The Securities and Exchange Commission’s Proposed New Rules on Crowdfunding: A Step in the Right Direction

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Introduction
Ts a Nigerian child who was born and bred in the country, I understand the power of giving and supporting members of one’s community or family. In traditional African society, many of our proverbs point to the need to be our brothers’ keepers, and this is often done through donations and collective investments with or without a profit motive. It is therefore, right to say that crowdfunding, albeit not in its most refined or commercial form, is not novel to the traditional African Society.

Modern Crowdfunding
Today, crowdfunding has become a popular way of raising funds for businesses and individuals. The online nature of this financing model makes it possible for people and businesses across jurisdictions to raise funds for a common cause, as was the case during the President Obama campaign. This form of financing provides a platform for a startup founder to raise capital outside his own network of friends and family, without accumulating debt. The use of technology comes with known threats, as experts anticipate that flexible disclosure rules may result in massive fraud in the crowdfunding market. Undoubtedly, if not carefully regulated, this innovative financing model will fizzle out.

A Case for Regulation
Crowdfunding can provide the much-needed boost to Nigerian infant industries, thus, providing employment opportunities. Business promoters often cite access to finance, as one of the major factors militating against business operations. The numerous advantages attached to this form of fund raising, underscores the need for regulatory measures to be put in place. Jurisdictions such as the United Kingdom and Germany are constantly on the lookout for legal fraud prevention mechanisms, in relation to crowdfunding. Buttressing the importance of crowdfunding regulation, is the result of a recent study carried out by a United Kingdom based law firm, Nabarro, which mentioned that one in five companies that raised money on equity crowdfunding platforms between 2011 and 2013, had declared bankruptcy.

The Role of the Securities and Exchange Commission (SEC)
Currently, the Investment and Securities Act (ISA), makes no provision for crowdfunding. As far back as August 2016, SEC, the primary regulator of securities in Nigeria, placed a ban on all equity crowdfunding activities in the country, sending out a caveat emptor warning to investors. In spite of the announcement, various unregulated activities are being carried out, without appropriate guidelines and punishments for breach of same. The market is characterised by vulnerable investors who are constantly looking for quick returns, particularly in a depressed economy. These uninformed investors can only rely on effective securities regulation, to ensure that their investments in crowdfunding platforms/ schemes are adequately protected.

The proposed new rules were made, pursuant to the several functions of SEC as set out in Section 13 Investment and Securities Act 2007. Notably, these rules are in 3 parts:
1.Proposed rules on crowdfunding.
2.Proposed rules on regulation of fund management product.
3. Proposed rules on nominee companies. The writer’s focus is on the rules relating to crowdfunding.

Analysis of the Proposed Rules
The regulations relating to crowdfunding are divided into ten parts, for ease of reference and convenience. The first part provides definitions of relevant terms including crowdfunding, crowdfunding portal, crowdfunding intermediary, investment-based crowdfunding, among others. Notably, the rules define crowdfunding as the process of raising funds to finance a project or business from the public, through an online platform. Also relevant, is the description of a crowdfunding portal as a website, portal, intermediary portal, application or other similar module that facilitates interaction between fundraisers and the investing public. It also discusses eligibility for registration, as a crowdfunding platform. The draft rules provide that, only duly incorporated Micro, Small and Medium Enterprises (MSMEs) with a minimum of 2 years’ operational record, are eligible to raise funds. The relevant definition of MSMEs, is that provided by the Small and Medium Enterprises Development Agency of Nigeria (SMEDAN). Though the rules generally require prior registration of securities and investments before using the crowdfunding portal, it makes provision for some exceptions.

Part 2 makes provision for the general requirements and criteria for registration, as it relates to crowdfunding portals. It also highlights instances where the SEC may revoke the registration of a crowdfunding portal. The minimum paid-up capital for crowdfunding portal operators, is pegged at N100 million.

Part 3 provides for the general obligations and responsibilities, of every crowdfunding portal. The obligations include due diligence, monitoring & reporting, data protection & privacy, operating a trust account, recording and issue, publication & acknowledgement of warning statements. Crowdfunding Platforms have the obligation to monitor investors, and take action against issuer misconduct. Also, they are expected to file both monthly and quarterly reports to the Commission. In addition, by the proposed Rules, SEC makes it mandatory for these platforms to establish appropriate safeguards, towards ensuring data protection and preventing privacy breaches. Also, the provision which states that every crowdfunding portal shall appoint a custodian, for the purpose of establishing and maintaining a separate Trust account for each funding round on its platform, is commendable. It must be mentioned that, the said financial institution must be registered as a custodian by SEC.

Further, Part 4 makes provision for crowdfunding participants and their functions. These include, the investors and issuers. Part 5 details the process by which transactions through the crowdfunding portal, must be carried out. The documents and general information to be obtained from an issuer proposing to be hosted on a crowdfunding portal, can be found in Part 6.

Importantly, Part 7 deals with the general restrictions placed on crowdfunding intermediary and issuers. On the other hand, Part 8 allows for additional requirements for a digital commodities investment platform willing to use the crowdfunding portal. Miscellaneous provisions are summarised in Part 9. Part 10 is the penalty clause. It states that where a crowdfunding portal or crowdfunding intermediary fails to follow the rules provided, a penalty of a fine of not less than N1 million and N10, 000 for each day a violation continues, is applicable.

Comments on the Proposed Rules
Securities regulation, is an important element of a properly functioning capital market. An effective crowdfunding regulatory regime will foster technology backed fundraising, by encouraging the participation of investors (both institutional and retail), bankers and project creators. SEC has adopted a disclosure-based regime of regulation, which seeks to ensure that investors have the information required to make informed investment decisions. Also, it must be mentioned that punitive measures for infraction of the rules, have been identified. However, one wonders whether the Investment and Securities Tribunal will be sufficiently equipped to penalise offenders.

Conclusively, the compilation of draft rules for crowdfunding is a step in the right direction. The crowdfunding rules seek to curtail any form of excesses, and regulate the amount of securities or investment instruments that can be offered and sold. It is however, important to put into consideration the risks relating to identity theft, money laundering and terrorism financing in relation to the due diligence to be conducted by the crowdfunding platforms. The fact that there is a higher risk of identity fraud because of the anonymity that the internet offers, makes it imperative for platforms to extensively vet project creators and lift the corporate veil where expedient.

Further, penalties should be considered for instances where committed funds are not received, or situations where there are delays in payments that are processed on these platforms. The problem of lack of uniformity in charges put out by crowdfunding platforms, poses a challenge in developed climes. It is imperative to ensure that, uniform charges are applicable across board. An effective regulatory regime for crowdfunding though the primary responsibility of SEC, is not its exclusive preserve. Cooperation and collaboration with other regulators and organisations including the Corporate Affairs Commission, National Information Technology Development Agency, Economic and Financial Crimes Commission, and Central Bank of Nigeria, cannot be overemphasised. Also, it must be observed that, the rules make no mention of peer to peer lending on such platforms, which still leaves a lacuna in this regard. Generally, peer to peer lending is executed through online platforms which put potential lenders in touch with potential borrowers, is fast-gaining ground as a viable finance option for Nigerian businesses. The responsibility may be on credit bureaus, to protect players in this space.

Qoute
“AS FAR BACK AS AUGUST 2016, SEC, THE PRIMARY REGULATOR OF SECURITIES IN NIGERIA, PLACED A BAN ON ALL EQUITY CROWDFUNDING ACTIVITIES IN THE COUNTRY, SENDING OUT A CAVEAT EMPTOR WARNING TO INVESTORS. IN SPITE OF THE ANNOUNCEMENT, VARIOUS UNREGULATED ACTIVITIES ARE BEING CARRIED OUT, WITHOUT APPROPRIATE GUIDELINES AND PUNISHMENTS FOR BREACH OF SAME”