Fraud – lots of people talk about it, but what is it? Many in the crowdfunding world see it as a bad guy running away with your money, and believe that the “collective wisdom” of the crowd is able to spot any scams before your money is lost. However, it rarely is that simple. The popular success story of the crowd spotting fraud, the Kobe Red scam, was actually led by a documentary team who played a major role in stopping the fraud before any money changed hands.
In addition, “fraud” in the context of securities offerings means something much broader than a Dr. Evil plotting to run away with your money. It also includes liability for misleading statements and omissions – meaning that a busy entrepreneur who did not include a material fact (something a reasonable investor would consider important in making an investment decision in the context of the information already provided), or who made a material statement that was misleading, would be considered “fraudulent.”
What does this mean, exactly? Say for example you are seeking investors for your company that builds solar-powered cars. Not mentioning that the solar-powered car cannot work in rain or snow would be considered an omission of a material fact, because people are going to assume “cars” can get them from point A to point B in most circumstances. A reasonable investor would want to know that important feature of the car before making an investment decision. Saying “we have sold many solar-powered cars” when you are still in production and people have expressed interest in buying them but have not actually bought them, would be considered a misleading statement. It would be more accurate to say “we intend to sell many solar-powered cars” or “many people have expressed interest in purchasing our solar-powered cars.”
Consequences include prosecution by the SEC and/or DOJ, being asked to return all profits, pay a fine, pay damages, and even criminal penalties (including jail). The law is murky in this area as to whether you need to intend to defraud, or simply be very busy and not think about it carefully (reckless), or even whether you “ought to have known” is sufficient. Given the lack of clarity, it is better to be safe than sorry.
As you can see, it’s pretty easy to make a misleading statement – in the excitement of possibilities and the exhaustion of running a startup, it’s easy to over-state and forget to mention something important. And it might not be something that normal people would even consider “fraudulent.” However, the consequences of misleading statements are high and entrepreneurs need guidance to walk this straight and narrow path. So let’s stop using the f-word (“fraud”) and focus on keeping the crowdfunding world safe from “misleading statements.”