In the CSEF context, what changes, if any, should be made, and for what reasons, to the current licensing requirements applicable to intermediaries?
In the CSEF context, what changes, if any, should be made, and for what reasons, to the current licensing requirements applicable to intermediaries?
At present any business that intends to operate a “business introduction and matching service” under ASIC class order (02/273) need to notify ASIC of their intention to do so. This process provides exemptions from the fund raising requirements of the Corporations Act 2001. (Small scale offerings which is what equity crowdfunding raises are)
This question asked is a broad one, and loaded to some extent, as it asks for input in the CSEF / licensing context when matchmaking platforms do not need to be licensed at present.
The present system of registering “business introduction and matching service” with ASIC to my knowledge works well. The main reason is because these intermediaries do not give advice. They just provide a platform for matching those with opportunities with those seeking to invest on opportunities.
If they don’t give financial advice the only reason to license them would be to regulate the market between Issuers and Investors to make it functional and de-risked.
Licensing that brings an onus on the Intermediary to rate or give advice on deals brings in risks. It also increases the costs directly through professional indemnity insurance and indirectly through assurances the Intermediary would have to gain from Issuers before proceeding with a raise. All-in-all raising the cost of capital and potentially lifting it beyond the level where CSEF can do the most good.
Licensing should provide operational guidelines for portals that make it clear they are never to give financial advice (and if they do there are severe penalties). Not to have “portal favourite raise” or “staff picks” etc as that is recommending a sub category of advice.
Any marketing material relating to the Offer is in the Issuers words, signed off by the Issuer not the portals. Any Offers must be in the pre-approved formats that allow for clear labelling
In other words, if the portal only publishes words that are effectively written by the issuer of the capital raising then the portal is definitely not attempting to influence a person or persons in making a decision in relation to an investment.
This is the way most CSEF platforms operate worldwide.
Thus they should not be licensed as an advice giving financial intermediary.
The “match making” exemption is probably not the best way to regulate the emerging CSEF legislation because it is geared for small scale offers and does that ok. CSEF is a large scale offer for small amounts the volume and emotional connection with CSEF is different.
Furthermore the CSEF legislation would be best if dropped Sophisticated Investor requirements and general solicitation requirements. Better to do this in a clearly new market than by expanding within an already seldom understood exemption.
In thinking about it, the government won’t consider equities – financial stakes in future income and equity growth of a venture – as the same as other P2P markets.
They should see the Intermediary as the place where Issuer and Investor engage and therefore the natural place to regulate and protect against the fraudulent activity they fear so much.
The best way for them to standardise and regulate that Intermediary environment would be through Licensing and renewal of License requirements. (Assuming new legislation, which is no guarantee).
None of this has anything to do with advice giving of a financial nature and that being the driver of Licensing.
Instead it is the risk of fraud driving government to make Intermediaries more than just a matching service: like ASSOB.
Instead government may see the Intermediaries role as vetting out fraud, counting statistics for use in various ways, the means of imposing government limits on Investors and ultimately if the sector outperforms other means of investment, then having Intermediaries playing the role of ‘tax collector’.
Why is CSEF Different to P2P exchanges like eBay?
The difference between selling a finished good – eBay and selling the future production of a good i.e rewards-based funding is a stretch that Kickstarter et al have managed to leap without specific CSEF legislation. Possibly because the horse bolted before legislators got the opportunity to look at it. These same legislators aren’t too worried now about the risk in this environment because in practice the crowd keeps people honest in rewards-based funding.
Additionally, the effort required in a pledge-based campaign deters fraudsters from trying to find a crowd, because the time for money value ratio is currently small.
Many items aimed at production on pledge-based portals sell for less that $25 and few for more than $250 and almost none at more than $2500. However when the jump is from a finished-goods P2P exchange like eBay to as yet created CSEF Intermediary the core products have also changed in scale and nature.
Investors are staking money and belief (we go to wars because of money and belief) in a planned venture that has yet to produce but potentially could produce returns with high yields and/ or social benefits.
Potentially people might be investing a few hundred or few thousand dollars. Some will invest tens of thousands maybe up to a hundred thousand. They may be hoping for returns on this investment and be entitled to believe offers advertised (assuming relaxation of non-solicitation laws) and made available on portals (Intermediaries) are offers where at least some vetting against fraudulent claims has happened i.e there is some regulation.
The ‘scale’ therefore between products – real or to-be-created ones is $1 – $2500 – and equities between $1 and $100,000 makes, the discussion about CSEF being legislated different to a discussion about legislating P2P exchanges. The scale of CSEF brings in the risk of fraudsters.
Every day hundreds of thousands of transactions take place by unlicensed entities under the Trade Practices Act, including every reward Crowdfunding platform where there are very clear rules about what is right and wrong and repercussions..
This Act also works for services and intangibles where people have no chance to assess in advance if the wedding planner, or concert promotor or cruise director will deliver on the promises they made even though thousands of dollars are involved.
Agreed … investment is based on hope which is not easy to assess however as it is the “issuers” and not the “licensees” story in peer to peer it is very much caveat emptor.
Where equity crowdfunding differs is that it is not the platform that is doing the selling but the issuer raising capital. If they put no effort into the raise they will not raise. The moment you transfer the burden of representation, sales and legitimacy to the platform you are implying that the platform is vouching for what the capital raising entities directors should stand for. How could a platform or intermediary really ever know enough to put it in the shoes of the issuer of an early stage opportunity and take full responsibility for it. Even experienced Angel Investors and VC’s get it wrong 9 times out of 10 and they are often on the board.
Equity crowdfunding is out in the open, transparent and receptive to feedback about bad actors. Besides having to meet money laundering regulations etc, within the existing laws here are just some of the barriers to fraud a good platform and good regulation should provide.
1) Intermediary Declaration to the platform that the Issuer appears legitimate
2) Intermediary precluded from pecuniary interest (stops pressure sales)
3) Upfront Fee (Fraudsters mostly chose paths where they don’t pay)
4) Founders and Entity Due Diligence to ensure no bad actors or entities
5) Marketing Docs Due Diligence to ensure no misrepresentation by issuers
6) Early Bird / FFF marketing (Own Crowd feedback)
7) Live Marketing (Crowd feedback)
8) Funding Targets & Escrow
9) 10 day Cooling off period
10) 3 Directors and Auditor
11) 3 monthly Directors reports on how the money raised is being used
In Paul Neidererers paper (CEO of ASSOB) “Fraud and the Crowd” he finds there are a lot easier ways to rip people off than using an open transparent equity funding platform that has mandated safeguards in place.
Most early stage companies need between $100,000 and $500,000 to get them to the next milestone. Using a licensed entity as U.S. regulations are stipulating will cost a company raising capital between $50k and $100k.
Australia needs smarter legislation at lower cost to protect Investors and Issuers and this should be done through Licensed Market Makers (Intermediaries).