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Blog

Ferreting out Fraud in Crowdfunding

JL Law

FERRETING OUT FRAUD IN CROWDFUNDING.png

Reuters noted all the way back in 2012 that crowdfunding was heading the risky list for investors. They also noted that the Jumpstart Our Business Startups (JOBS) Act would make crowdfunding more attractive to the scam artist crowd that always follows the easy money.

The Title III provisions of the act were approved by the Securities and Exchange Commission in 2015, and have been in force since 2016.  Together with Title II and Title IV, they enable a form of crowdfunding commonly referred to as equity crowdfunding (even though it could involve debt and other securities) to truly emerge into the marketplace as an option for investors seeking to diversify in ways that weren't possible before. Prior to that, companies had to tap private networks to raise capital, and investors had to be in such private networks in order to know about these deals.  The advent of equity crowdfunding meant greater access to capital for businesses that needed it.

However, as Reuters was prescient enough to know, it also heightened risks to the investor. There are, however, often warning signs, and crowdfunding is no different than any other place to put your investment--due diligence on the part of the investor can save a lot of heartache (and dollars), in the end. 

Just one example--there were plenty of warning signs with the Triton Scuba Mask (3). The product had "concept" written all over it, literally, in the first publications about the new underwater breathing apparatus that would supposedly allow people to dive without oxygen tanks. The "microporous hollow fiber," was touted as being able to pull oxygen sufficient to sustain a human diver directly from seawater. Reviews all over the web noted that it was far-fetched, but they pulled well over $600,000 from unwary investors before disclosing that liquid oxygen tanks would be necessary to make the apparatus work, and were obliged to refund their backers' money.

Financial Poise lists a number of less obvious traps to be alert to when investigating the possibilities inherent in crowdfund investments, including in-group investing, or "affinity fraud." The nature of the group dynamic can lead to losing money as the members are reluctant to bring in the authorities to mitigate the process. They also cite "pump and dump schemes," where speed is not the investor's friend, and the hazard of trusting online information, whether newsletters or chat rooms. Scam artists often go to great lengths to make a crowdfunding-type scheme look legitimate, including posting fraudulent reviews touting imaginary gains. The best advice for investors is, if there is pressure being exerted, the possibility for it being a scam just went up exponentially.

Avoiding Crowdfunding Fraud

Tread Lightly With Platforms: Many platform do SOME due diligence for you, although it varies from one to the next. Be extremely wary of new crowdfunding platforms, which seem to pop up every day.  Look to see if a particular platform has any listing criteria or underwriting criteria, and take a look at the deals that appear on their site. 

Do Your Own Due Diligence: It cannot be over-emphasized that research across every available resource is the easiest way to avoid fraud. You don't have to pay attention to every single negative point—every investment has its downsides. But you should pay attention when the negatives far outweigh the positives. Another red flag should be absence of information, such as a complete lack of negative information. Try to validate the information they claim to be making through outside, third-party sources, and think critically to see if they really will be able to provide you the investment returns that are promised.