Crowdfunding and Fraud

As crowdfunding becomes more popular, the possibilities for fraud grow.

For that reason, so far the U.S. government has not allowed funders to purchase stakes in the companies. However, England and Australia already have legalized equity-based crowdfunding, and the United States is soon to follow. In 2012, the U.S. Securities Exchange Commission passed the Jumpstart Our Business Startups (JOBS) Act to ease some federal regulations on entrepreneurial ventures. In July 2013, the SEC approved Title II to the JOBS Act, which adds provisions for equity crowdfunding.

Funders could be better protected if governments put mechanisms in place to make entrepreneurs accountable for committing fraud, demonstrating incompetence, or making false promises, according to a recent book chapter by Ajay Agrawal, associate professor of strategic management at the University of Toronto’s Rotman School of Management in Canada; Christian Catalini, assistant professor at the MIT Sloan School of Management in Cambridge, Massachusetts; and Avi Goldfarb, professor of marketing at Rotman. They also recommend that governments develop resources that provide funders with information about the startups seeking funding.

That said, Agrawal also points out that the level of concern over equity crowdfunding could be somewhat misplaced. “It feels like we are being far more protective of people making mistakes buying small amounts of equity through crowdfunding than we are of people making mistakes buying other goods and services on the Internet that are sometimes fraudulent, of lower-quality, or overpriced.”

“Some Simple Economics of Crowdfunding” can be purchased online at www.nber.org/papers/w19133. The paper appears as a chapter in the book Innovation Policy and the Economy 2013 by the National Bureau of Economic Research in Boston.