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Erscheinung:16.06.2014 | Topic Consumer protection V. Müller-Schmale, BaFin

Crowdfunding: Supervisory requirements and investor responsibility

Crowdfunding projects are emerging as an increasingly popular option for investors. Crowdfunding is a way in which a large number of backers provide financial support for a specific project. Funds are usually raised via an online crowdfunding platform.

Crowdfunding can offer advantages to investors and help expand the market to include new and creative concepts. However, as well as giving rise to certain obligations, crowdfunding also brings with it fundamental risks, since the offerings form part of the unregulated capital market. Investors should be aware of these risks and consider the consequences carefully before deciding to invest.

Creative, cultural and social projects

Project initiators are increasingly turning to crowdfunding as an alternative or supplement to traditional forms of finance such as loans, venture capital, business angels, or grants. Crowdfunding is often an attractive option for creative, cultural and social projects since there are practically no financial offerings tailored to their specific needs. This form of finance is also used by numerous start-up companies and initiators of innovative projects, who are often unable to meet the requirements for conventional financial instruments such as providing audited financial statements or collateral.

One well-known example of crowdfunding is the cinema adaptation of the German television series Stromberg. In December 2011, the production company launched an online appeal to raise funds for the film. The intention was to raise one million euros by March 2012, a goal which was achieved within a week.

However, the idea of crowdfunding is in fact much older. One well-known and documented historical crowdfunding project was the financing of the Statue of Liberty’s pedestal in New York. Since it initially proved difficult to obtain funds for the statue’s base, in March 1885 the founder of the “New York World”, Josef Pulitzer, launched a campaign to raise US$100,000 in donations. Regardless of the amount given, anyone donating to the project was promised a mention in the newspaper. The fundraising campaign was a success – the statue’s pedestal was financed by 120,000 people, with the average donation amounting to less than one US dollar.

Types of crowdfunding

There are many different forms of crowdfunding platforms. In practice, a distinction is currently made between four main crowdfunding models: donation-based and rewards-based crowdfunding, which are also referred to as crowd sponsoring, loan-based crowdfunding (crowd lending) and crowd investing. In both these latter types, the aim is to generate a financial return. That said, crowdfunding platforms and projects do not always fit neatly into one single model. The attention of the supervisory authorities is focused on crowd lending and crowd investing. The following explanations therefore relate exclusively to these two models.

Crowdfunding - the four models

  1. Donation-based crowdfunding: the public donate money to a specific project within a set timeframe, without receiving anything in return.
  2. Rewards-based crowdfunding: backers receive a symbolic non-monetary reward, such as a mention in the credits of the film they have helped to finance or a personal item from the artist they supported.
  3. Loan-based crowdfunding (crowd lending): backers are promised repayment, with or without interest.
  4. Crowd investing: backers receive an interest in the financed project’s future profits, or equity or debt instruments if the investment involves securities.

Authorisation requirement

Where finance is raised through crowd lending or crowd investing, BaFin examines the terms of the contracts to determine whether there is an authorisation requirement. Pursuant to section 32 (1) of the German Banking Act (KreditwesengesetzKWG), anyone wishing to conduct banking business or to provide financial services in Germany commercially or on a scale which requires a commercially organised business undertaking needs written authorisation from BaFin.

Business is performed commercially if the operation is intended to continue for a certain length of time and the business operator intends to generate a profit. One key indication of such an intention to generate a profit is that the business operator charges money for its services. Whether or not the scale of the business requires a commercially organised business undertaking depends in particular on the nature and scope of the business activity. However, for the authorisation requirement it is irrelevant whether the business is actually run commercially.

Individual examination
There are significant differences between individual crowdfunding platforms. Consequently, this article only provides a broad overview of potential authorisation requirements. BaFin can only make a binding statement on authorisation requirements after examining each case individually.

Crowd lending

In principle, simply brokering loans does not require an authorisation under the KWG, although one may be required pursuant to section 34c of the German Industrial Code (GewerbeordnungGewO). Therefore, BaFin does not usually supervise lending platforms. However, depending on the contractual arrangements, prudential authorisation requirements may be applicable to both users and the operator of the platform (see BaFin Guidance Notice on the Authorisation Requirements for Operators and Users of Online Lending Platforms – only available in German). If these are not observed, BaFin may take the measures listed in section 44c and section 37 of the KWG against the operators and users, and also against the lending platform as a dependent undertaking. These measures include requests for information and submission of documents, inspections and searches, and – if business is conducted without the required authorisation – the powers to discontinue and wind up the business.

Backers of crowd lending projects who conduct their business commercially or on a scale which requires a commercially organised business undertaking are conducting lending business within the meaning of section 1 (1) sentence 2 no. 2 of the KWG that requires authorisation (see BaFin Guidance Notice on the Statutory Definition of the Lending Business – only available in German) or, if they purchase loan receivables under a master agreement, are engaged in factoring within the meaning of section 1 (1a) sentence 2 no. 9 of the KWG that requires authorisation (see BaFin Guidance Notice on the Statutory Definition of Factoring – only available in German).

Borrowers who raise money commercially or on a scale which requires a commercially organised business undertaking via a platform are potentially also operating a banking business, namely a deposit business within the meaning of section 1 (1) sentence 2 no. 1 of the KWG that requires authorisation (see BaFin Guidance Notice on the Definition of the Deposit Business – only available in German), since they accept funds from others as deposits or other unconditionally repayable funds from the public.

In addition, brokering of deposit business in a state outside the European Economic Area (EEA) is covered by a special statutory definition, that of non-EEA deposit broking under section 1 (1a) sentence 2 no. 5 of the KWG (see BaFin Guidance Notice on the Statutory Definition of Non-EEA Deposit Broking – only available in German).

Crowd investing

Depending on the design of the crowdfunding platform, crowd investing may also be subject to prudential authorisation requirements. The platform operator may potentially provide financial services which require authorisation, such as investment broking within the meaning of section 1 (1a) sentence 2 no. 1 of the KWG (see BaFin Guidance Notice on the Statutory Definition of Investment Broking – only available in German), contract broking within the meaning of section 1 (1a) sentence 2 no. 2 of the KWG (see BaFin Guidance Notice on the Statutory Definition of Contract Broking – only available in German) or placement business within the meaning of section 1 (1a) sentence 2 no. 1c of the KWG (see BaFin Guidance Notice on the Statutory Definition of the Placement Business – only available in German). However, this presupposes that the equity investments offered via the platform are financial instruments within the meaning of section 1 (11) of the KWG (see BaFin Guidance Notice on Financial Instruments pursuant to section 1 (11) sentence 1 nos. 1 to 7 of the KWG). Even if the platform operator meets one of the definitions for activities requiring authorisation specified above, section 2 (6) of the KWG specifies that it will not require authorisation under the KWG if it merely performs investment or contract broking and does not obtain ownership or possession of the money, or if the placement business is conducted exclusively for providers or issuers. This is the case in the majority of investments being offered to date. However, investment intermediaries may be subject to an authorisation requirement pursuant to section 34f of the GewO.

In addition, authorisation requirements pursuant to the Payment Services Supervision Act (ZahlungsdiensteaufsichtsgesetzZAG) may be applicable if the crowdfunding platform operator accepts money from investors and passes it on to the offeror of the equity investment, and engages in money remittance business (see BaFin Guidance Notice on the Payment Services Supervision Act – only available in German). Obligations under the Securities Trading Act (WertpapierhandelsgesetzWpHG) may also be applicable.

Investment offerors or issuers should also take into consideration the obligation to draw up a prospectus that applies to offers to the public exceeding €100,000 pursuant to the Securities Prospectus Act (WertpapierprospektgesetzWpPG) or the Capital Investment Act (VermögensanlagengesetzVermAnlG). If an investment offer is subject to the requirement to draw up a prospectus, the offeror is also required to draft a capital investments information sheet before the offer to the public commences.

Investor responsibility

Crowdfunding can bring benefits both for the recipients of funds and for investors. For businesses it provides an additional opportunity to fund projects, and often serves as a first market test. Investors have the chance to support specific projects, including those where private investors had previously been unable to participate.

Package of measures by the Federal Government
A few days ago the Federal Government presented a package of measures designed to improve protection for small investors. Its aims include removing loopholes and possibilities to circumvent legislation. Where this affects crowdfunding, the aim is to find solutions to protect investors, but also to meet the needs of young businesses which raise finance through crowd investing.

Before making an investment decision, investors should carefully weigh up the associated opportunities and risks. They must be conscious of the fact that the majority of platforms do not require authorisation, and as such are part of the unregulated capital market. This term refers to a situation in which an offeror does not require authorisation from BaFin and must only fulfil a handful of statutory requirements (see the article entitled “The Unregulated Capital Market in Germany”).

In themselves, investments made via the unregulated capital market are not necessarily associated with greater risks. However, investors are exposing themselves to a market segment which is not regulated by the state. Neither the products nor the integrity or financial standing of the provider and investors are supervised. In addition, there is no ongoing oversight, no enforcement of financial reporting requirements and no deposit protection. Unfortunately this makes it easier for unscrupulous providers to place their products on the unregulated capital market. Investors should be aware of this before reaching investment decisions. They themselves are responsible for choosing products which correspond to their personal risk appetites and investment objectives.

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