The crowdfunding alternative

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Crowdfunding as a way of securing investment is beginning to gain ground on both sides of the Atlantic. What are the current regulatory requirements and how is this likely to change?

Investment-based crowdfunding involves an entity seeking modest subscriptions from a large number of people, typically through a website operated by an authorised firm, as a means of raising funds. The subscribers receive a (modest) allotment of shares in return. (Loan-based crowdfunding, also known as peer-to-peer lending, is also possible – and is increasingly popular – but the focus of this article is investment-based crowdfunding.)

Investment-based crowdfunding platforms will carry on regulated activities – notably arranging investments – and will therefore require to be regulated by the Financial Conduct Authority (the FCA). At present, the FCA imposes restrictions on firms applying for authorisation to operate an investment-based crowdfunding platform. These are reviewed on a case-by-case basis but the FCA will usually restrict the operation to promotions to sophisticated or high net worth investors. However, this is not a formal procedure and in the autumn the FCA opened a consultation on how to regulate investment-based crowdfunding on a more structured basis. It is proposing that firms that communicate direct offer financial promotions for investment-based crowdfunding, restrict the offer to:

  • clients who are certified or self-certified as sophisticated investors
  • clients who are certified as high net worth investors
  • clients who confirm that, in relation to the investment promoted, they will receive regular investment advice or investment management services from an authorised person
  • clients who certify that they will not invest more than 10 per cent of their net investible portfolio in unlisted equity or unlisted debt securities.

Where advice is not provided to retail clients, the proposal is that firms will be expected to apply an appropriateness test before providing clients with promotions for unlisted equity or debt securities.

The proposal is for the new regime to become mandatory from 1 October 2014.

The new rules are likely to add to the regulatory burden on operators and make the process more burdensome for the “crowd”. The restrictive regime countenanced by the FCA is somewhat at odds with the position in Europe and the United States. The European Commission has been consulting on proposals aimed at facilitating and widening access to crowdfunding. In the US, the Securities and Exchange Commission has recently proposed a regulation which will provide an exemption from the registration and prospectus requirements of the US Securities Exchange Act 1934, which apply to public offerings, for crowdfunding of limited amounts.

Walker Morris comment
The next few years should show us whether investment-based crowdfunding will have a role to play in bridging funding gaps. The FCA has had plenty to deal with, since assuming some of the functions of the Financial Services Authority last year, not the least of which will be attempting to ensure that internet-based investment promotions are subject to adequate regulation.