The Fraud Examiner
has become a hot topic among investors, regulators and fraud examiners as the
phenomenon has gained traction over the last few years. This method of raising
funds allows entrepreneurs to appeal directly to a large number of individuals through an online crowdfunding platform, thus avoiding banks, brokers
or other intermediaries.
While it has
been used to generate financial support for new products, artistic support and
charity, the recent JOBS act created an exemption to federal securities laws by
allowing crowdfunding to be used as a means to buy and sell securities. Regulators
like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory
Authority (FINRA) have proposed new rules and are still determining what
controls are needed to help protect investors in this new frontier.
To gain some insight into this emerging issue, The Fraud Examiner spoke with Eric Miles, CFE, CPA, CFF, partner
in charge of Moss Adams’ Business Risk practice for Northern California and national practice leader for the firm’s technology industry group. Miles
has participated in several panel discussions on crowdfunding and shed some
light on securities crowdfunding.
Crowdfunding has existed for a few years
now. But can you tell us what is new with the concept of “securities
have product-based and donation-based crowdfunding, but securities crowdfunding will allow a non-accredited
investor to participate in early startups through Internet portals. The SEC has
new rules that would affect this type of investing. What we would potentially
see with securities crowdfunding is a whole new class of investor, and that,
frankly, might be where some of the fraud risk comes from. You have investors
who may not do the same amount of due diligence (as experienced investors or
What will be the main differences between
existing crowdfunding and the new securities crowdfunding?
crowdfunding involves an entrepreneur saying, “I want to create this new
product.” As a participant, you are not buying equity or debt. You’re buying the
product, or some other definable benefit. So to this point, we’ve had
product crowdfunding or, in some cases, donation crowdfunding, where you are
giving to a cause. But now (with securities crowdfunding) we are
talking about debt and equity funding. Which, to
me, is light years different in terms of risk. When you invest in a product,
there is an end point. The product is made (and then it either sells, or it doesn’t).
Equity investing means you buy this equity and you don’t really know what you
are going to get. It could be fraud, or it could be a failed idea.
What makes security crowdfunding inherently
I think one
of the main questions here is why a company would use it. If you are a company
that needs to use securities crowdfunding, that is a warning sign in and of
itself. The reason I say that is because if you have a viable product, a
venture capital group (or other more traditional financing means) would have backed you.
So with some
of these startups, you have to wonder: is there going to be a stigma? Are
people going to ask themselves (or others) before they invest, “why are they using
security crowdfunding when, if they had a viable business model, they could
have received the funding by other means?”
One of the
questions I’ve been asked is what concerns me the most. Equity securities can
be really squishy in terms of “what is expected.” The company could go
bankrupt. Or it could be a fraud. Also, what happens if you invest and then
have no control over future investments? Your investment could be diluted out
of any value.
issue is pump and dump. Although the SEC proposed rules specifically addressing the advertising of crowdfunding securities, I think there is still a real concern that you are going to
have various parties pumping up through social media the value of the
investment... basically like selling stock. They will be pumping it up and then
selling pretty worthless securities. This is not an uncommon type of fraud for penny or microcap securities, and I would imagine it could be worse with securities crowdfunding. This plays into the risks of emotional
investing, especially using an Internet portal.
Do financial experts agree about the risks
of securities crowdfunding?
two schools of thought on crowdfunding today. There are people, like me, who
are skeptical – who see the potential for harm. Then there are those who
believe in the “wisdom of crowds” – the assertion being that the crowd itself,
because of its collective wisdom, can identify fraud. This is fueled by social media and our overall connectedness in today’s world. Editor’s note: Read more on the merits vs. risks of crowdfunding in
this ABC News article
What else do you see in the proposed SEC
rules that garners our attention?
There is an
interesting aspect that is going to make this fascinating. The SEC put a lot of
onus on these intermediaries (the portals) in expecting them to do some of
their own due diligence (in terms of vetting the investment opportunities). According
to what I’ve read, investors may be able to hold those portals accountable (in
the case of fraud). I’m curious to see who gets in the game here. There are the
proposed SEC rules, and then there is another set of rules from FINRA. If I
were a potential portal, I would have my own rules: if you want to raise money
on my website, you need to go through these due diligence checks in order to do
What advice would you give investors who
are considering participating in a crowdfunding opportunity?
all of your eggs in one basket. These types of investment opportunities are
Eric Miles, CFE, CPA, CFF, is the partner in
charge of Moss Adams’ Business Risk practice for Northern California and national practice leader for the firm’s technology industry group. Miles specializes in business risk management
including internal audit consulting, SOX 404 and enterprise risk management.
Miles is the outsourced director of internal audit for several organizations and
specializes in the technology, life sciences and healthcare industries. Miles is
a Certified Public Accountant (CPA), Certified Fraud Examiner (CFE), Certified
in Financial Forensics (CFF) and holds a Certification in Inventory Management
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