There has been some debate amongst the North American investment community about whether the legalization of equity crowdfunding would unleash a new wave of clever fraudsters on an unsuspecting public. Recently, the Ontario Securities Commission (OSC) published newly proposed exemptions to become available to certain investors, including a proposed crowdfunding exemption. The proposed framework, which is likely to become law after a 90 day consultation period, seeks to strike a balance between protecting the public and embracing the inevitable investment paradigm shift to crowdfunding. The OSC has found a convenient middleman on which to place the burden of ensuring that offerings are in fact legitimate – the crowdfunding portal.
While issuers under the proposed framework are obliged to provide certain disclosure under an offering document, it is the obligation of the crowdfunding platform to conduct a fairly comprehensive due diligence on the issuer and its directors, executive officers, promoters, and control persons. It would appear that the portal is to become the investor’s insurance policy against fraud. Portals are required to perform background checks on the foregoing parties to verify the qualifications, reputation, and track records of those involved in the key aspects of the offering. Those checks must include identifying criminal and regulatory issues, including any history of bankruptcy, securities fraud, and whatever else may be disclosed by court records. Crowdfunding portals will be required to understand the general structure, features and risks of securities presented on their platforms and may not include any issuer information or communication that appears to be false, deceptive, misleading or misrepresentative. Additionally, portals will be obliged to meet rigid reporting requirements, be subject to minimum capital and insurance obligations, and will need to register with the OSC. Fortunately, the Ontario Securities Commission has stopped short of also requiring that portals be obliged to assess the commercial reliability of the issuers.
At the end of the day, whether or not one believes that all of this is necessary to protect individual investors, to the extent that other jurisdictions adopt a similar approach, the business model of the prospective portals will need to change and legitimate issuers will ultimately have to bear a higher cost of raising much needed capital. With these added requirements, equity-based portals will not be viable if they intend to only charge the 5-7% rates that are typical of rewards-based platforms such as Kickstarter.