New Technology, But Just the Same Old Traditional Fraud

This article was originally published in the April 2019 edition of the NAGTRI Center for Consumer Protection Monthly newsletter.

Crowdfunding has fast entered many people’s lexicons in the past ten years. It has grown from a $2.7 billion market in 2012 to a $34.4 billion market in 2015 and is predicted to have a $300 billion potential by 2025.¹ Crowdfunding is the practice of funding a project or business idea by raising small amounts of money from a large number of people, typically via the Internet. Crowdfunding has been used to fund a wide variety of activities, from new business ideas—be it goods or services—to disaster relief or political campaigns. A crowdfunding campaign typically involves a platform, creator(s), and backers. The “platform” is the website or organization that hosts or facilitates the crowdfunding campaigns. The “creator” is the person or business that creates the campaign. The “backers” are the people who pay or donate the small amounts of money to fund a campaign.

Crowdfunding comes in three common forms: (1) donation-based crowdfunding platforms² that are typically designed for charities or those raising money for a personal cause; (2) reward-based crowdfunding platforms³ that promises the backers a particular “reward” for funding the creator’s campaign; and (3) debt and equity crowdfunding, where the backer receives a financial interest for their investment.

All three types of crowdfunding have two similarities. First, each type typically provides little information and few disclosures in their campaigns. Second, this low threshold for information makes crowdfunding platforms fertile ground for fraudulent schemes. Donation-based crowdfunding schemes have led to criminal convictions where, for example, individuals raised money using a made-up homeless veteran story,⁴ faked a child’s death for a campaign to raise money for the boy’s bucket list,⁵ and claimed to have a fraudulent neurological disorder to raise more than $126,000.⁶ Similarly, reward-based crowdfunding fraud has also led to lawsuits brought by the FTC⁷ and attorneys general offices.⁸ These regulatory authorities brought actions alleging that the creator of a campaign used deceptive methods to raise money and either delivered defective goods or didn’t deliver any goods. In many cases, individuals in deceptive campaigns are found to have spent the funds on themselves and not on the campaigns. Lastly, debt and equity crowdfunding has led the SEC to bring actions against crowdfunding companies like iFunding LLC⁹ and companies that fraudulently used crowdfunding for initial coin offerings.¹⁰

While debt and equity crowdfunding has at least been lightly regulated by Title III of the JOBS Act¹¹ and traditional securities regulations,¹² reward crowdfunding is still largely unregulated. Crowdfunding platforms provide little in the way of consumer protections themselves.¹³ Scams and frauds have become so normalized that websites have popped up that track crowdfunding scams, such as “kickscammed.com,” that plays off Kickstarter’s website and attempts to track the amounts of active crowdfunding scams.¹⁴ Kickstarter is the largest reward based crowdfunding website: as of April 2019, funds pledged to Kickstarter campaigns alone exceeded $4.2 billion. Meanwhile, this type of crowdfunding has been consistently growing as a marketing tool for new and small businesses. For example, many completed campaigns on Kickstarter and other similar sites such as Indiegogo feature links to websites to further promote additional donations and businesses.

It is important that state attorneys general continue to monitor and apply consumer laws to this relatively unregulated space. Despite the new terminology like “creator,” “backer,” and “rewards” – the underlying transaction often remains a consumer transaction under state UDAP laws. The reward promised to a backer supporting a campaign is the good or service developed by the creator of the campaign.

Crowdfunding fraud can be approached by attorneys general using states’ traditional consumer protection statutes. For example, in 2017, the District of Columbia brought a case against a company called Sivil. Sivil marketed and offered consumers athletic apparel in a reward-based crowdfunding scheme. Sivil offered consumers who paid more than $35 to the campaign performance athletic shirts. The Sivil campaign raised $284,028 from 3,676 consumers, with 3,626 (or 98.6%) consumers paying $35 or more. The Sivil campaign ended and was fully funded. Sivil received consumers’ funds from Kickstarter. However, no shirts were ever delivered. Sivil kept promising consumers that production had started and that various issues were slowing delivery. Eventually consumers flooded the District of Columbia Attorney General’s consumer protection hotline and the office issued a subpoena to Sivil. Documents obtained showed that of the $284,028 raised from consumers to ostensibly manufacturer shirts, Sivil’s owner spent most of it on unrelated businesses or himself. Over 56% of the funds were spent on expenses unrelated to the business, and not one athletic shirt was ever manufactured. Meanwhile, Sivil made misrepresentations to consumers from the beginning of the campaign up until the District initiated its case.¹⁵ The District obtained summary judgment against Sivil and received full restitution for each consumer, civil penalties, and the costs of the investigation and law enforcement action. [Note 16]Id. at *6-7.¹⁶

Reward crowdfunding, at its core, is a marketing tool for companies to market their goods or services on the Internet and take payment at the same time. Just like any other business, promises made in advertisements—be it in person, in writing, or on a crowdfunding website—must not be misleading. If they are, they should be investigated and prosecuted like any other traditional marketing or misrepresentation case.

Crowdfunding campaigns are often popularized and promoted through social media and the Internet, so they often impact consumers nationally. Approaching these new methods of fraud through a consumer protection lens has proven to be effective. While the FTC has been prosecuting large-scale fraudulent crowdfunding campaigns, it is important that attorneys general also utilize their states’ consumer protection statutes to combat these fraudulent campaigns and assess whether seemingly unsuccessful campaigns are in fact fraud.

Endnotes

1. See Dominika P. Galkiericz & Michael Galkiewicz, Crowdfunding Monitor 2018: An Overview of European Projects Financed on Startnext and Kisckstarter Platforms between 2010 and mid-2017 14 (2018), https://www.fh-kufstein.ac.at/content/download/3537648/file/Crowdfunding_Monitor_2018.pdf.; Fundly, Crowdfunding Statistics [Updated for 2017], https://blog.fundly.com/crowdfunding-statistics/ (last visited Apr. 11, 2019) (predicting the growth of crowdfunding); Massolution, 2015CF: The Crowdfunding Industry Report, (2015), http://www.smv.gob.pe/Biblioteca/temp/catalogacion/C8789.pdf. [↩]
2. See Go Fund Me, www.gofundme.com (last visited Apr. 11, 2019); LexShares, https://www.lexshares.com/ (last visited Apr. 11, 2019) (offering crowdfunding for commercial litigation). [↩]
3. See Kickstarter, www.kickstarter.com (last visited Apr. 11, 2019); IndeGoGo, www.indegogo.com (last visited Apr. 11, 2019). [↩]
4. KC Baker, Homeless Man and N.J. Woman Who Bilked $400,000 in GoFundMe Donations with Fake Story Plead Guilty, People (Mar. 7, 2019), https://people.com/crime/homeless-man-new-jersey-woman-gofundme-scam-plead-guilty/. [↩]
5. Scott Sonner, Nevada woman accused of faking son’s illness, death for money, Las Vegas Rev.-J. (Apr. 19, 2017, 7:18 PM), https://www.reviewjournal.com/local/local-nevada/nevada-woman-accused-of-faking-sons-illness-death-for-money/. [↩]
6. Kendra Mangione, Fraud charge for woman accused of faking illness to raise money, CTV News Toronto (May 7, 2015), https://toronto.ctvnews.ca/fraud-charge-for-woman-accused-of-faking-illness-to-raise-money-1.2363579. [↩]
7. Press Release, FTC, Crowdfunding Project Creator Settles FTC Charges of Deception (June 11, 2015) (https://www.ftc.gov/news-events/press-releases/2015/06/crowdfunding-project-creator-settles-ftc-charges-deception).  [↩]
8. See Press Release, Off. of the Att’y Gen. for the D.C., Attorney General Racine Files Suit against Company that Abused Kickstarter to Raise Personal Funds (Dec. 19, 2017) (on file with author); Press Release, Off. of the Att’y Gen. for the Commonwealth of Pa., Attorney General Shapiro Announces Settlement in Kickstarter Consumer Scam T-Shirt Case (Apr. 24, 2017) (on file with author); Press Release, Wash. St. Off. of the Att’y Gen., AG makes crowdfunded company pay for shady deal (July 27, 2015) (on file with author).  [↩]
9. Litigation Release, SEC, SEC Charges Founders of a Real Estate Crowdfunding Portal with Fraud (Sept. 26, 2018) (on file with author).  [↩]
10. Litigation Release, SEC, SEC Obtains Preliminary Injunction in Fraudulent Coin Offering Scheme (June 7, 2018) (on file with author).  [↩]
11. Jumpstart Our Business Startups Act, 112 P.L. 106, 126 Stat. 306, 315-26 (2012). [↩]
12. See SEC, Regulation Crowdfunding, https://www.sec.gov/smallbusiness/exemptofferings/regcrowdfunding (last visited Apr. 11, 2019). [↩]
13. See Rick Cohen, The Feds Take Action against Crowdfunding Fraud, and It’s About Time!, Nonprofit Quarterly (July 2, 2015), https://nonprofitquarterly.org/2015/07/02/the-feds-take-action-against-crowdfunding-fraud-and-its-about-time/ (stating how the backers are the real protectors of integrity as opposed to the automated systems Kickstarter has in place).  [↩]
14. KickScammed, http://kickscammed.com/ (last visited Apr. 11, 2019). [↩]
15. Pl’s Statement of Facts in Supp. of Mot. for Summ. J. at 10, District of Columbia v. Sivil, Inc., 2019 D.C. Super. LEXIS 2 (D.C. Super. Ct. Jan. 25, 2019) (“[Sivil] ha[s] used 0% of the Kickstarter funds for personal use”; (2) everything [was] being produced and [would] be shipped ASAP”; and (3) “every dime has [gone] towards creating a shirt that [Sivil] always planned on creating”). [↩]
16. Id. at *6-7. [↩]