By Aishwarya Dhakarey, Symbiosis Law School, Pune.

In simple words, inviting funds from multiple investors for a specific social cause or project or undertaking and all this takes place in a web-based platform or a social networking website. Crowd funding is sub divided into various types namely, donation crowd funding, reward crowd funding, peer-to-peer lending and equity crowd funding[1]. Nevertheless, the scope of this piece is restricted to Equity Crowd funding. It is a fact that crowdfunding is technologically assisted and social media enabled.

Due diligence by the crowdfunding portal (Element of fraud) – In India, there is no legal safeguards to the investor if a proper due diligence is not conducted by the portal on the issuer in respect of its Intellectual Property, founders, etc. Due diligence is nothing but a kind of probe prior to striking any deal or initiating any transaction. There are additionally instances when authentic websites fall prey to fraudulent projects or issuers. The goodwill of the website is thus, exploited by such issuers.

Lack of business model, strategy or vision- Under the existing legal framework, there is no mandate on the issuers to come up with a business model which is viable enough to insure the investors against the risk of loss to investors in the company. There is also a problem with such types of investors as they are not capable and skilled enough to assess the risks in these investments.

India recently considered regulations for security crowdfunding emulating the examples from other countries. Under the proposed regulations, the portals are required to create a ten-member committee for conducting due diligence on the offers available on the platform. The “Screening Committee” has to be composed by professionals coming from the financial sector and from the startups and entrepreneurship world. Liabilities of crowd funding intermediaries or these websites, their liabilities must be fixed to make disclosures on their websites as and when required.

Another feature of crowdfunding is that its operation and continuity totally relies on the number of people interested to contribute in the project/cause in the cyberspace at a given time. There is also a need for a model or draft of best practices for cyber work or cyberspace activities that need to be adhered to. On a contractual level for the subsisting contract between the web portal and the issuer, it is crucial to include clauses like transfer of funds, intellectual property and mutual promotion of brand and business, confidentiality of trade secrets, design, specifications and other related information, Choice of law & jurisdiction, termination, et al.

Crowdfunding, furthermore, depends a lot on social media promotions and as such they need to device tactics to lure more investors who do not expect any returns out of lending or donation. This is however, restricted to Donation Crowdfunding. There is yet another concern that the Internet websites that try to sell the securities require registration as broker-dealers with Securities Exchange Board of India that are subject to securities regulations. As crowdfunding is being more and more prevalent in the Indian context, new pertinent issues will emerge sooner or later.

Cyber security menace- Hacking of the web based platforms is possible as they are rarely protected because of their small budget. Lack of IT infrastructural measures makes them prone to cyber-attacks. Another point is that the investors should have sufficient knowledge about the default information of the issuer.[2] Internet connectivity is another factor which determines the ease of crowdfunding. Crowdfunding is best for those internet entrepreneurs who wish to invest in start-ups and make more money in a small span. Meanwhile, the USA has already come up with a crowdfunding legalization legislation termed as the JOBS[3] Act.[4] However, the Securities Exchange Commission will have to release and publish the final rules to ensure enforceability.[5]

Conclusion: India is one of those least prepared nations for cyber law related tribulations. Our laws and policies do possess loopholes. Moreover, we are not equipped with the latest technical know-how. So, if few fraudulent crowdfunding initiatives become widespread in the nation, the laws at hand, the pertinent SEBI regulations will have to be adhered to in order to deal with the menace. The concerned authorizes, both the legal and technical wings of the departments will have to ensure cyber safety as well as investor protection. SEBI, in such a case, will have undoubtedly a pivotal role to play.

[1] Patricia Lee, Question time: Werner Bijkerk, head of research, IOSCO on crowd funding,( Feb 27, 2014)

[2] Ibid

[3] ACRONYM for Jumpstart Our Business Startups Act

[4] Kevin Harrington, Will JOBS Act Equity Crowdfunding ever happen?, FORBES (March 2, 2015, 2: 42 PM)

[5] Ibid