The Fraud Examiner

Another Fraud in the Crowd?
 

January 2014 

The Fraud Examiner 

 

Crowdfunding 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 crowdfunding?”  

We currently 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 proposed 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 venture capitalists).

 

What will be the main differences between existing crowdfunding and the new securities crowdfunding?  

Product 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.



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