Legal Challenges and Compliance Risks in Crowdfunding

Crowdfunding poses notable legal challenges due to its potential use in money laundering, terrorist financing, and fraud. The article "Compliance Risks for Crowdfunding: A Neglected Aspect of Money Laundering, Terrorist Financing, and Fraud" by Fabian Teichmann, Sonia Ruxandra Boticiu, and Bruno S. Sergi highlights the legal risks and threats posed by crowdfunding platforms (CFPs). Despite its growing popularity as an alternative financing method, crowdfunding remains fraught with significant compliance risks, including money laundering, terrorist financing, and fraud. The article emphasizes the need for robust legal frameworks to mitigate these risks and protect all stakeholders involved in crowdfunding activities.

Risks in Crowdfunding

Money Laundering and Terrorist Financing: Crowdfunding platforms can be exploited for money laundering and terrorist financing due to insufficient regulatory oversight and the lack of stringent anti-money laundering (AML) and customer due diligence (CDD) measures. The anonymity and rapid transaction capabilities of these platforms make them ideal for criminals to launder money or finance terrorism. For example, fraudsters may use fake crowdfunding campaigns to launder money or terrorists may use anonymous donations to fund their activities. There is also risk in investment failure where crowdfunding investments in early-stage ventures carry a high risk of failure, particularly when managed by entrepreneurs lacking the necessary expertise. Legal implications arise when these investments fail, leading to potential disputes and litigation. Fraud is a major legal risk in crowdfunding and can take several forms:

• Campaign Fraud: Misleading investors about the nature or outcome of a project to solicit funds.
• Investor Fraud: Investors withdrawing their support to sabotage a project.
• Equity Crowdfunding Fraud: Promising shares in a non-existent company.
• Platform Fraud: Fraudulent platforms soliciting donations.
• Misuse of Funds: Diverting donated money for personal gain.

The article also covers the recommended measures companies can take for reducing the risks and what regulations are already in place in the European Union.

The EU Regulation on European Crowdfunding Service Providers for Businesses (ECSPR) aims to harmonize rules across member states and enhance investor protection. Key provisions include:

• Due Diligence: Platforms must conduct thorough checks on projects and their owners, including criminal record assessments.
• Credit Risk Assessment: Obligatory risk assessments for projects.
• Pre-Contractual Reflection Period: A four-day period allowing investors to withdraw offers.
• Suitability Tests: Assessing the financial situation and experience of non-specialist investors to ensure they understand the risks involved.

Several measures to mitigate legal risks in crowdfunding

• Enhanced AML and CDD Practices: Implement robust anti-money laundering and customer due diligence measures to prevent illicit activities.
• Legal Compliance and Oversight: Adhere to EU regulations and national laws, ensuring proper legal oversight of crowdfunding activities.
• Investor Protection Mechanisms: Establish clear guidelines for due diligence, risk assessments, and transparency to protect investors.
• Education and Awareness: Educate investors and platform operators about legal risks and compliance obligations.
• Technological Solutions: Utilize advanced technology to monitor transactions and detect suspicious activities, ensuring compliance with legal requirements.

You can find more on this topic here: Fabian Teichmann, Sonia Ruxandra Boticiu, Bruno S. Sergi (2022). https://www.emerald.com/insight/content/doi/10.1108/JFC-05-2022-0116/full/html