FinTechRegulatory Compliance for Crowd Funding Platforms

INTRODUCTION

In the recent years, crowd-funding has emerged as a potent force for capital raising, fuelling innovation and frosting entrepreneurial dreams. Crowdfunding is a funding method that involves raising small amounts of money from a large number of people to finance a project, business, or cause. It leverages the collective power of a crowd, often facilitated through online platforms, to pool resources and support initiatives that may struggle to secure traditional funding sources.

As per the Securities and Exchange Board of India (hereinafter referred to as “SEBI”) consultation paper released in 2016, ‘crowd-funding’ is defined as “a solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause”.

Crowd-funding platforms usually tend to serve as an intermediary between start-ups and potential investors.

Crowdfunding has democratized the funding landscape, allowing innovators and individuals to access capital outside of traditional financial institutions. In India, the evolving eco-system of crowd-funding is poised for exponential growth. However, navigating through the complicated legal landscape has proven to be a challenge for crowd-funding platforms.

TYPES OF CROWD-FUNDING MODELS & EXISTING LEGAL FRAMEWORK

As per the SEBI’s consultation paper, not all types of crowd-funding model will fall under the purview of SEBI, as not all of them involve issuance of securities for financial return and hence some may require authorization from other regulators such as Reserve Bank of India, in the case of peer to peer lending.

The following are the major types of crowd-funding models:

1. Donation Based Model

Donation model includes solicitation of funds for social, artistic or philanthropic purpose and not in exchange for anything tangible or no financial return in form of return on investment regulated. The donation based model is regulated vide SEBI circular No. SEBI/HO/CFD/PoD-1/P/CIR/2022/120 which provides for framework on Social Stock Exchange.

2. Equity based Model

In equity based crowd funding model, in consideration of funds solicited from investors, equity shares of the company are issued to the investors.

After the case of Sahara India Real Estate Corporation Ltd. & Ors. v. Securities Exchange Board of India & Anr (2013) 1 SCC 1), wherein two companies belonging to the Sahara group of companies, namely, Sahara India Real Estate Corporation Limited (hereinafter referred to as “SIRECL”) and Sahara Housing Investment Corporation Limited (hereinafter referred to as “SHICL”) sought to have raised funds through the means of private placement by issuing optionally fully convertible debentures and claimed that the information memorandum was distributed solely to friends, associate group companies, workers or employees and other individuals associated with Sahara group, however, it was alleged that they actually raised INR 17,400 crores from over 2 million investors in the name of private placement and denied listing their securities on any stock exchange as it was a private placement, the Hon’ble Supreme Court held that the Sahara group companies were in violation of the provisions of the Companies Act, 2013 and instructed the Sahara companies to refund the amount raised with interest. Equity crowd-funding was also declared illegal after the Sahara Scam.

In another case of Anbronica Technologies Private Limited, the Registrar of Companies Delhi & Haryana(Adjudication Order dated 1st March 2023, ROC (Delhi)), wherein the company raised money through ‘Tyke’, a technology based community platform providing services of assistance in completing the compliance procedures of private placement under the Companies Act, 2013 inter alia. The ROC held that the website compromised on the conditions under Section 42 of the Companies Act, the investors were also not identified before making the private placement. The company was then penalised by the ROC on violations of the provisions of Companies Act, 2013.

3. Debt based / peer to peer lending Model

In peer to peer lending, the online platform matches investors with borrowers to provide unsecured loans at interest rate set up by the funding platform. The master directions issued by RBI in 2017 on the basis of SEBI’s consultation paper, namely, Master Directions – Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017, provide for registration and operation of Non-banking financial company – peer to peer lending platforms.

The eligibility criteria under the directions include, the non-banking financial institution to be a company, and shall not commence business without obtaining a certificate of registration and shall have a net owned fund of not less than twenty million or any higher amount that the bank may specify.

4. Reward based Model

Reward crowd-funding, implies to the solicitation of funds, whereby investors receive existing or future tangible reward as consideration for free or for discounted price. As on the present date, there is no framework or guidelines for the regulation of Reward Based Model of crowd-funding in India.

LICENSES FOR CROWD-FUNDING PLATFORMS

SEBI License Procurement under ALTERNATIVE INVESTMENT FUNDS REGULATIONS, 2012 (LAD-NRO/GN/2012-13/04/11262))

The crowd-funding platforms must be registered under the said regulations as a channel of Alternate Investment Funds (hereinafter referred to as “AIF”).  An AIF, is a privately pooled investment vehicle which collects funds from investors for investing it in accordance with a definitive investment policy for the benefits of its investors.

The platform to obtain a license, must meet certain criteria:

i. the platform must be a registered company under the Companies Act, 2013,

ii. should have a minimum net worth of Rs. 2 crores,

iii. board of directors of the platform is a must out of which 2/3^rd of the members must be independent directors,

iv. platform must have a sound technological infrastructure and adequate risk management and

v. the platform must comply with the Know Your Customer (hereinafter referred to as “KYC”) – Anti-Money Laundry (hereinafter referred to as “AML”) Guidelines RBI/2011-12/25DNBS (PD) CC No.231/03.10.42/2011-12 issued by RBI

LIMITATIONS FOR CROWD FUNDING PLATFORMS IN INDIA

Limitations of the 2014 SEBI consultation paper

Although the 2014 paper lays down the groundwork for regulating the recent growing crowd funding market in India, the paper tends to set some unrealistic standards, limitations hindering its possible effectiveness and also create a sense of uncertainty for the investors and the platforms.

The paper has inducted the concept of “eligible entities”, “eligible investors” and “eligible offeror”, with stringent categories and benchmarks to be checked upon to be able to qualify to fall under the above mentioned categories.

Investor Risk

The possible crowd-funding framework seems to have been formulated on a conservative premise, owing to the same the actual situation seems to have been neglected, like one person companies, limited liability partnerships and sole proprietorships have been denied access to crowd-funding platforms and only unlisted public companies are included.

AMLEGALS REMARKS

India, as a country is at a stage of peak development and the only way to keep up this graph is to change and adopt with the changing times. The lack of a proper statute governing crowd-funding in India leaves a huge gap for commission of errors and fraud.

Even without proper regulations, guidelines or directions there are various crowd-funding platforms in India, that are raising money every-day in the name of ‘donations for social cause’, and the citizens are blindly putting in their money into these ‘donation drives’ with no guarantee of whether their donations are reaching the actual beneficiaries or not.

The 2014 SEBI Consultation paper appears to be an initial effort to explore and potentially regulate the crowdfunding market. However, what India truly requires is a comprehensive statutory framework specifically tailored to regulate crowdfunding, encompassing all four potential models of the practice.

-Team AMLEGALS assisted by Ms. Dhwani Tandon (Intern)

For any query or feedback, please feel free to get in touch with mridusha.guha@amlegals.com or jason.james@amlegals.com.