In March of this year, the Financial Ombudsman ordered an investment-based Crowdfunding platform to repay a customer his investment on the basis that they had not provided enough information surrounding the details of the investment. This article explores that decision and outlines what measures might be taken by a platform to prevent similar findings.
The Platform was and is a well-regarded, market-leading investment-based crowdfunding platform that promotes investment by way of pitches. Prospective investors can view information about a business and the details of the investment in these pitches on the Platform before deciding whether to invest. In return for their investment, they receive shares in the business.
The Investor made an investment in a food takeaway company (Company Z) via the Platform in 2016. The Investor invested around £18,000 in Company Z during this fundraising round. As Company Z substantially surpassed its initial £500,000 target, the round successfully closed in January 2018, and he was allocated shares.
Company Z entered into creditors’ voluntary liquidation, following a winding-up resolution passed by Company Z’s members in May 2020.
Prior to the liquidation, the Investor had requested that Company Z buy back his shares for the same price. He was not happy that Company Z had spent the investment in the manner they had outlined and he maintained that the information provided prior to the investment was misleading. Company Z refused to buy back his shares.
The Investor’s chief complaint was that Company Z did not use the funds raised to open new additional stores. The Investor complained that the information provided on the Platform led him to legitimately believe that the funds raised would be used to open new sites.
As company Z was not regulated by the FCA and had since been placed into liquidation, the Investor raised a complaint against the Platform and requested that they refund him his investment.
The Ombudsman assessed what was fair and reasonable in all the circumstances of the complaint and made the following key observations and comments:
“Having grown from 2 sites to 4 since their last round on [Platform], [Company Z is] revolutionising the…takeout industry through its takeaway only locations with rapid delivery and custom technology. Now raising funds for further expansion.”The Ombudsman found that the “pitch provided no further clarification regarding what further expansion for [Company Z] entailed”.
To determine whether the Platform had adhered to its regulatory obligations, the Ombudsman referred to the FCA’s consultation paper on loan-based (‘peer-to-peer’) and investment-based crowdfunding platforms for guidance. In this, the FCA explained:
“It is our view that it will be unlikely that a platform could argue that it has met its obligations under Principle 2, Principle 6 (PRIN 2.1.1R) and the client’s best interests rule (COBS 2.1.1R) if it has not undertaken enough due diligence to satisfy itself on the essential information on which any communication or promotion is based.”
The Ombudsman interpreted this to mean that the Platform had to satisfy itself on the essential information on which the promotion (pitch) of Company Z was based.
The Ombudsman also drew attention to the FCA’s statement in the Consultation Paper regarding future commercial success, which explained that:
“In relation to statements about future commercial success, this should include at least a basic plausibility check. For example, if a borrower says it is going to build a block of flats within 6 months but it does not have the relevant construction permissions, it would seem reasonable for a platform to question the plausibility of the project.”
On this point, the Ombudsman noted that the phrase “further expansion” was a statement about future commercial success. As such, the Platform should have conducted a plausibility check on this.
The Ombudsman noted that the particular due diligence process a platform should perform was not specified, nor was a set minimum standard of due diligence prescribed. The FCA recognised this in its March 2014 publication on the regulatory approach to crowdfunding over the internet, and the promotion of non-readily realisable securities by other media. However, the FCA did advise that:
“Promotions will need to ensure that they comply with the rules, particularly the requirement for the promotion to be fair, clear and not misleading.
In satisfying the financial promotion rules we expect sufficient detail to be provided to give a balanced indication of the benefits and the risk involved, including whether or not any due diligence has been carried out on an investee company, the extent of the due diligence, and the outcome of any analysis.”
The Ombudsman interpreted this to mean that although there is no specifically prescribed amount of due diligence a platform should perform, it was clear that in order to comply with the fair, clear and not misleading requirement, the Platform needed to make the Investor aware of the extent of which it performed due diligence on Company Z. It should have let the Investor know that outcome of any due diligence carried out on an investee company, and the diligence required to be sufficiently detailed to allow the Investor to weigh up the risks and benefits in investing in Company Z.
The FCA has since published its policy statement and new rules following the Consultation Paper. However, they provide little further guidance with respect to a situation such as this.
There are a number of lessons from this decision that may be useful to Crowdfunding platforms:
The full decision can be found at www.financial-ombudsman.org.uk/files/301390/DRN7590473.pdf. This article has tried to summarise the key aspects of the decision. It is worth nothing that the Platform cooperated fully and, it was clear, had tried to comply with the regulation to the best of its understanding; to that extent the Platform was unlucky, as the guidance on these issues is still fledgling, and still being fleshed out. The result is, as the Platform found, that the guidance is not always clear and can result in unanticipated interpretations.