Article 6 min

Backer Beware: The Risk of Crowdfunding Scams

crowdfunding scams

February 23, 2016  

crowdfunding scams

In our last blog post on crowdfunding, we highlighted the different types of crowdfunding and looked at some very impressive numbers that spoke to the exponential growth of this industry. Undoubtedly, the future looks very bright for crowdfunding.

However, this is not to say that crowdfunding is not without its inherent risks. As with all other businesses, where there is money, there is fraud. Crowdfunding is certainly no exception to this rule.

It’s hardly a secret that crowdfunding sites have been attracting more con artists over the past few years. In fact, there is even an entire website that is dedicated to exposing known scams on Kickstarter.

While crowdfunding offers an easy and inexpensive way to fundraise for social good and special projects, it’s inevitable that scam artists will abuse the generosity of compassionate donors on crowdfunding platforms for their own financial gain. Part of the problem is that rewards-based and donation crowdfunding as industries are not formally regulated, and as such, does not have any regulatory body overseeing their operations.

Does this mean that victims of crowdfunding fraud have no recourse? Not exactly.

Governments Are Getting Involved

In the first of its kind in the U.S., the Washington State Attorney General’s Office announced in July 2015 that it had completed an enforcement action against a crowdfunding scam after filing a lawsuit in April 2014. The defendant was ordered to repay almost $700 to the 31 backers who live in the state as well as pay $31,000 in civil penalties and just over $23,000 to cover court costs.

Even though there are no laws or regulations in place that specifically address crowdfunding, the state’s Consumer Protection Act provided sufficient grounds for the Attorney General’s Office to pursue legal action in order to seek justice.

“Washington State will not tolerate crowdfunding theft,” said Attorney General Bob Ferguson. “If you accept money from consumers, and don’t follow through on your obligations, my office will hold you accountable.”

Regulators Are Noticing As Well

Problems related to crowdfunding fraud are also gaining the attention of U.S. federal regulators. The Federal Trade Commission (FTC) said in a press release issued in June 2015 that it had taken legal action against a Kickstarter project creator who deceived backers of his board game project.

Although he had exceeded his original goal by nearly 350 percent, raising over $122,000, the project creator not only failed to deliver the final product to his backers, but he also never issued a refund as a result of cancelling the project. Instead, the FTC found that he had spent the money on personal expenses completely unrelated to the project, including rent, moving himself to Oregon, personal equipment, and licenses for a different project.

As a result of the FTC complaint that was filed in the U.S. District Court for the District of Oregon, Portland Division, the project creator settled with the regulator. Under the terms of the settlement order, he is barred from misrepresenting any crowdfunding campaign and from misusing or failing to properly dispose of backers’ personal information. There was also a hefty penalty of just under $112,000 levied against the defendant, but that was suspended due to his inability to pay.

“Many consumers enjoy the opportunity to take part in the development of a product or service through crowdfunding, and they generally know there’s some uncertainty involved in helping start something new,” said Jessica Rich, Director of the FTC’s Bureau of Consumer Protection. “But consumers should be able to trust their money will actually be spent on the project they funded.”

How to Spot a Crowdfunding Scam

Although it’s reassuring to know that governments and regulators are stepping up their efforts to fight against crowdfunding fraud, prevention is always better than seeking restitution after falling victim to a scam. As with detecting and avoiding any type of fraud, it pays to do your research.

Consumer Reports has provided some helpful guidelines to prevent backers from being scammed:

Is the creator legitimate?
It’s quite common for crowdfunding platforms to require project creators to use a Facebook account in order to use the service. However, as we all know, having a Facebook account is guarantee that someone is trustworthy. Have a look at the activity and the friends for the account. Does the timeline have a long history, or does it appear that the account was recently created? Do the friends appear to be real? Also, can the creator be found on other social media networks?

Carry out your own due diligence check
Just as a bank won’t issue a loan without doing a proper background check, you should do the same before deciding to back a crowdfunding project. See what you can find out about the project creator’s track record. What other projects has this person launched? What qualifications and expertise does the project creator have related to the project?

Don’t let your guard down
Look for any signs of suspicious behavior. For example, has this person created the same project on different crowdfunding platforms? If so, that might indicate a possible scam, since they are trying to raise as much money from as many people as possible.

Crowdfunding Regulation

The two rewards-based crowdfunding scams that were brought into a court of law are just a tiny portion of the vast number of cases where project creators have betrayed their backers. This means that the vast majority of supporters of crowdfunding scams have had no resolution to their cases. Although rewards-based and donation crowdfunding are not currently covered by regulators, other forms of crowdfunding fall under regulatory supervision.

In the UK, the Financial Conduct Authority (FCA) regulates both equity and debt crowdfunding, since there are many similarities between these types of crowdfunding and more traditional financial and investment services. In the U.S., the Securities and Exchange Commission (SEC) announced in October 2015 that it would update its rules to allow equity crowdfunding under Title III of the Jumpstart Our Business Startups (JOBS) Act.

Financially supporting donation and rewards-based crowdfunding projects can carry higher risks compared with equity and debt crowdfunding, particularly due to a lack of controls that comes with regulatory oversight. Finding ways to discourage and detect scams, such as requiring project creators to verify their identities, could go a long way in reducing the occurrence of fraud.

Do you think enough is being done to protect donors and investors on rewards-based and donation crowdfunding sites?