Equity Crowdfunding: Considerations for Anti-Money Laundering Regulation

Equity crowdfunding involves the use of an internet-based platform to market equity shares in a given company to a wide range of potential investors (the “crowd”). The result is financial democratization of sorts – harnessing the power of the crowd to make many small investments instead of relying on large capital infusions from a relatively small number of sophisticated investors. The key to equity crowdfunding is to keep transaction costs low, so that small businesses are able to participate, without sacrificing investor protection. This latter consideration is especially important given the potentially low financial sophistication of the crowd.

In my last post, I discussed how equity crowdfunding could help small and medium-sized enterprises (SMEs) in developing countries overcome corruption-related barriers to accessing finance. Because equity crowdfunding makes use of internet-based platforms, it is particularly useful for cross-border transactions. As a result, SMEs in developing countries that are unable to access finance through traditional means (often because of corruption in domestic capital markets) can use equity crowdfunding platforms to connect with investors outside of their home countries. As with other technology-based tools that have the potential to sidestep the effects of corruption and contribute to economic development, though, there is also reason to be concerned about the opportunities for corruption for which equity crowdfunding could be abused. In particular, equity crowdfunding platforms could be used to facilitate money laundering, in at least two ways:

  • Platforms facilitating sham transactions between distributors and customers: The distributor of an illegal product (narcotics, unregistered firearms, etc.) could create a sham company and market that company’s securities on an equity crowdfunding platform. Buyers could “legitimately” buy (worthless) shares via the platform, while also receiving the product on the side. Distributors would thus be able to receive funds electronically, rather than in cash, and could also aggregate multiple payments into one capital stream. The online nature of the payments makes them easier to integrate into the financial system than proceeds from cash transactions.
  • Distributor on both sides of a platform-led equity crowdfunding transaction: The distributor could create a fictional venture, and markets its securities via a crowdfunding platform. Through an online alias, the same distributor could also invest illicitly received money into its own venture (an easy way to move illegally gained money across borders). This concern may be lessened at least within the United States, given that regulations currently limit crowdfunding activity to domestic companies alone. But, cross-border equity crowdfunding is already possible in Europe, and will likely be a viable option in the United States in the future.

Recently, the United States has initiated steps to counter these risks. Just weeks before equity crowdfunding went live in the U.S. (due to passage of a statute called the JOBS Act), the Financial Crimes Enforcement Network (FinCEN) published a notice of proposed rulemaking regarding anti-money laundering protections for the crowdfunding industry. (The comment period on this proposal closed earlier this month.) Under the FinCEN proposal, equity crowdfunding platforms would be tasked with developing internal policies, procedures, and controls, designating a compliance officer, creating an employee training program, providing for independent audits, establishing a written customer identification program, collecting information on certain transfers of funds, reporting large or suspicious transactions, and acceding to disclosure standards and procedures.

In essence, the proposal applies the anti-money laundering protections required of “broker-dealers” under the 1934 Securities and Exchange Act to equity crowdfunding platforms. This approach is not unusual. Anti-money laundering directives and regulations apply to equity crowdfunding platforms based in the European Union. But, treating equity crowdfunding platforms too much like broker-dealers has the potential to erode the niche that regulators carved out to promote equity crowdfunding via the JOBS Act. The key innovation of the JOBS Act was to exempt equity crowdfunding platforms from registering as broker-dealers. As a result, the platforms can market securities to a wider range of investors, rather than just the wealthy, and need not comply with a host of burdensome, costly requirements. If equity crowdfunding is to remain a viable and potent solution for SMEs in developing countries or in marginalized communities within developed countries, it will be essential to keep these costs low. The challenge for policymakers will be to balance the competing interests of safety and simplicity, as they endeavor to maintain crowdfunding’s accessibility without leaving it overly susceptible to nefarious use.

One thought on “Equity Crowdfunding: Considerations for Anti-Money Laundering Regulation

  1. Pingback: Equity Crowdfunding: Considerations for Anti-Money Laundering Regulation | Anti Corruption Digest

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