal requirements, the Cambridge University and Nesta study found that in 2014, 62% of surveyed equity-based crowdfunding investors were retail investors without any prior experience with early stage or venture capital investment. The FCA was therefore concerned that some firms are not coherently presenting information in a way that investors “are reasonably able to understand the nature and risks of investment,” and can “make investment decisions on an informed basis.”

The FCA identified similar problems for business loan-based crowdfunding platforms, pointing out some potentially misleading practices. For example, crowdfunding investments were compared to savings accounts, thereby giving the investor a false impression that his or her capital was secure. Furthermore, crucial information, such as taxation of investments, was missing from promotions.

As a result of its investigation, the FCA contacted the firms making these misleading communications who then agreed to make the required changes on their websites to comply with FCA standards.

Despite these shortcomings, the FCA considered the UK regulatory approach to be favorable compared to the crowdfunding regulations of other jurisdictions, which were analyzed in a report by the International Organization of Securities Commissions, a global standard setting body in the area of securities. The FCA maintained that it “provides a proportionate set of rules, under which the market can develop and consumers are appropriately protected.” Indeed, the FCA provides other consumer protection rules, requiring firms to protect client money, satisfy minimum capital standards, and establish resolution plans so lenders are repaid even if the platform collapses. Additionally, only firms that have received authorization from the FCA can operate these crowdfunding platforms.

The crowdfunding market has continued to grow notwithstanding regulatory constraints, leading the FCA to assert that it does not feel the need to change its regulatory framework for crowdfunding, although it will continue to monitor the market.