Crowdfunding and the Protection of Trust – Fundamentals and Comparative Law Considerations
In my latest research contribution, I analyse the regulatory framework of crowdfunding in Switzerland, the UK and the USA. After describing crowdfunding and its potential as an alternative means to finance private consumption and small businesses, the article turns to economic analysis of the underlying issues of a generic unregulated crowdfunding market. It concludes that, due to the usually sharp information asymmetries, all elements of a typical market for lemons can be identified and, therefore, the crowdfunding market is prone to fail without adequate countermeasures.
In a second step, the article argues that private ordering, including social mechanisms and institutions, such as reputation, signalling, trust and contractual arrangement, as well as standard legal tools like tort law and criminal law are insufficient to overcome the identified issues. Instead, specific regulatory interventions are required to create a favourable framework for a well-functioning and efficient crowdfunding market. To this, standard market-related regulatory approaches to overcome information asymmetries, such as disclosure and transparency, are hardly suitable due to the mostly non-qualified investors. Regulation of crowdfunding intermediaries, the so-called crowdfunding platforms, appears to be the most promising approach. For this reason, the particularities of their business model deserve close attention. On one hand, capital and liquidity requirements by analogy to the regulation of banks or securities dealers seem misplaced where platforms only arrange the transfer of money. On the other hand, fiduciary obligations towards non-qualified investors, including suitability and appropriateness tests and the corresponding liability rules are both suitable and necessary to overcome the ‘lemons problem’.
The contribution then analyses the current regulatory frameworks for equity-based and loan-based crowdfunding in Switzerland, the UK and the US against the backdrop of these theoretical findings.
The Swiss approach pivots on deregulation and a new FinTech license in order to enable crowdfunding. However, the Swiss regulatory approach contains no convincing strategy to overcome or at least mitigate the identified fundamental issues. Therefore, self-regulation by the industry is likely to play a key role in further developing the Swiss crowdfunding market.
The US approach mainly relies on the established concepts of financial market regulations. Extensive disclosure obligations of the project initiators form the core of these regulations. However, this approach has its limitations regarding the protection of non-qualified investors. In addition, the approach contains elements that might foster herd behaviour and bears the danger of disclosing sensitive information to competitors. The costs might therefore exceed the benefits.
The UK approach, in contrast, precisely addresses the identified weaknesses. It focuses on crowdfunding platforms, which are subject to the supervision of the FCA. The main pillar consists of extensive (fiduciary) duties of the platforms, especially towards the investors, which include suitability and appropriateness tests for certain types of crowdfunding and investors.
From the three regulatory frameworks, the UK approach appears to be the most suited and promising one to foster the development of a sound and efficient crowdfunding market. The Swiss approach fails to address and solve the fundamental issues, while the US approach has conceptual limitations, especially in markets with non-qualified investors.
Tizian Troxler is a PostDoc and Lecturer at the Faculty of Law, University of Basel.
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