LL.B. Thesis, Vesela Yaneva

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THE HAGUE UNIVERSITY OF APPLIED SCIENCES
FACULTY OF INTERNATIONAL & EUROPEAN LAW
LL.B. THESIS
Equity Crowd-Funding and Investor
Protection: A Comparative Analysis
Student name: Vesela Valentinova Yaneva
Student number: 11034394
Submission date: 09.02.2015
LL.B. Thesis Mentor: Dr. Abiola Makinwa

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Table of Contents
Chapter 1: Introduction.............................................................................................................. 3
1.1. Research question and structure....................................................................................... 3
1.2. Methodology.................................................................................................................. 4
Chapter 2: General overviewof crowd-funding .......................................................................... 5
2.1. Definition of crowd-funding ................................................................................................ 5
2.2. Types of crowd-funding ...................................................................................................... 7
2.3. Differences between equity crowd-funding and traditional financing methods......................... 8
2.4. Advantages of equity crowd-funding.................................................................................... 9
2.5. Challenges in the equity crowd-funding market....................................................................10
2.6. Legal implications of crowd-investing: investor protection ...................................................11
Chapter 3: Crowd-funder protection in Europe........................................................................ 13
3.1. European regulatory framework for crowd-funding investor protection .................................13
3.2. The protection of crowd-funding investors by European national regimes..............................15
3.2.1. Legal framework in the United Kingdom: fromunregulated to regulated.........................16
3.2.2. Legal framework in France: towards a balanced regulation...........................................17
3.2.3. The innovative Italian equity crowd-funding law............................................................19
3.3. Conclusive lines.................................................................................................................20
Chapter 4: Crowd-funder protection in the United States......................................................... 22
4.1. The US securities regulatory past: keeping the crowd away ..................................................22
4.2. The proposed crowd-funding exemption under the JOBS Act ...............................................24
4.3. Potential impact on investor protection................................................................................27
Chapter 5: Comparative review................................................................................................ 29
5.1. Imposition of investment caps on crowd-funders..................................................................29
5.2. Requirements for equity crowd-funding intermediaries.........................................................29
5.3. Information for investors ....................................................................................................30
5.4. Availability of exit rights....................................................................................................30
5.5. Dispute resolution rules......................................................................................................31
5.6. Differences and similarities identified .................................................................................31
Chapter 6: Conclusion and Recommendations.......................................................................... 33
Bibliography.............................................................................................................................. 36

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Chapter 1: Introduction
The scarcity of traditional means of financing in the past years has contributed to the
increased ubiquity of crowd-funding as an alternative investment method. The media has been
reporting fascinating stories of creative projects which become reality thanks to people who
encountered them on the Internet, liked their ideas and decided to help them get launched with
small monetary contributions. In exchange they merely expect to see an artist perform his
skills or receive the product resulting from the collected capital. However, crowd-funding has
also made it possible for anyone with Internet access to support projects by purchasing shares
in them if he thinks it has the potential to become the next Google or Facebook. This type of
crowd-funding is known as equity crowd-funding and is the focus of this thesis due to the
legal difficulties it creates for legislators, drafting specific laws in the field.
1.1. Research question and structure
What does it mean to invest in a business which has not yet reached the market? It
means risk and risk again. A product or a process which has not been tested yet may not
survive more than a year, and not surprisingly, financial watchdogs such as the Financial
Conduct Authority in the United Kingdom describe crowd-investing as likely to cause
investors to lose all their money.1 A person from the general public does not have the
knowledge and experience to fully understand the risks of early-stage investment. The risks in
equity crowd-funding are big, placing the trust of investors in this emerging market at stake.
Due to the fact that equity crowd-funding is a novel financing model involving an open call
offering shares to the general public, the perceptions regarding its legality and most suitable
way of regulation vary among countries. In the last two years, the major crowd-funding
markets, Europe and the United States, introduced laws in the field aimed to reduce the risks
and serve the interests of both capital-seekers and investors. The goal of this thesis is to
investigate the recent developments in equity crowd-funding regulation, concerning
protection of investors. For that purpose it will analyze the positions in Europe and the United
States in order to compare the approaches they have developed to protect investors in a new
risky market and assess the need of further improvements to the way crowd-investing is
regulated.
In order to conduct a thorough and clear comparison between Europe and the United
States, the thesis will go through each system’s crowd-investing regulatory framework.
1 Judith Evans, ‘Equity crowd-funding thrives despite high risks’ (Financial Times, December 7th 2014) <
http://www.ft.com/home/europe> accessed on 24 January 2015.

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Chapter 2 will begin by looking into the nature and features of crowd-funding in general,
emphasizing its potential to fill in the capital gap created by the hardships in obtaining
traditional financing and explain the major legal problem associated with equity crowd-
funding – investor protection. Chapter 3 will turn the attention to the regulatory approach
towards investor protection in Europe by looking into the implementation of the relevant EU
Directives in the domestic legal orders of three selected jurisdictions – the United Kingdom,
France and Italy, along with their specific national crowd-investing regulations. Chapter 4 of
the thesis will look at the proposed legal framework for equity crowd-funding in the United
States and its position on crowd-funder protection. Finally, Chapter 5 will present a
comparative review between the selected European jurisdictions and the USA in order to
assess their strong and weak sides and accordingly provide recommendations towards each
legal system for strengthening its measures and achieving better results.
1.2. Methodology
The research paper is going to trace the developments in equity crowd-funding and
investor protection by using the comparative analysis method – looking into two different
positions on regulating investor protection in equity crowd-funding, the European and the US
one, and compare them to highlight their differences and similarities.
The mentioned systems have been selected as the focus of this paper because they are
interesting to be separately analyzed and challenging to compare. The situation in Europe is a
suitable choice because it is the second biggest crowd-funding market and the regulation of
the latter involves two levels – the supranational and the national one. The levels’ co-
existence and its impact on investor protection are of significant importance. The situation in
the USA, the biggest crowd-funding market, is strongly debated due to the fact that the legal
framework on equity crowd-funding itself has not been “tested” yet. It is therefore
challenging to examine the proposed rules and outline the direction they intend to give to the
US equity crowd-funding market.
The selected European countries and the United States will be compared on the basis
of specific criteria developed after having discussed the regulatory positions towards investor
protection.

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Chapter 2: General overview of crowd-funding
This chapter is going to provide a general overview of crowd-funding as an alternative
investment method. In particular, it will discuss the nature of the process, its roots, types of
crowd-funding which currently exist and the type which is the focus of this paper. Thereafter,
the chapter will look at the factors that have led to the existence of equity crowd-funding
making it an attractive option for small businesses. Finally, the advantages and disadvantages
of equity crowd-funding for national economies will be discussed as well as investor
protection as the biggest legal issue associated with this model of crowd-funding.
2.1. Definition of crowd-funding
Approximately 100 million new business start-ups are launched globally every year
according to a study by Moya K. Mason.2 This is the number of various novel ideas waiting to
get to the market and end users. Before going there, however, entrepreneurs need to find an
appropriate ‘bridge’ to substantiate their business plans and allow their actual development –
resources such as equipment, raw materials, pivotal studies, trials, campaigns, personnel, etc.
According to Leah Grant the most traditional way in which an entrepreneur can get a
promising business idea financed is by applying for a small business bank loan. The same
article lists three other traditional methods for financing small businesses3. Venture capitalists
or firms willing to invest their money into ventures and seize the returns on those are another
possibility.4 The last two ‘seats’ are reserved for angel investors or wealthy individuals
looking for business projects with high potential to bring returns and private or public grants
available for particular types of businesses on a strict basis.5
Various factors have however made it quite difficult for small businesses to seize these
traditional financing methods such as the global economic crisis, the risky nature of start-ups,
the uncertainty regarding when can first profits be expected, etc.6 Deprived of traditional
funding means, small businesses have in recent years started seeking alternatives that would
enable them to launch their business ideas.
2 Moya K. Mason,‘Worldwide Business Start-ups’(2014), <http://www.moyak.com/papers/business-startups-
entrepreneurs.html> accessed on 25 November 2014.
3 Leah Grant, ‘Four Traditional Funding Methods for Small Businesses’(NASDAQ, 12 October 2010)
http://www.nasdaq.com/article/four-traditional-funding-methods-for-small-businesses-cm40099, accessed on 25
November 2014.
4 Ibid.
5 Ibid.
6Gmeleen Faye B. Tomboc, ‘The lemons problem in crowd-funding’ (2013) 30 J. Info. Tech. & Privacy L. 253,
2.

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One particular type of alternative financing for start-ups and small businesses is
crowd-funding. It is associated with the process of raising money from the crowd, the general
public, normally through the means of the Internet.7 Andrew Schwartz provides a definition of
crowd-funding by comparing it to crowd-sourcing outlining their similarities and differences.8
In his view, crowd-funding similarly to crowd-sourcing is an online activity in which a
company or an organization proposes in an open call to a large group of people the
undertaking of a particular task on a voluntary basis9. He highlights this similarity by various
examples of crowd-sourced projects such as Wikipedia10, and Yelp!.11 However, the main
difference Schwartz identifies between crowd-sourcing and crowd-funding is that in the latter
the crowd invests capital instead of labour and, depending on its type crowd-funding may give
the participants something in return.12
The way in which crowd-funding works in real life and the actual operation of the
market can be most clearly exemplified by looking at case studies of successful crowd-
funding campaigns from different countries.
The first example comes from the Netherlands where in 2012 the Dutch solar energy
developer Off-Grid Solutions raised $100,000 for its WakaWaka Solar Light technology
through Symbid, an equity-based crowd-funding platform.13 320 investors financed the
project and became equity investors expecting while the crowd-funding campaign allowed the
company to develop, manufacture and market high-tech low-cost solar lamps and chargers
globally.14
Another interesting crowd-funding campaign is that of the Pebble watch listed on the
US crowd-funding platform Kickstarter. The idea behind the project was to create an
inexpensive e-paper watch which could be customized with applications and provide email
7 P. Belleflamme, T. Lambert, & A. Schwienbacher, ‘Crowd-funding: Tapping the Right Crowd’ (2014) J. of
Bus. Vent. 29(5), 585-609.
8 Andrew Schwartz, ‘Crowd-funding Securities’ (2013) 88:3 Notre Dame Law Review 1457, 1459.
9 E. Estelles-Arolas & F. Gonzales-Ladron-de-Guevara, ´ Towards an Integrated Crowd-sourcing
Definition’(2012) 38 J. Info. Sci. 189, 197; A. Ley & S. Weaven, ‘Exploring Agency Dynamics of
Crowdfunding in Start-up Capital Financing’ (2011) 17 Acad. Entrepreneurship J., 85, 86.
10 Wikipedia, WIKIPEDIA, http://en.wikipedia.org/wiki/Wikipedia, accessed on 25 November 2014.
11 What is Yelp?, YELP, http://www.yelp.com/faq#what_is_yelp, accessed on 25 November 2014.
12 C. Steven Bradford, ‘Crowd-funding and the Federal Securities Laws’ (2012) Colum. Bus. L. Rev. 1, 16–17.
13 O. Gajda & J. Walton, Review of Crowd-funding for Development Initiatives (IMC Worldwide for Evidence
on Demand Paper, July 2013), 15.
14 Ibid.

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and calendar notifications.15 Pebble exposed the idea to the public via Kickstarter’s website
and set a target to raise $100,000 for research and development. Donating to the campaign
promised as a reward the receipt of the watch once done. By the end of the campaign Pebble
had collected $10 million, 100 times its initial goal.16
The roots of the broader concept of crowd-funding stem from the microfinance
movement pioneered by Nobel Prize winner Muhammad Yunus aimed at fighting poverty by
providing access to financing to individuals who otherwise cannot afford the costs of bank-
based financing.17 Dr. Yunus from Bangladesh was strongly inspired by a woman he met,
who was trying to make a living from weaving bamboo stools but was unable to afford buying
the materials she needed, given that commercial banks were rejecting a person with no
assets.18 Dr. Yunus was determined to make stories like this remain in the past. He established
Grameen bank in his native Bangladesh to lend small amounts of cash to local people for
developing small businesses by for example buying a sewing machine to make clothing or a
cow to sell milk.19 Dr. Yunus claimed that the poor people were equally creditworthy as the
rich if lending was based on trust, not on financial guaranties. His undertaking inspired other
banks throughout the world to follow his example and open up towards small entrepreneurs.20
According to Anand Giridharadas and Keith Bradsher from the New York Times the selection
of Dr. Yunus for the Nobel Prize reflects two developing ideas namely that tackling poverty is
essential to achieving peace and that private enterprise is essential to tackling poverty.21
2.2. Types of crowd-funding
Depending on what the backers of a particular business idea receive in return for their
money, different types of crowd-funding can be identified.
15 George Deeb, ‘Lessons in Entrepreneurship: Pebble’s $10 MM Raise via Kickstarter’ (Red Rocket Blog, 16
July 2012) http://redrocketvc.blogspot.nl/2012/07/lessons-in-entrepreneurship-pebbles.html accessed on 25
November 2014.
16 Ibid.
17 Ross S. Weinstein,‘Crowd-funding in the U.S. and abroad: what to expect when you’re expecting’ (2013) 46
Cornell Int’l L.J. 427, 3.
18 A. Giriharadas & K. Bradsher, ‘Microloan Pioneer and His Bank Win Nobel Peace Prize’ (New York Times,
Oct. 13, 2006), <http:// www.nytimes.com/2006/10/13/business/14nobelcnd.html?_r=0> accessed on 25
November 2014.
19 Ibid.
20 Ibid.
21 Ibid.

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Crowd-funding in which the crowd does not receive anything in return for its money is
called donation-based and the motivating factor is the cause for which the crowd is donating
such as helping to develop a social rights campaign or supporting a politician’s campaign.22
Another crowd-funding model is the reward-based one in which backers receive
rewards in exchange for their money. This model has gained popularity in the art world where
the crowd may support art projects and in return receive free tickets for concerts or get the
chance to meet artists23. A similar type of crowd-funding is the pre-purchase arrangement in
which funding participants receive the fruits of the project they have backed up such as for
instance the original copy of a book they have financed.24
The type of crowd-funding where crowd-funders make loans, with or without interest,
and expect to receive their contributions back in the future is called peer-to-peer lending.25
The most challenging variation of crowd-funding is the equity-based type, involving
businesses that, using the Internet connect to diverse and usually large in number groups of
people, interested in owning stock in their company.26 Equity crowd-funding is the focus of
the present paper because unlike other crowd-funding types it involves the establishment of an
investment relationship over the Internet between early-stage ventures and members of the
general public who may have never before had a similar experience and may therefore not be
aware of the associated risks. It creates an exception to the tradition of offering unlisted
securities only to accredited investors, investors who are financially sophisticated and have a
reduced need for regulatory protection27 due to their financial knowledge or ability to bear the
risk of loss.28
2.3. Differences between equity crowd-funding and traditional financing methods
While traditional early-stage funders, angel investors and venture capitalists, have a
background in finance and entrepreneurship, crowd-funders, members of the general public
who finance business projects online, have differing backgrounds and often no experience in
22 Supra note 12, at 15-16.
23 Supra note 12, at 3.
24 Steven Johnson, Future Perfect: The Case for Progress in a Networked Age (Riverhead Trade, 2013), 15-16.
25 John S. (Jack) Wroldsen,‘The social network and the Crowd-fund Act: Zuckerberg, Saverin, and venture
capitalists’ dilution of the crowd’ (2013) 15 Vand. J. Ent. & Tech. L. 583, 5.
26 Joan MacLeod Heminway & Shelden Ryan Hoffman, ‘Proceed at Your Peril: Crowdfunding and the
Securities Act of 1933’ (2011) 78 Tenn. L. Rev. 879, 892-907.
27 Laura Michael Hughes,‘Crowd-funding: Putting a Cap on the Risks for Unsophisticated Investors’,(2014) 8
CHARLR 483, 486.
28 Benjamin P. Siegel, ‘Title III of the JOBS Act: Using Unsophisticated Wealth to Crowdfund Small
Business Capital or Fraudsters'Bank Accounts?’,(2013) 41 Hofstra L. Rev. 777, 794.

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investments.29 Furthermore, crowd-funding investments take place online and most investors
are quite distant from the ventures they invest in, whereas angel investors and venture
capitalists invest locally and nationally in order to be able to keep in touch with the companies
they fund.30 Another aspect in which these three types of early-stage financing differ is the
due diligence of the venture selected for financing – crowd-funders frequently omit this step,
while angel investors and venture capitalists carry out due diligence at all times.31 The way in
which the investment deals take place also differs as crowd-funding deals flow through an
intermediary, an online platform, while angel investments and venture capital investments can
take place directly between the investors and the ventures.32 Finally, crowd-funders differ in
their role following an investment as they remain passive while angel investors and venture
capitalists get involved in the control of the funded venture.33
2.4. Advantages of equity crowd-funding
Crowd-funding gives a chance to small entrepreneurs who have not yet commenced
their businesses but cannot afford relying on personal funds to launch and face refusal by the
traditional sources of capital.34
Bank loans are not a good option due to the hardship for start-ups to fulfil their
requirements coupled with their overall reluctance to give loans in the context of global
financial instability.35 Venture capital funds are also not a reliable financing source for start-
ups as they normally invest huge amounts in only a few selected projects and their pickiness
has increased even further due to the economic crisis.36 Angel investors, wealthy individuals
with entrepreneurial experience are another unsuitable choice because their number is not as
big as the number of companies in need of funding and they prefer pooling their funds in large
projects rather than in start-ups.37 Raising capital via initial public offering (IPO) is also
29 K. E. Wilson, Financing High-Growth Firms: The Role of Angel Investors (OECD Publishing Paper,
December 2011).
30 A. K. Agrawal, C. Catalini & A. Goldfarb, Some simple economics of crowd-funding (National Bureau of
Economic Research Working Paper 19133, 2013).
31 Supra note 27.
32 Supra note 27.
33 Supra note 27.
34 Supra note 6.
35 Jill E. Fisch, ‘Can Internet Offerings Bridge the Small Business Capital Barrier?’(1998) 2 J. Small &
Emerging Bus. L. 57, 60-61; Peter C. Sumners, ‘Crowdfunding America's Small Businesses after the JOBS Act
of 2012’, (2012) 32 Rev. Banking & Fin. L. 38, 38.
36 D. Tapascott & A. D. Williams, Macrowikinomics – Rebooting Business and the World (Penguin Portfolio,
2010), 51; D. Mashburn,‘The Anti-Crowd Pleaser: Fixing the Crowdfund Act's Hidden Risks and Inadequate
Remedies’, (2013) 63 Emory J. L. 127, 136-140.

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improper in the case of start-up companies due to the numerous costs associated with
registrations and compliance.38
Another advantage of equity crowd-funding is the economic benefits it has the
potential to bring to national economies. Jason Best, Sherwood Neiss and David Jones,
crowd-funding capital advisors, suggest that crowd-funding can boost jobs creation because
start-ups create the most employment opportunities within an economy.39 Moreover it can
help in increasing national Gross Domestic Products by providing an open forum for testing
risky ventures and therefore decrease their failure rate and allow the easy monitoring of
transactions reducing governmental costs for screening agencies.40
Finally, equity crowd-funding is advantageous due to its reduced transaction costs.41
The existence and operation of the Internet has made it possible for entrepreneurs to connect
in real time to millions of potential investors at no transaction cost, leaving in the past the
costs associated with lending money from banks.
2.5. Challenges in the equity crowd-funding market
Among the main downsides of equity crowd-funding is the volatile nature of early-
stage ventures as they aim to launch new products or services which have not yet been proven
on the market and therefore their success is a big unknown.42 However, this aspect of
securities crowd-funding cannot be amended via regulation as it is an inherent characteristic
of the process, what can be changed is its facilitation.
One of the biggest challenges associated with crowd-investing is the so called ‘lemons
problem’.43 Online investors face a higher degree of uncertainty than offline ones due to the
information asymmetry in equity crowd-funding.44 Extensive and detailed information on
listed business projects remains hidden from investors as presented business plans on the
platforms’ websites are mere projections45 and exposing too detailed business plans creates
39 Jason Best, Sherwood Neiss & Davis Jones, “How crowd-fund investing helps solve three pressing
socioeconomic challenges (Crowdfund Capital Advisors Paper, 2012).
40 Ibid.
42 Karina Sigar, ‘Fret No More: Inapplicability of Crowd-funding Concerns in the Internet Age and the JOBS
Acts Safeguards’ (2012) 64 Admin. L. Rev. 473, 481-482.
44 Toshio Yamagishi et al., ‘Solving the Lemons Problem with Reputation’ in Karen S. Cook et al. (eds.), Etrust:
Forming Relationshipsin the Online World (Russel Sage Foundation, 2009).
45 Ibid., 73.

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the risk that the ideas may easily be stolen by any visitor of the website.46 Investors cannot tell
which start-ups are high-potential ones and which are unworthy and will therefore reduce the
average amount they will invest.47 Receiving lower funding than expected, entrepreneurs with
good ideas may exit the market, which will reduce even further the amount funders will be
willing to invest.48 In the end, the market will only be inhabited by low quality ideas, also
referred to as ‘lemons’.49
Closely related to the ’lemons problem’ is the wisdom of the crowd factor in crowd-
funding. Internet crowds comprise of individuals connected to issuers of securities over the
Internet,50 sharing similar interests and therefore likely to select which projects to finance
based on their popularity among the crowd and relying that the other backers have made their
choices wisely.51 However, sometimes crowds are not wise and it may turn out that the initial
funders were not skilled or informed enough to assess the potential value of a project.52 The
described behaviour is referred to as herding behaviour caused by information cascades,
decision making in which decisions are based on inferences made from the choices of
previous decision-makers.53
Finally, the lack of repeated interactions with crowd-funding platforms for
entrepreneurs may reduce the potential of reputation as a tool to motivate entrepreneurs to
behave in accordance with investors’ interests.54 As a crowd-funding campaign may be a one-
time event for an entrepreneur, he/she may not see a big advantage in behaving properly and
is therefore more likely to commit fraud.
2.6. Legal implications of crowd-investing: investor protection
It is reasonable to question the legality of raising capital for unlisted companies from
the general public without issuing a prospectus, a document describing financial securities to
47 Stephen J. Choi, ‘Gatekeepers and the Internet: Rethinking the Regulation of Small Business Capital
Formation’ (1998) 2 J. Small & Emerging Bus. L. 27, 38.
48 Supra note 27.
49 Supra note 6.
50 Joan MacLeod Heminway, ‘Investorand Market Protection in the Crowd-funding Era: Disclosing to and for
the “Crowd’ (2014) 38 Vt. L. Rev. 82, 3.
51 Supra note 12.
52 E. L. Mollick, ‘The Dynamics of Crowd-funding: an Explanatory Study’ (2013b) J. of Bus. Vent. 29, no 1:1-
16.
53 Charles Mackay, Extraordinary PopularDelusions and the Madness of Crowds (Three Rivers Press, 1980).
54 Supra note 12.

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their buyers and disclosing the risks.55 Equity crowd-funding functions without prospectuses56
and governments realize the rationale behind that – start-ups cannot afford the expensive
issuing process and the amounts they aim to raise are normally not as high as the ones public
companies set as a goal.57
This being said the question remains of how investors in equity crowd-funding are
protected and made aware of risks if no prospectuses are issued by the companies they fund.
The issue is brought to a higher level keeping in mind that a crowd-funding investor involves
anyone from the general public, with or without knowledge and experience in investments. It
is true that sometimes the amount provided by an individual investor is not significant
(sometimes as less as $20) and losing it may not seem like causing significant harm.
However, the equity crowd-funding industry should not turn into gambling where people lose
money on day-to-day basis because of mere curiosity to “try out the experience”. Equity
crowd-funding aims at more than that – presenting small businesses with the capital they need
but also with knowledgeable investors who can advise entrepreneurs and participate in
growing the business they own equity in.
How should the general public member be protected in the context of equity crowd-
funding? This question is of major concern for legislators worldwide who currently consider
introducing equity crowd-funding legislation for the first time. Different jurisdictions however
may not perceive the legislative solution to the issue in the same way due to a variety of
factors. These include the degree to which equity crowd-funding has entered into the national
capital market, the availability of traditional financing methods, the presence of supranational
rules, history and traditions in the national legal order.
The following chapters will discuss the differing regulatory opinions on investor
protection in equity crowd-funding in Europe and the United States as they are the two major
crowd-funding markets on a global scale, they do not share the same regulatory history or
legal tradition, the methods of financing differ in each of the two and supranational rules exist
in one but are absent in the other.
55 Antti Hemmilä, ‘Legal Challenges Related To Crowdfunding: Volume 2’, 26 November 2012 <
http://www.arcticstartup.com/2012/11/26/legal-challenges-related-to-crowdfunding-volume-2> accessed on 02
December 2014.
56 Directive 2010/73/EU of the European Parliament and of the Council of 24 November 2010 amending
Directives 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to
trading and 2004/109/EC on the harmonisation of transparency requirements in relation to information about
issuers whose securities are admitted to trading on a regulated market (‘Prospectus Directive’), Article 1(2)(h).

13
Chapter 3: Crowd-funder protection in Europe
The first regulatory approach towards crowd-investing to be discussed is the European
one. Europe represents the second biggest crowd-funding market in the world, after the
United States. In Europe venture capital financing and business angels are not common and
banks are the more popular choice for early-stage financing. However, obtaining start-up
loans from banks has become close to impossible after the crisis in 2008. Crowd-funding
provides half a million European projects per year with capital they may otherwise have no
means to obtain given for instance the decrease in investments made by venture capital
funds.58 Discussing the regulatory approach towards crowd-investing in Europe is challenging
– adopted national legislations have crucial importance but remain limited within the scope
provided for by EU.
This chapter will first discuss the supranational EU laws affecting investor protection
in equity crowd-funding and a selection of European national equity crowd-funding
legislations. The paper does not aim to cover all European jurisdictions but to exemplify the
diversity of national laws in the clearest way possible. Therefore, the most differing regimes
on equity crowd-funding will be taken into consideration: the United Kingdom which has
swayed from an ‘open’ no-regulation attitude to a recently welcomed regulation in the crowd-
funding field, France which previously had an overly stringent regulatory regime but recently
introduced balanced laws, and Italy giving an innovative regulatory example to other
countries both in Europe and globally.
3.1. European regulatory framework for crowd-funding investor protection
The European Union shares with the Member states the competence to regulate in the
field of the internal market, involving the regulation of financial activities for both traditional
and alternative sources.59
Since the focus of this paper is placed upon the issue of investor protection in the
context of equity crowd-funding only the EU rules having the potential to affect this matter
will be discussed.
58 Ernst & Young, ‘Turning the corner: global venture capital insights and trends 2013’,
http://share.endeavor.org/pdf/Turning%20the%20corner_VC%20insights%202013.pdf accessed on 17
December 2014, 13.
59 Treaty on the Functioning of the European Union, Article 4(2)(a).

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For the time being, no specific European legislation has been passed to regulate equity
crowd-funding and until this happens the market needs to comply with the existing EU
Directives created for financial activities in general and implemented on national level.
The most important EU legislation that concerns equity crowd-funding is the
Prospectus Directive.60 Its general aim is to protect investors and provide for market
efficiency by imposing a requirement on companies intending to offer equity to the public to
publish a prospectus informing investors about the risks of purchasing shares and allowing
them to make reasoned decisions.61 The Directive exempts from this general requirement
public offerings worth less than €5 million62 where most crowd-funding campaigns are likely
to fall.63 Irrespective of this exemption, the Directive further provides for other situations
which would not require the issuing of a prospectus.64 Crowd-funding campaigns aimed at
raising more than €100.000 may wish to rely on the general €5 million exemption, but it will
only exempt them from the European prospectus requirement. These campaigns will not be
exempted from the national regimes on public offerings which have the discretion under the
Directive to vary from full prospectus exemption to full prospectus requirement.65
De Buysere considers that equity crowd-funding platforms could theoretically fall
within the definition of Alternative Investment Fund Manager under the Alternative
Investment Fund Manager Directive (‘AIFMD’) being a legal person whose regular business
is the managing of one or more Alternative Investment Funds.66 However, equity platforms
are not likely to go beyond the €100 million size threshold required for the Directive to
apply.67 The AIFMD requires EU member states to implement minimum regimes consisting
60 Directive 2010/73/EU of the European Parliament and of the Council of 24 November 2010 amending
Directives 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to
trading and 2004/109/EC on the harmonisation of transparency requirements in relation to information about
issuers whose securities are admitted to trading on a regulated market (‘Prospectus Directive’).
61 Ibid.
62 Ibid., Article 1(2)(h).
63 K. De Buysere, O. Gajda, & D. Maron, ‘A Framework for European Crowdfunding’ (Stockholm, Sweden,
EURADA, INSME & European Crowd-funding Network, October 2012), 28.
64 Supra note 60, Article 3(2) : including the offer of securities to accredited investors only or to fewer than 150
unaccredited investors.
65 Supra note 63.
66 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative
Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No
1060/2009 and (EU) No 1095/2010, Article 6; Article 4(1)(a): “Collective investment undertaking which raises
capital from a number of investors with a view to investing it in accordance with a defined investment policy for
the benefit of those investors.”
67 Ibid., Article 3(2)(a).

15
of at least a registration and an information requirement68 in achieving the general goal of the
Directive to provide for a coherent approach towards investor protection within the Union.69
Finally, the Market in Financial Instruments Directive (‘MiFID’) aims to reinforce the
transparency of financial markets and improve investor protection by requiring investment
firms to establish systems and controls for ensuring a robust governance framework.70 While
the definition of an investment firm is wide enough to cover crowd-funding platforms, the
factor having a decisive role in determining if they need authorization under the Directive is
whether they perform any of the activities listed in Annex I Section A.71 This determination is
left to Member states’ interpretation meaning that a platform’s activities may fall under the
MiFID in one Member state but be considered as falling outside its scope in another.72
The EU directives affecting the equity crowd-funding market bind Member states only
with regards to their goal and allow national authorities to select the methods of
implementation. They give a great scale of discretion to national legislators in determining the
rules for offers below the Prospectus Directive’s €5 million threshold, the choice on whether a
crowd-funding platform falls in the definition of Alternative Investment Fund Manager and
whether a platform’s activities would fall within the scope of the MiFID. The diversified
national implementation creates a landscape with a high level of legal uncertainty concerning
investor protection.
3.2. The protection of crowd-funding investors by European national regimes
It is important that a distinction is made between legislative frameworks created on
European level and the implementation of the same on national Member state level.73 The
differing implementation of European Directives results in a fragmented regulatory landscape
for equity crowd-funding and investor protection in Europe.74
68 Ibid., Article 3(3).
69 Ibid., Consideration (2).
70 European Securities and Markets Authority, Consultation Paper MiFID (ESMA/2011/446), December 2011, 6.
71Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial
instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European
Parliament and of the Council and repealing Council Directive 93/22/EEC, Annex I, Section A.
73 Aschenbeck-Florange et al., ‘Regulation of Crowdfunding in Germany, the UK, Spain and Italy and the
Impact of the European Single Market’ (European Crowdfunding Network in association with Osborne Clarke,
June 2013), 5.
74 K. De Buysere, ‘The ‘new’ venture capital cycle: Obstacles in using the Internet for equity raise campaigns’,
January 2012, 28. On file with author.

16
3.2.1. Legal framework in the United Kingdom: from unregulated to regulated
The UK has implemented the Prospectus Directive in the UK Financial Services and
Markets Act 200075 fully exempting offers worth less than €5 million for a period of 12
months.76 The AIFM Directive has also been transposed into UK national law but a limited
compliance regime has been introduced for managers with total assets under management of
less than €100 million (where most crowd-funding platforms are likely to be).77 These are
required to either register with the FCA as a small registered AIFM and provide annual
reports on the level of their funds under management or become authorized as a small
authorized AIFM and comply with a limited conduct of business and capital requirement
regime.78
Until recently the United Kingdom has been the most notable example in Europe of an
open regulatory approach towards equity crowd-funding as it had no specific regulation in the
field. UK regulators were observing the market’s development willing to learn the specific
needs of all stakeholders before passing laws.79 The field was dominated by a high degree of
uncertainty where some equity platforms were authorized by the Financial Conduct Authority
(FCA) under the Financial Services and Markets Act 200080 while others were making use of
the variety of exemptions available to avoid regulation.81
In March 2014 the FCA produced a policy statement82 outlining the new crowd-
funding rules that came into force on 1st April, 2014. The major driving force behind them
was the belief that crowd-investing should only be promoted to those who understand or have
the financial capacity to deal with all the risks associated with this type of alternative
investment.83
The new regime places an important limitation on the type of investors to whom
equity platforms are allowed to send offers of unlisted securities - professional clients, retail
clients confirming they will receive regulated investment advice from an authorized person,
75 Financial Services and Markets Act 2000, Section 85.
76 Ibid, Section 86.
77 Tax & Legal Work Group of the European Crowd-funding Network, “Review of Crowd-funding Regulation.
Interpretationsof existing regulation concerning crowd-funding in Europe,North America and Israel”
(European Crowd-funding network AISBL, 2013), 186.
78 Ibid.
80 Financial Services and Markets Act 2000.
81 Financial Promotions Order (‘FPO’).
82 The Crowdfunding and the Promotion of Non-Readily Realisable Securities Instrument 2014, March 2014.
83 King & Wood Mallesons, ‘UK new crowd-funding rules’, 27 March 2014,
http://www.sjberwin.com/insights/2014/03/27/uks-new-crowdfunding-rules accessed on 17 December 2014.

17
venture capital firms, certified sophisticated investors, certified high net worth investors, and
clients certifying they will not invest more than 10% of their net investible financial assets in
unlisted securities during one year.84 The new laws also provide that if an equity platform
does not provide investment advice it must check that clients have the knowledge and
experience necessary to assess the risks associated with investing in unlisted securities by
sending them an appropriateness test in line with the rules in Chapter 10 of the Conduct of
Business Sourcebook.85 Not in the last place, the new legislation introduces dispute settlement
rules for loan-based crowd-funding but does not envisage similar that fit into the context of
the equity-based model.86
The UK has taken a cautious approach towards equity crowd-funding but the mere fact
that regulation has been put in place carries a positive sign. The new legislation has brought
legal certainty in the market and the importance of protecting crowd-funders to the spotlight.
However, the solutions of the FCA for protecting investors do not seem to be the most
suitable and effective ones. Is really high net income the most appropriate filter in assessing
an investor’s experience and readiness to cope with the risks associated with crowd-investing?
An individual can have a high salary and still lack sufficient knowledge of investments. UK
legislators deserve admiration for regulating equity crowd-funding but need to reconsider the
selected methods.
3.2.2. Legal framework in France: towards a balanced regulation
France has implemented the Prospectus Directive requiring public offerings to prepare
prospectuses and get approval by the securities regulator, the Autorité des Marchés Financiers
(AMF).87 The exemptions available to this rule closely follow the Prospectus Directive and
even adopt a stricter approach.88
The AIFMD on its side although implemented in France89 is not likely to affect crowd-
funding activities in the country. This stems from the fact that under French law equity-based
84 Supra note 82, Section 4.7.7 R (1), (2).
85 Supra note 82, Section 4.7.7 R (3).
86 Ibid.
88 Code monétaire et financier (CMF), Article L.411-2; AMF Règlement Général, Article 211-2. The exceptions
available include private placements addressed to qualified investors and fewer than 150 otherinvestors,for up
to 20% of the issuer’s pre-offer capital or high value placements (at least €100.000 per investor or €100.000 per
security) and for offerings of less than €100.000 in total or larger offerings representing up to 50% of the issuer’s
pre-offer capital and not exceeding €2.5 million if traded on a multilateral trading facility or €5 million if not so
traded.
89 Code monétaire et financier, Articles L.214-24.

18
platforms do not meet the definition of collective investment undertakings as they raise capital
from investors with commercial purpose, do not maintain the collected amounts in the form of
collective investments and allow the establishment of investors-funders relationships.90
Unlike the United Kingdom, France had until late 2014 quite rules, making the
operating of the whole crowd-investing market burdensome.91 On 1st October 2014 specific
equity crowd-funding law entered into force in France ‘liberalizing’ the regulatory
landscape.92 The most interesting aspect of the legislation is that it provides for a separate
legal status of equity crowd-funding platforms – ‘conseiller en investissements participatifs’
(CIP)93 and abolishes the previous minimum capital requirement for platforms.94 The CIPs are
required to register with ORIAS (the Single Register of Insurance Intermediaries),95 adhere to
a code of conduct and establish adequate management procedures.96 Portal managers need to
have a background in banking or finance and must not be bad actors.97 The website of an
equity platform is required to provide investors with minimum information about the authors
of listed projects and the risks associated with investing in unlisted securities, and get their
confirmation that they realize the risk of losing the money they have invested.98 Another
important change is that the crowd-funding limit for equity raised through the website of a
CIP has been increased from €100.000 to €1 million per issuer in any 12-month period with
the requirement of issuing a light 4-5 pages prospectus document.99
The new French crowd-investing law places on the shoulders of equity-based
platforms the responsibility to ensure they are capable of operating in that market and
accordingly ensure that investors will be appropriately informed about its risks. Along with
that French legislators try to balance the interests of investors with those of entrepreneurs by
increasing the maximum amount allowed to be raised within a year to €1 million.
91 Ludwine Dekker, ‘Figuring Out Crowd-funding: Should We Support Open or Closed Markets?’, 14 April
2014 http://www.crowdfundinsider.com/2014/04/35872-figuring-crowdfunding-support-open-closed-markets/
accessed on 19 December 2014.
92 Ordonnance no. 2014-559 du 30 mai 2014 relative au financement participatif (Presidential Order no. 2014-
559); J. D. Alois, ‘French Crowd-funding Laws Now in Force’, 2 October 2014
http://www.crowdfundinsider.com/2014/10/51484-french-crowdfunding-laws-now-force/ accessed on 20
December 2014.
93 Décret no. 2014-1053 du 16 septembre 2014 relatif au financement participatif (Ministerial Decree no. 2014-
1053).
94 Ibid.
95 Ibid.
96 Ibid.
97 Ibid.
98 Ibid.
99 Ibid.

19
3.2.3. The innovative Italian equity crowd-funding law
Italy is the first country in the world that enacted specific equity crowd-funding
laws100 and one cannot omit noticing that the spirit behind these is protecting investor
interests in a new, risky market such as equity crowd-funding.
On 17 December 2012 Decreto Crescita Bis 2.0 came in force legalizing equity crowd-
funding only for ‘innovative start-up companies’101 and delegating the final implementation of
the law to the CONSOB, the Italian Securities and Exchange Commission. The law
transposed the Prospectus Directive into Italian law102 and the MiFID by requiring each
securities offering to be finalized by a CONSOB-registered broker-dealer who is required to
manage an investor’s money and check his readiness to assess the investment risks by filling
in questionnaires.103
In July 2013 CONSOB implemented Regulation No. 18592 providing the legislative
framework for the conduct of all crowd-funding activities through Italian-based equity
platforms. The general rules contained therein require equity platforms to register with
CONSOB104 upon meeting specific competence and reputation requirements.105 The same
regulatory organ has the right to supervise the crowd-funding activities carried out on
platforms and impose penalties when necessary.106 CONSOB moreover manages the
arbitration chamber solving conflicts between investors and broker-dealers. Also, at least 5%
of the amounts raised via crowd-funding shall be invested by a professional investor as
defined in the CONSOB Regulation.107There is, however no investment cap on the amount
that a retail investor is allowed to invest in a single project or within a calendar year.
100 The Soho Loft, ‘Italy announced for Equity Crowdfunding today’, 12 July 2013,
http://thesoholoft.com/2013/07/12/italy-law-announced-for-equity-crowdfunding-today/ accessed on
20 December 2014.
101 Italian Growth Decree bis 2.0, Article 25(2).
103 A. M. Lerro, ‘Protections Offered to Investors underItaly’s Equity Crowd-funding Law’, 2 August 2013,
<http://www.crowdsourcing.org/editorial/protections-offered-to-investors-under-italys-equitycrowdfunding-
law/27455> accessed on 20 December 2014; Italian Growth Decree bis 2.0, Part II, Title III, Article 15.2(b).
104 Italian Growth Decree bis 2.0, Part II, Title I, Articles 4-6.
105 Ibid., Part II, Title II, Articles 8,9; Root,’A look into Italy’s Recent Crowdfunding Legislation (Part I)’, 15
July 2013 www.crowdsourcing.org/editorial/a-look-at-italys-recent-crowdfunding-legislation-part-i/27122
accessed on 20 December 2014.
106 Ibid., Part III, Articles 24, 25.
107 Ibid., Part I, Article 2(j),Part III, Article 24.2.

20
The Regulation moreover provides for a simplified process for small investments108
not requiring the involvement of a broker-dealer and risk assessment testing of investors.109
One of the most significant rights granted to Italian crowd-funders is to exit the
investment they have entered into. They can do that without any reason within seven days
from investing,110if something new happens or a material mistake affecting their investment
decision is found after the investment but before closing of the offer and within 7 days from
finding out such news,111 or if the founding shareholders sell the business or somehow amend
the control of the company.112 Therefore, companies must include such rights in their
shareholders agreements before being admitted to crowd-funding and keep them there as long
as they benefit from the ‘innovative start-up’ status. Interestingly, retail investors are
encouraged to keep their investments up to 2 years by tax incentives – they can deduct up to
25% of their investment, €0.5 million at a maximum.
The regulatory approach in Italy can be regarded as the most developed one in Europe
due to its carefully developed features. It provides for a high degree of investor protection by
delegating it to an experienced regulatory organ, CONSOB, requiring utmost competence by
platforms, ensuring that investors are thoroughly informed, and giving them the right the exit
their investments.
3.3. Conclusive lines
Currently there is no EU equity crowd-funding legislation meaning that this activity is
subjected to the existing EU Directives as implemented in domestic legal orders and to the
national-specific rules across Europe. Fragmentation and legal uncertainty is created by the
varying methods of implementation of the EU Directives affecting crowd-investing. Italy is
the only country in Europe which has developed adequate measures upholding investor
protection in its national crowd-investing laws and therefore represents a genuinely advanced
regulatory regime. The EU is considering the possibility of harmonizing the equity crowd-
funding field and the European Commission has been monitoring crowd-investing’s
development since late 2013, exploring its added value to the internal market and the need for
108 Small investments are up to €500 per investment and €1000 per year for individuals and ten times the same
amounts for legal persons.
109 Italian Growth Decree bis 2.0, Part II, Title III, Article 17.4.
110 Ibid., Part II, Title III, Article 13.5.
111 Ibid., Part III, Article 25.2.
112 Ibid., Part III, Article 24.1(a).

21
EU legislation through consultations with involved parties113. Harmonizing equity crowd-
funding legislation across the EU would improve investor protection by removing the legal
uncertainty created by different regimes in each Member state and setting a common playing
field in the internal market.
113 A. Root, ‘A Cloudy Forecast: Equity Crowdfunding In Europe’, 25 October 2012,
www.crowdsourcing.org/editorial/acloudy-forecast-equity-crowdfunding-in-europe-part-1/20692, accessed
December 17 2014.

22
Chapter 4: Crowd-funder protection in the United States
The second regulatory approach towards investor protection in equity crowd-funding
under discussion is that of the United States. It has been selected to form part of this paper
along with Europe due to the fact that it is the leading crowd-funding market on a global scale
and therefore US legislators have been concerned with the question of its regulation in the
past years. Moreover, comparing the US regulatory approach to the European one in terms of
providing investor protection is challenging because the two systems do not share the same
history or legal order. It is interesting to see if the two world leaders in crowd-funding
approach similarly the same legal issue qua regulation given their significantly differing
features.
This chapter is going to provide an overview of the regulatory landscape for crowd-
investing in the United States and the status of crowd-funder protection there. The discussion
is going to start with a briefing on the US federal laws governing securities offerings and an
explanation of how these laws create hardships for start-ups in obtaining early-stage capital.
Afterwards, the chapter will examine the proposed exemption from US securities regulations
for crowd-investing under Title III of the Jumpstart Our Business Startups Act (JOBS Act).
Last but not least, the chapter is going to look at the proposed crowd-investing law’s approach
towards upholding investor protection and outline the problems it may cause to crowd-
funders.
4.1. The US securities regulatory past: keeping the crowd away
In 2012 the US President Barack Obama signed the JOBS Act, whose Title III
proposes exempting equity crowd-funding from the registration requirement under the
securities regulations in order to boost the economy and create jobs.
However, before the proposed exemption comes into force equity crowd-funding
offerings are subject to US federal securities rules as they involve the sale of securities to the
general public.114The legislative requirements for offering securities to the public in the
United States are highly demanding and overly costly for businesses aiming to raise small
amounts of money.
114 Securities Act 1933 (15 U.S.C., 2012), s 2(a)(1) (“investment contracts” as a form of “securities” under the
Act); SEC v. W. J. Howey Co. [1946] 328 U.S. 293, 300-301 (defining “investment contract” underthe
Securities Act as requiring an investment of money, due to an expectation of profits arising from, a common
enterprise, which depends solely on the efforts of a third party); Daniel M. Satorius & Stu Pollard, ‘Crowd
Funding: What Independent Producers Should Know About the Legal Pitfalls’, (2010) Ent. & Sports L., 16.

23
The major laws governing the sales and offerings of securities in the United States are
the 1933 Securities Act, regulating the primary securities market, and the 1934 Securities and
Exchange Act, governing the secondary market and establishing the Securities and Exchange
Commission (SEC). Both Acts were adopted by the US Congress after the stock market crash
of 1929 and were aimed at protecting from fraud buyers of securities from the general public
by requiring extensive disclosures by sellers of securities.115 Therefore, the laws require
issuers of securities to register with the SEC116 and disclose enough information to
prospective investors to allow them to make informed decisions regarding securities
purchases in light of the associated risks.117
The following requirements apply to all public securities offerings in the United
States, including equity offerings by start-ups until enactment of the JOBS Act. The 1933
Securities Act prohibits any offering of securities to the public unless the same is registered
with the SEC or qualifies for one of the registration requirement exemptions.118For the
purpose of registering a public security offering with the SEC, a company must prepare a
registration statement with disclosures on ownership, description of the business, director
background information, balance sheet, a profit and loss statement.119 The document must be
filed with the SEC and made available as the SEC requires.120 Crowd-investing is in practice
prohibited under Section 5 of the Securities Act which bars the use of “means or instruments
of transportation or communication in interstate commerce or of the mails” to sell an
unregistered security. Along with the registration requirement, a company selling securities is
obliged under the Securities and Exchange Act to comply with periodic disclosure reporting
requirements.121 Complying with both the registration and the disclosure and reporting
requirements involves costly preparation which may exceed the amount of capital a company
is aiming at.122 This explains why early-stage companies are reluctant to seek seed capital by
means of a public offering and are looking for alternatives.123
115 Deepa Sarkar, ‘Securities Law History’ (2012) Cornell U. L. Sch. Legal Info. Inst.,
<http://www.law.cornell.edu/wex/securities_law_history> accessed on 17 January 2015.
116 James D. Cox et al., SecuritiesRegulation:cases and materials (6th ed., Aspen Publishers, 13 May 2009)
1019.
117 Ibid.
118 Securities Act 1933 (15 U.S.C., 2012) §77e(c).
119 Securities Act 1933 (15 U.S.C., 2012) §77aa(4)-(6), §77aa(8), §77aa(25), §77aa(26).
120 Securities Act 1933 (15 U.S.C., 2012) §77aa.
121 Securities Act 1933 (15 U.S.C., 2012) § 78o(d); Michael B. Dorff, ‘The siren call of equity crowd-funding’
(2014) 39 J. Corp. L. 493, 5.

24
Before the JOBS Act came on the US regulatory stage start-ups may try to raise
capital by making use of the available registration requirement exemptions. Issuers may
consider making Regulation A offerings amounting up to $5 million124 – a satisfactory
amount for an early-stage financing round. However, the exemption requires the filing of a
disclosure document with the SEC, Form 1-A, which amounts to a partial registration
process125 that pushes small entrepreneurs away.126 Another possible alternative to exempt a
securities offering is Regulation D providing for three separate registration exemptions
depending on the targeted funding amounts.127All Regulation D exemptions however prohibit
general solicitation or advertising of the offerings by their issuers which makes them
incompatible with equity crowd-funding.128
The US federal securities laws were enacted at times when legislators were worried
that allowing citizens to invest their money in a process not subjected to securities regulation
could harm both the investors and the economy due to wrong decisions taken in relation to
unregulated investment activities.129 However, decades have passed since the 1930s and the
perceptions have changed which leads to asking if the time for a change in the attitude
towards offering securities to the general public has come.
4.2. The proposed crowd-funding exemption under the JOBS Act
The costly regulatory burden of registering a security transaction with the SEC and the
inappropriateness of existing registration exemptions for crowd-investing have motivated
equity crowd-funding proponents to advocate for easing small businesses in accessing early-
stage capital by exempting crowd-investing from federal securities regulation.130 The
legislative proposals started in 2010 and after a number of introduced amendments131 on April
124 Securities and Exchange Act 1934 (17 C.F.R., 2013) § 230.251(a)(2).
125 Ibid., § 230.251(d); Supra note 121.
126 Eliminating the Prohibition against General Solicitation and General Advertising in Rule 506 and Rule 144A,
Securities Act Release No. 9354, 77 Fed. Reg. 54, 464, 54, 477, n.126 (proposed Aug.29, 2012).
127 Securities and Exchange Act 1934 (17 C.F.R., 2013) § 230.504(b)(2), § 230.505(b)(2), § 230.506: Rule 504
exempts security offerings amounting up to $1 million, Rule 505 exempts offerings up to $5 million, and Rule
506 exempts offerings with no limitation in their amount but allowing only 35 non-accredited investors to take
part in the offering; Ryan Sanchez, ‘The new crowd-funding exemption: only time will tell’ (2013) 14 U. C.
Davis Bus. L. J. 109.
128 Thomas Lee Hazen, ‘Crowd-funding or Fraud-funding? Social Networks and the Securities Laws - Why the
Specially Tailored Exemption Must be Conditioned on Meaningful Disclosure’ (2012) 90 N.C. L. Rev. 1735,
1769.
129 Edmund W. Kitch, ‘Crowd-funding and an innovator’s access to capital’ (2014) 21 Geo. Mason L. Rev. 887,
2.
131 C. Steven Bradford, ‘The New Crowd-funding Exemption: Promise Unfulfilled’ (2012) 40 No. 3 Sec. Reg.
Law J., 1.

25
5th 2012 the JOBS Act was signed into law.132 The Act’s Title III known as the Crowd-
funding Act is aimed at increasing the opportunities for entrepreneurs by exempting start-ups
from compliance with the costly federal registration requirements when raising capital.133 The
task of implementing the JOBS Act is delegated to the gate-keeper of the capital markets in
the United States, the SEC.134 On October 23rd 2013 the SEC proposed rules to implement the
crowd-funding exemption but final rules are still expected and until adopted crowd-investing
over the Internet violates the federal securities registration requirement.
The following constitute the requirements for conducting crowd-investing in the
United States as proposed by Title III of the JOBS Act.
Issuers are allowed to raise a maximum of $1 million from crowd-funders within a 12-
month period.135 They are however banned from advertising their offering except if aimed at
directing investors to the portals where they can invest.136 There is no limit on the number of
shareholders an issuer can have as the Act exempts all crowd-funders from the shareholder
caps contained in other securities regulations.137Strict disclosure requirements apply for
issuers depending on the capital they aim to raise. If the targeted amount falls below
$100.000, the issuer is obliged to provide the most recent income tax returns along with
financial statements prepared by an internal accountant.138 If the amount goes above $100.000
but below $500.000, the issuer is required to provide financial statements prepared by an
independent public accountant.139 If the targeted amount of the crowd-funding offering
increases $500.000 the respective issuer must provide an audited financial statement140 and
give information about the intended purpose and use of the offering’s proceeds.141 An issuer
must also provide general business information to the SEC and to investors: name, legal
status, physical address, website address, names of directors and substantial shareholders,
description of the business and a business plan, financial condition, price of the securities and
the method of determining their price, capital structure and ownership.142 Along with these
132 Jumpstart Our Business Start-ups Act 2012, Pub. L. No. 112-106, 126 Stat. 306.
133 Supra note 8, at 1460-61; Jacques F. Baritot, ‘Increasing Protection for Crowdfunding Investors underthe
JOBS Act’, (2013) 13 U.C. Davis Bus. L. J. 259, 281.
134 Lindsay Sherwood Fouse, ‘The Crowd-funding Act: a new frontier’ (2013) 16 Duq. Bus. L. J. 21.
135 Jumpstart Our Business Start-ups Act 2012, Pub. L. No. 112-106, § 302(a)(6), 126 Stat. 315.
136 Ibid., § 302(b)(b)(2), 126 Stat. at 318.
137 Supra note 8.
138Jumpstart Our Business Start-ups Act 2012, Pub. L. No. 112-106, § 302(b)(b)(1)(D)(i), 126 Stat. 317.
139 Ibid., § 302(b)(b)(1)(D)(ii), 126 Stat. 317.
140 Ibid., 302(b)(b)(1)(D)(iii), 126 Stat. 317.
141 Ibid., § 302(b)(b)(1)(E)-(G), 126 Stat. 317.
142 Ibid., § 77d-1(b)(1).

26
disclosures, issuers are obliged to report annually the results from their business operations
and financial statements to the SEC and to investors.143
The Crowd-funding Act imposes limits and requirements on investors as well. The
amount an investor is allowed to pool in a single crowd-funding project in a 12-month period
depends on his net annual income.144 If an investor’s income is less than $100.000, his
investment in an offering cannot go beyond 5% of that income and be no greater than
$2000.145If an investor’s net income is equal to or exceeds $100.000, he can invest a
maximum of 10% of his annual income, no greater than $100.000.146 Crowd-funding
intermediaries are under the obligation to ensure that no investor exceeds the relevant to his
case investment cap.147 In order to be allowed to crowd-fund a project, investors are required
to show that they understand the risks involved in crowd-investing by reviewing investor-
education information and affirming that they agree with the associated responsibilities.148
Finally, after having purchased crowd-funding securities, investors are banned from selling
them for one year from the date of the purchase, unless transferring to a family member or an
accredited investor.149
Crowd-funding offerings must be conducted via an intermediary, a broker-dealer or a
funding portal registered with the SEC150 and a member of the Financial Industry Regulatory
Authority.151 Intermediaries have the responsibility of providing investors with disclosures
and extensive information regarding the risks they may face through investor-education
materials and ensure that they affirm to accept these risks.152 Investors shall be allowed by
intermediaries to withdraw their investment at any time prior to the deadline set by the issuer
to collect his targeted amount.153 Intermediaries shall moreover, take appropriate measures to
prevent investor fraud154 and protect the privacy of the information provided by
143 Ibid., § 302(b)(b)(4), 126 Stat. 318.
144 Ibid., § 302(a)(6)(B), 126 Stat. 315.
145 Ibid., § 302(a)(6)(B)(i), 126 Stat. 315.
146 Ibid., § 302(a)(6)(B)(ii), 126 Stat. 315.
147 Ibid., § 302(b)(a)(8), 126 Stat. 316.
148 Ibid., § 302(b)(a)(4)(A)-(C), 126 Stat. 316.
149 Ibid., § 302(b)(e)(1), 126 Stat. 319.
150 Ibid., § 302(b)(a)(1)(A)-(B), 126 Stat. 316.
151 Supra note 127.
152 Ibid., § 302(b)(a)(3), 126 Stat. 316.
153 Ibid., § 302(b)(a)(7), 126 Stat. 316.
154 Ibid., § 302(b)(a)(5), 126 Stat. 316 (requiring the portal to obtain a background and securities enforcement
regulatory check on each officer, director, and person holding twenty percent of the outstanding equity of every
issuer).

27
investors.155Not in the last place, the proposed law establishes rules for liability for misleading
statements against issuers156 and the SEC is encouraged to adopt disqualification rules for
brokers, funding portals and issuers.157
4.3. Potential impact on investor protection
The proposed crowd-investing exemption is challenging and its constituent rules were
a difficult compromise among legislators because they attempt to balance between supporting
small businesses in raising early-stage capital while protecting members of the general public
willing to become investors.158All disclosure requirements provided for in the proposed
Crowd-funding Act are aimed at protecting investors coming from the general public. The
legislative proposal addresses the risks of fraud and inaccurate information and caps the
amounts crowd-funders are allowed to pool in crowd-funding campaigns to off-set potential
losses. Moreover, it envisages civil action right for investors in case of misrepresentations or
inaccurate statements. Are the proposed protections however likely to succeed in their
purpose to prevent fraud towards crowd-funders?
One of the main shortcomings of the proposed crowd-funding exemption is the failure
of the drafters to realize that investor protection arises not only from providing one with
adequate information but also from the ability to understand that information.159
Unsophisticated investors who are able to become crowd-funders in accordance with the
proposed Crowd-funding Act lack sufficient financial knowledge by definition160 which
makes availing them of thorough information inefficient as a protective legislative measure,
because they will not understand it and make informed decisions on its basis. Moreover, it
remains unclear how funding portals are going to ensure that crowd-funders have understood
the risks of the investment they make161 and merely informing them that a risk exists is
insufficient to protect them.
Furthermore, crowd-funders in the USA will be faced with a liquidity problem as the
proposed Crowd-funding Act bans the transfer of purchased crowd-funding securities within
one year since their purchase. There is therefore no envisaged market for the secondary
155 Ibid., § 302(b)(a)(9), 126 Stat. 316.
156 Ibid., § 302(b)(c)(2)(A), 126 Stat. 319.
157 Ibid., § 302(d), 126 Stat. 320-321.
158 Supra note 128.
159 Thomas G. James, ‘Far from the maddening crowd: does the JOBS Act provide meaningful redress to small
investors for securities fraud in connection with crowd-funding offerings?’ (2013) 54 Boston College L. Rev.
1767, 1783.
160 Thomas Lee Hazen, The Law of SecuritiesRegulation (5th ed., West Group, April 1 2005).

28
distribution of such securities making them quite illiquid.162 Reselling crowd-funding
securities after the one-year restriction will require compliance with federal securities laws.163
Another aspect of the crowd-funding exemption endangering investor protection is the
right to private action against issuers in cases of fraud. It may turn out to be an unworkable
option in the case of small crowd-funders, who are limited to investing only a small amount of
money, because the Crowd-funding Act allows recovering only the amount that has been
invested and eventually lost due to issuer fraud.164 Faced with substantial costs for bringing an
individual action,165 small crowd-funders may consider an alternative remedy - bringing a
class action against fraudulent issuers.166 Doing so, however, would be impeded by the
pleading restrictions imposed by the Private Securities Litigation Reform Act of 1995
(PSLRA) governing private class actions alleging securities fraud.167 Showing the defendant
crowd-funding issuer’s intent to defraud168 and proving that the same caused the investor
losses prior to discovery169 would be quite difficult for crowd-funders classes given the scarce
information available about the issuer, despite the disclosures made.170 Therefore, neither the
right to private action in the proposed Crowd-funding Act nor the right to a securities fraud
class action under the PSLRA can provide small investors with an efficient remedy against
issuer fraud.
162 Supra note 12, at 108-109.
163 Supra note 12.
164 Jumpstart Our Business Start-ups Act 2012, § 77d-l.
165 Supra note 128, at 1736–37.
167 John W. Avery, ‘Securities Litigation Reform: The Long and Winding Road to the Private Securities
Litigation Reform Act of 1995’ (1996) 51 Bus. Law, 335.
168 Private Securities Litigation Reform Act (PSLRA) 1995, § 78u-4(b)(2)(A).; Ernst & Ernst v. Hochfelder
[1976] 425 U.S. 185, 193; Tellabs, Inc. v. Makor Issues & Rights Ltd. [2007] 551 U.S. 308, 324.
169 PSLRA § 78u-4(b)(4); Dura Pharm., Inc. v. Broudo [2005] 544 U.S. 336, 345.
170 Taku Yoichiro, ‘Crowd-funding: Its Practical Effects May Be Unclear until SEC Rulemaking Is Complete’
(2012) Bus. L. Today, 3.

29
Chapter 5: Comparative review
Chapters 3 and 4 of this paper looked into the approaches taken by three European
countries and the United States towards regulating crowd-investing activities and solving the
issue of investor protection. In order to investigate their similarities and differences, the
present chapter will conduct a comparative review between the discussed jurisdictions
pertaining to crowd-funder protection based upon five key areas developed through studying
them. Each area of comparison will be discussed in a separate section to follow in the present
chapter and in its end the identified similarities and differences will be presented.
5.1. Imposition of investment caps on crowd-funders
The imposition of investment caps on crowd-funders represents an important
regulatory measure aimed at risk-diversification. It serves to protect investors from losing all
their money in early-stage investing and therefore restricts them to investing only a
percentage of their wealth depending on their net income.
Only the UK among the three examined European regimes has introduced a rule
restricting retail investors to investing up to 10% of their net financial wealth in order to off-
set potential losses. France has introduced an investment cap for participants in the loan-based
model of crowd-funding, while Italy has decided to disregard including such a measure in its
legislation at all. The proposed crowd-investing legislation in the United States contains a
notable provision imposing investment caps on crowd-funders depending on their net annual
income - if less than $100.000, the investment in an offering cannot go beyond 5% of that
income and be no greater than $2000; if equal to or exceeding $100.000, an investment can be
up to 10% of the annual income and no more than $100.000.
5.2. Requirements for equity crowd-funding intermediaries
The next key area of comparison is the requirements imposed by the discussed
jurisdictions on equity crowd-funding platforms in order to allow them to operate. This issue
is of particular significance for investors, since ensuring that crowd-funding is facilitated by
intermediaries possessing recognized competence, skills and reputation can build investor
trust and can reduce the risks. Knowledgeable platforms are capable of implementing
effective measures to prevent fraud and to protect investors.
Both the European national rules and the US rules envisage some requirements for the
intermediaries facilitating crowd-funding campaigns. In Europe, the United Kingdom has not
imposed specific competence and background requirements for platforms but merely

30
delegates the task of their monitoring to the FCA. France has introduced a separate legal
status for crowd-investing platforms, requiring them to register with ORIAS, to have
managers with background in banking or finance, who are not bad actors, to adhere to a code
of conduct and set up adequate management procedures. Platforms in Italy are required to
register with CONSOB as long as they meet specific competence and reputation criteria. The
proposed rules in the United States require crowd-funding deals to be facilitated via
intermediary, a broker-dealer or a funding portal. To be either of the two, an equity platform
is required to register with the SEC and become a member of the Financial Industry
Regulatory Authority.
5.3. Information for investors
The information required to be provided to crowd-funders by each legal system will be
compared next. The aspect of access to proper information is of huge importance for investors
due to the problem of information asymmetry existing in crowd-funding. It is therefore crucial
to assess how the European jurisdictions and the USA aim to tackle the informational
asymmetry in crowd-investing.
The three European jurisdictions have all to a certain extent imposed on platforms the
responsibility to ensure that investors are aware of the risks associated with early-stage
investments. The UK legislation requires platforms to check the knowledge of investors via
the means of an appropriateness test, while the French obliges platforms to inform investors
regarding the projects listed on their website and the risks they face by investing and to get
confirmation by investors that they realize these risks. In Italy, the task of checking and
ensuring investor readiness to participate in crowd-funding is delegated to broker-dealers who
do so by requiring investors to fill in questionnaires. In the United States crowd-funding
intermediaries are under the obligation to provide investors with disclosures and extensive
information regarding the projects they list, their owners and the risks through investor-
education materials. The proposed law moreover requires intermediaries to ensure that
investors agree to take these risks but does not specify how they have to do that.
5.4. Availability of exit rights
The availability of exit rights has significance for retail investors because it allows
them to exit an investment at any time. Lacking an exit right condemns investors to being
stuck with shares which may harm them once the particular business starts going down – a

31
situation which does not occur on a sporadic basis with start-ups, being the main ventures
listed on crowd-funding websites.
In Europe only Italy gives investors an exit right in three different situations, but
encourages them to keep their investments through tax incentives. In the United States, the
law does not allow investors to sell their investment once the funding target set by an
entrepreneur has been met unless selling to sophisticated investors or family members. This
limitation on exiting an investment lasts for one year after which an investor is allowed to sell
the purchased equity.
5.5. Dispute resolution rules
Finally, the comparison will turn to the presence of dispute resolution rules
specifically established for crowd-investing, because investors’ interests are closely knit to the
remedies made available to them by law in case their rights are infringed. Being a new
method of financing, crowd-funding may call for tailor-made dispute settlement mechanisms
corresponding to its needs.
The European countries and the USA differ concerning the last criterion of dispute
resolution rules. In Europe, the framework in France is ‘silent’ on that aspect and the UK has
only introduced specific dispute resolution rules for loan-based crowd-funding. Italy,
however, has decided to rely on arbitration for solving disputes between investors and broker-
dealers administered by CONSOB. The proposed rules on crowd-investing in the United
States give investors the right to a civil action in case of fraud or misrepresentation by issuers
or portals.
5.6. Differences and similarities identified
It appears that the US and some of the European national legislations share certain
protections accorded to crowd-funders and differ concerning others. The USA was the first to
propose a limitation on the amount an investor should be allowed to pool in a crowd-funding
project depending on his net annual income while in Europe only the UK has so far followed
this example via the so called ‘10% rule’. The legal systems differ in their approaches towards
the requirements for crowd-funding platforms. In Europe, France and Italy oblige platforms to
register with the relevant monitoring regulatory body and meet qualification criteria. In the
USA crowd-funding intermediaries must instead comply with expensive and complex
registration and membership requirements. They moreover differ with regards investors’ right
to exit since in Europe Italy gives crowd-funders an immediate right to exit their investment,

32
while the US legislation strictly forbids the immediate transfer of the investment. Another
aspect of difference is the approach towards crowd-investing dispute resolution. In Europe,
Italy is the only regime which has so far addressed this issue requiring conflicts between
investors and broker-dealers to be resolved via arbitration, while the proposed Title III of the
JOBS Act allows investors to individually bring civil action against issuers or portals. There
is unanimity among the discussed legislations, though, that intermediaries shall be responsible
for ensuring investors’ awareness of and an agreement to investment risks.

33
Chapter 6: Conclusion and Recommendations
The lack of specific regulations in the field of equity crowd-funding faces all of its
stakeholders with legal uncertainty. Governments have started encouraging crowd-investing
because of its benefits for national economies but the adopted legal frameworks differ from
each other due to the varying countries’ perceptions and preferences. The way in which one
country addresses a particular issue in its legislation may completely contradict the approach
of another country. One of the major legal problems in equity crowd-funding, protection of
crowd-funders has been selected as the focus of this paper and it aimed at investigating the
multiplicity of regulatory approaches towards solving that problem in order to assess their
similarities, differences, and the areas where improvement is required.
Regarding the strong and the weak aspects of each regulatory approach, the following
can be stated. It is positive that some European jurisdictions have enacted crowd-investing
laws and moreover that these laws offer some efficient measures for investor protection. The
biggest disadvantage of the European system is the lack of harmonization and legal certainty
in the field of equity crowd-funding, which creates a fragmented regulatory landscape
endangering investor protection and hindering the market’s development within Europe.
The US regulatory approach has some crucial drawbacks in its attempt to provide
adequate investor protection. The imposed investment caps measure on crowd-funders may
result in that wealthier investors will be able to push away the rest as they will be allowed by
law to pool larger amounts or even fund whole projects. This means that the investment cap
measure indirectly discriminates against less wealthier investors. Moreover, the proposed
legislation does not impose competence or reputation requirements on platforms before being
allowed to operate which compromises investor protection and the expertise involved in the
crowd-investing market of the USA. A huge disadvantage of the proposed US legislation is
the one-year ban on crowd-funding securities transfer, meaning that crowd-funders are faced
with a lack of liquidity in the newly emerging market, at least for a year. Finally, the
investor’s right to civil action is a strong side of the legislative proposal but unfortunately
inefficient in practice because it allows crowd-funders to claim back only the amount they
have invested – therefore small investors would prefer to let the lost amount go rather than to
bring an individual claim that would cost them more than their investment.

34
On the basis of the comparative review between the European and the US regulatory
approaches presented in Chapter 5, the following recommendations can be made towards each
of the two systems.
Investors can be protected in the most effective way in Europe if the EU harmonizes
the rules in the equity crowd-funding market. Adopting supranational legislation in the field
would help the development of crowd-investing and would bring legal certainty for all
stakeholders who will no longer need to familiarize themselves with all existing different
regimes. EU crowd-funding regulation will make the functioning of the market more
transparent as crowd-funding platforms will need to abide to the same set of rules rather than
having a different status in each member state. The EU has headed towards harmonizing the
crowd-investing market as it currently monitors its developments and added value. The Italian
legal framework can serve as a good example for the EU being the most innovative regime so
far and offering the most adequate investor protection balanced with not overly burdensome
obligations for issuers and platforms. Standardization will eliminate the barriers for investors,
entrepreneurs and platforms and allow the market to develop.
The US equity crowd-funding legislative proposal should reconsider some of its
measures. The investment cap requirement should not depend on the investor’s net income
but instead on his experience and knowledge in the investment field. Moreover, the US
legislation should impose competence and reputation requirements on platforms to ensure
their fair, transparent and professional operation. The one-year transfer restriction on crowd-
funding securities should be removed in order to encourage investors to participate in the
market and have trust in it. Finally, the provision giving investors the right to civil action
should be amended to allow them to recover only the invested amount in case where it
outweighs the costs of bringing an individual claim. For all other cases the provision should
refer to the right to initiate a securities fraud class action under the PSLRA, which on its side
should introduce an exemption from its strict pleading restrictions for equity crowd-funding.
As a final recommendation, both the European and the US systems should
acknowledge that educated investors are the key to achieving the highest gains for both
entrepreneurs and investors. The aim of crowd-investing laws should be to crate sustainable
value and for that purpose legislators should encourage traditional funders to guide crowd-
funders and educate them. One way to do so could be an educative program for crowd-

35
funders and professional investors combined with guidance by angels, venture funds and
banks sharing their investment knowledge with crowd-investors via the platforms’ websites.
Regulating a fast-growing risky market at an early stage is crucial for its survival.
Crowd-investing is not a traditional financing method and as such should not just be placed
within the existing frameworks. It needs specific legislation, addressing the needs of all
stakeholders in order to achieve its purpose. All parties involved in equity crowd-funding
would benefit from specific regulations in the field, but the biggest stake is for the general
public member, who now gets the chance to pool his money in promising business ideas and
become an investor. He needs protections at an early stage in order to become educated, learn
the industry and trust the market. Therefore, governments drafting equity crowd-funding laws
should aim at striking balance between the overall idea of unpacking new capital for early-
stage businesses and protecting investors from the crowd.

36
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