1 | P a g e

Title: Crowdfunding: The New Face of Financial Crimes?

Sherrie Sessoms

Table of Contents Introduction ........................................................................................................................................... 2

What is Crowdfunding? ........................................................................................................................ 2

A. History of Crowdfunding: ............................................................................................. 3

Crowdfunding Models ........................................................................................................................... 4

A. Key Players in Crowdfunding ....................................................................................... 5

B. How a Crowdfunding Platform Works .......................................................................... 5

C. The Crowdfunding Process ........................................................................................... 6

D. Popular Crowdfunding Platforms .................................................................................. 6

Advantages and Disadvantages of Raising Funds through Crowdfunding ......................................... 7

Rules and Regulations ........................................................................................................................... 9

Potential Risks Associated with Crowdfunding.................................................................................. 12

A. Fraud Risk .................................................................................................................. 12

B. Money Laundering Risk .............................................................................................. 14

C. Terrorist Financing Risk ............................................................................................. 15

D. Case Examples............................................................................................................ 16

Conclusion ........................................................................................................................................... 17

Works Cited ......................................................................................................................................... 19

2 | P a g e

Introduction

When was the last time you had an idea that you thought would revolutionize the world as we

know it? Have you ever wondered how people get loans or funding for their ideas, start-up

businesses, charities, and even personal hospital bills or projects? Is your credit not so good so

you can’t get a traditional loan? Want an untraditional and more convenient way to get those funds

you need to make your idea a reality or to get your new business started? In today’s world, the

Internet and technology has drastically altered the manner by which individuals and companies get

their thoughts and ideas presented before large groups of people who may be willing to contribute

or invest to help make their dreams come to life or help them through troubling times. This,

therefore, bypasses traditional funding by a financial institution (FI). Is this safe for a consumer

or investor? How does this affect the financial industry? This paper will discuss the process of

crowdfunding and its advantages and disadvantages for a consumer/investor. It will also assess

the potential risk it poses to the FIs when utilized as a tool to commit money laundering, terrorist

financing, fraud, and other financial crimes, in order to gather a better understanding of how best

to identify this type of activity in an effort to minimize risk.

What is Crowdfunding?

What is crowdfunding? The term itself is very confounding without a doubt and remains a riddle

to most and due to its many variations is hard to clearly define. However, for the purpose of this

paper, crowdfunding is defined as the demonstration and procedure of raising expansive amounts

of cash, funding or financing from numerous people who are interacting via the internet in online

consumer communities. It is becoming one of the main avenues for individuals, small businesses

and visionaries around the world to raise capital online for various ideas and projects. It has

become an alternative to the typical and traditional financing means we’ve known in the past.

Customarily, an entrepreneur, per say, would invest months filtering through their own systems,

reviewing potential backers, and investing their own energy and cash to get before them. In the

past they would have needed to compile their strategy or business plan, complete their marketing

research, create their prototypes and then pitch their idea to a limited pool of wealthy people or

organizations including banks and various investment firms, truly constraining their options for

funding. Today, crowdfunding is regularly conducted by means of internet based registries

(websites), also known as “crowdfunding platforms” and is perfectly legal.

Crowdfunding platforms make things simpler by providing an entrepreneur a single platform to

fabricate, showcase, and pitch their idea and significantly streamlines the conventional model

making it much less demanding for them to get their chance before more invested individuals and

give them more approaches to develop their business.

3 | P a g e

History of crowdfunding:

Although “crowdfunding” may seem to be only a couple of years old, it is exploding as another

method for pulling in subsidizing and financing for individuals, small organizations and business

visionaries around the globe and appears to be a cutting edge development as it is vigorously reliant

on innovation, it has been a part of history for centuries, definitely long before the presence of the

Internet. In spite of the fact that mainstream banks have held influence over financial services

throughout the last 200 years, look back and you can track the historical backdrop of crowdfunding

to as far back as scriptural times. Long before Internet-based crowdfunding as we know it,

neighbors loaned to neighbors. Towns and communities would come together and consolidate

funds to finance the things they required. In fact, the foundation to hold the Statue of Liberty was

somewhat financed and constructed in 1885 with funds derived from donations from various

American and French people, a campaign which was organized by Joseph Pulitzer by utilizing his

daily newspaper, The New York World; but the first examples of modern day crowdfunding can

be observed in the mid to late 90s when Internet-based campaign funded projects and charity

crowdfunding platforms began to pop up. In 1997, the rock band Marillion, who had scheduled a

European tour to support their newest album, announced on the Internet that they would not be

traveling to the United States due to a lack of funding. The band’s fans joined together and raised

more than $60,000, allowing the band to complete its tour. The Internet and social networking

sites enabled the creation of crowdfunding platforms that are revolutionizing entire industries by

promoting and hosting the meeting of would-be lenders, investors and supporters with aspiring

artists, innovators and entrepreneurs and serving as the megaphone to catapult a simple product,

idea, or venture into an internationally acclaimed, must have, must follow, icon.

Acquiring financing from an “alternative” source is intriguing since what we now perceive as the

“sharing economy” is not all that new by any stretch of the imagination. “Alternative” financing

sources are a return to our roots, enhanced with new technology advancements to get more people

involved.

4 | P a g e

Crowdfunding Models

Crowdfunding is typically categorized into one of the following:

A. Equity – equity-based crowdfunding is asking a large crowd of backers who are looking

to own a piece of the pie in a current or up-and-coming privately=owned business to donate

(a minimum of at least $1,000, but normally quite a bit more) to your business or project

in exchange for equity for a lower than average fee.

B. Donation or Reward – donation- or reward-based crowdfunding is asking a crowd to

donate (usually, but not limited to, between $1 and $1,000) to your project in exchange for

tangible, non-monetary rewards such as memorabilia including but not limited to t-shirts,

cups, thank you notes, film, artwork, pre-released music CD, or other finished products,

and, in some cases, nothing other than simple gratitude. This type of crowdfunding is

typically categorized as “all or nothing aka fixed” or “keep what you raised aka flexible.”

The “all or nothing” requires the campaign initiator to meet the fundraising goal they set

at the time of inception before their campaign ends; and the “keep what you raised” allows

the campaign initiator to keep any amount of funds raised no matter their original goal or

date set for campaign deadline.

C. Lending (Peer-to-peer) or Debt – lending- or debt-based crowdfunding is borrowing

funds for your business or project, at a lower interest rate, from a crowd of people versus a

bank. In exchange for their funds, backers receive a financial return, repayment or interest

5 | P a g e

rate higher than the return they would receive on a savings account or other more traditional

investments.

Key Players in crowdfunding

The crowdfunding model depends on three sorts of performers: the initiator who comes up with

the campaign project or event; groups of individuals, donors or investors (all also known as

backers) who are in support of the idea in exchange for a reward or financial return; and an

intermediary or moderator (aka the “platform (funding portal) or a traditional broker-dealer”) who

brings everyone together to launch the campaign. For a transaction conducted via crowdfunding

the essential contact between the campaign initiator and backers is facilitated by the funding portal;

however, the back office exchange of funds is directed by a bank or qualified third party.

How a Crowdfunding Platform Works

Various opinions indicate that a crowdfunding platform will work comparably for both an

individual and an organization. That being said, to start, I’ll layout the general crowdfunding

process and steps in creating a campaign.

Step 1: Pick your platform(s)

set measurable goals

decide a reasonable time frame

determine your targeted audience, starting with having a small group of eager

family/friends willing to donate or invest, promote and urge others to do the same

Step 2: Create a fundraiser profile to include:

6 | P a g e

a short and concise video pitch

a presentation or outline of the project

a list of rewards for levels of donations/investments

relevant photos

Step 3: Once the profile is created, the importance revolves around promoting; including creating

a compelling and irresistible message that intrigues backers and keeps them interested and

contributing to the cause.

Popular Crowdfunding Platforms

7 | P a g e

Kickstarter – is an “all or nothing” platform that targets the consumer audience and the site makes

a 5 percent commission on the amount of funds raised in addition to the 3 to 5 percent the financial

institution processing the payments takes.

Indiegogo – is both an “all or nothing” and “keep what you raised” platform with no specific

audience target; however, the fees vary depending on if the campaign initiator meets their targeted

goal or not. Although the set commission for both is approximately 4 percent, the fee if they don’t

meet their goal increases substantially, to approximately 9 percent of the funds raised.

GoFundMe – is an “all or nothing” platform that targets the consumer audience and the site makes

a 5 percent commission of the amount of funds raised in addition to the 2 to 3 percent the financial

institution processing the payments takes.

EquityNet – is more focused on industry, targeting backers in various areas including but not

limited to computer software, healthcare, and biotechnology. They don’t benefit from charging

fees to raise the funds but operate as a subscription service where the campaign initiator pays them

a pre-determined monthly fee for their services.

RocketHub – is a “keep what you raised” platform that targets projects specific to science, art and

business, and the site makes a 4 percent commission, in addition to a 4 percent credit card handling

fee; however, the commission and credit card service fees increase to 8 percent if the goal is not

met. An interesting fact about RocketHub is they teamed up with the A&E television network for

its project startup.

LendingClub – is a loan-based crowdfunding platform that targets both borrowers and backers,

globally, allowing funds to be loaned between individuals without the use of a bank. A one-time

processing fee ranging from 1.11% to 5.00% of the loan amount is charged to the borrower; in

addition to approximately a 1% service fee charged to backers for each payment they receive as

repayment of the loan.

Although these are some of your more popular, more traditional crowdfunding platforms, there are

many more. In addition, there are also some popular social media apps that are being utilized for

crowdfunding due to evolving technology, Twitter and Facebook. Both are ideal for crowdfunding

if utilized correctly as a result of their global span and speed with which news can travel. What

should be known and stressed is that the companies providing these social networks themselves

are not participants in the illegal activities and most times work with the authorities by allowing

access to data related to the crime and work to freeze or close accounts that are pivotal for the

dispersal of terrorist funds?.

Advantages and Disadvantages of Raising Funds through Crowdfunding

8 | P a g e

If you are contemplating raising equity for a business you presently have, or a new business or

project you might be considering raising funds through crowdfunding, there are some advantages

and disadvantages that should play a valuable part in your decision. It’s important to mention the

fact that not all crowdfunding is regulated; donation and reward based crowdfunding are not

regulated; loan (peer-to-peer) and equity based crowdfunding are regulated by the Jumpstart Our

Business Startups Act (“JOBS Act”). The JOBS Act is described below.

Advantages of crowdfunding include:

It can be a quick approach to raise money with no forthright expenses

Pitching an idea for a business or any project through crowdfunding can be a significant

tool in promoting it

Sharing your idea, can get you advice and opinions from subject matter experts on the most

proficient method to enhance it

It is a great way to get the opinions of the public as they relate to your thoughts and ideas

and if people and businesses are eager to contribute, the chances that your idea or project

could function admirably in the business sector is increased

Backers can keep tabs on your development - this may help you to advance your image

through their systems

Ideas that may not speak to ordinary financial specialists can regularly get financed all the

more effortlessly

Your backers can frequently turn into your most faithful clients through the financing

procedure

It's an alternative financial avenue that can be utilized in the event that previous attempts

to get funding through the traditional methods have failed

Disadvantages of crowdfunding include:

The process is not guaranteed to be simpler and less demanding than those of tradition –

not all ideas, projects and ventures will be approved for a crowdfunding campaign

When you are approved by your platform of choice, you have to do a considerable amount

of work and marketing to build and increase enthusiasm before your project is launched –

lots of cash and/or time might be required

If you don't achieve the measureable goals you set, any funds that have been donated or

invested will as a rule be returned to the interested parties and you will get nothing

Failed crowdfunding campaigns may cause reputational damage to the notoriety of your

business and individuals who have donated or invested their cash in your idea

If you haven't ensured your business thought with a patent or copyright, somebody may

see it on a crowdfunding site and take your idea

9 | P a g e

Rules and Regulations

Business pioneers and reporters have observed for quite a while that the regulatory requirements

to be met with a specific end goal to back organizations in the United States have turned out to be

excessively oppressive and a demoralized enterprise. In the fallout of the financial crisis of 2008,

national attention moved to job creation and the reaction against over regulation as a result of the

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. As a result, the Jumpstart

Our Business Startups (JOBS) Act, passed with bipartisan support, was signed into law on April

5, 2012 by President Barack Obama and Title I was effective immediately. The JOBS Act is a law

intended to support funding to small businesses in the United States by easing numerous securities

regulations. Although the JOBS Act is comprised of Title I (Reopening American Capital Markets

to Emerging Growth Companies), Title II (Access to Capital for Job Creators), Title III

(Crowdfunding), Title IV (Small Company Capital Formation), Title V (Private Company

Flexibility and Growth), Title VI (Capital Expansion), and Title VII (Outreach On Changes to the

Law or Commission); it is regularly used to refer specifically to just Titles II and III of the

legislation which are the two most vital pieces to much of the equity crowdfunding and startup

groups. The JOBS Act incorporates various measures to facilitate capital formation, including:

An initial public offering (IPO) entrance ramp for another classification of backer,

“emerging growth companies.”

Removal of the restriction(s) against general sales and general promoting in certain private

positions.

A new exception under the Securities Act of 1933, as altered (Securities Act) for

crowdfunding offerings. The Securities Act, often referred to as the “truth in securities

law”, is a law upon which the current financial regulator system is based, requiring backers

to receive any significant or financial information about corporations’ securities offerings.

An amendment to the Securities Act (casually alluded to as Regulation A+) allowing

organizations to lead offerings to raise up to $50 million through a “smaller than normal

enlistment” process like Regulation A+.

Higher triggering limits for Securities and Exchange Commission reporting commitments

under the Securities Exchange Act of 1934 (Exchange Act), a law governing the secondary

trading of securities in the United States.

Title I had a stated objective of “improving access to public capital markets for emerging growth

companies (EGCS).” EGCS are defined backers with aggregate gross revenues of under $1 billion

amid its most recent completed fiscal year (subject to inflationary modification by the SEC every

five years) that has not sold its basic stock in an SEC registered offering before December 8, 2011.

To urge these companies to go public and address a concerning drop-off in IPOs, Congress made

an IPO “on-ramp” for ECGS by unwinding the administrative revelation prerequisites for going

public, thereby minimizing critical legal and bookkeeping costs. Also ECGS may submit

preliminary draft registrations for private, non-public review by the SEC.

10 | P a g e

According to Citi, ECGS have represented 86 percent of IPOs in 2015 compared to 66 percent of

IPOs in 2014, as indicated by another study

Title II of the JOBS Act was the first form of crowdfunding and was officially passed in September

2013, with the plan to make it simpler for new companies and small organizations to raise capital

through the sale of securities. These EGCS looking to raise the capital through the sale of securities

must either register the offering with the SEC, or depend on being excluded from registering. Most

exemptions from registration prevent the general sales (for example, promoting in the daily paper,

on the web, and so on) and require sales to accredited (wealthy) investors only. The act defines

an accredited investor as any individual who has either total assets of $1,000,000 (your primary

residence can’t be incorporated into this amount), or who made in excess of $200,000 a year for

the three years prior to their present securities purchase and have documentation to support the

fact. So, although Title II places hefty restrictions on general solicitation and who can purchase

the securities offered, it requires the SEC to lift the noteworthy restriction on public solicitation,

and allows the company to utilize “general solicitation” for marketing provided they follow all

rules and regulations relating to Rule 506 of Regulation D. This narrows the ECGS’ investment

pool marginally, however the possibility to reach more backers in a short period of time

considerably outweighs the negative and includes no limitations on the number of backers or on

the amount of capital that can be raised under this exemption.

According to a study by Crowdnetic, for the first two years, there have been more than 6,000

securities offerings directed under Title II, with recorded funding pledges of $870 million;

however, there is no way of tracking what amount of those funds were successfully raised.

Title III was adopted in October 2015 and took effect May 16, 2016 and has gained considerable

amounts of attention and is considered the most revolutionary provision as it permits a company

to make security offerings to non-accredited backers. This allows all Americans, regardless of

wealth, to invest in privately owned companies more easily for the first time in 80 years. The

public has been waiting on this for the last several years as the SEC continuously stalled in

finalizing rules to permit non-accredited backers to come into the business sector and invest in

ECGS. It sets the stage and allows crowdfunding to continue to grow exponentially over the next

three to five years, in addition to the existing market for accredited investors. In theory, this would

permit a company to solicit an uncapped number of backers from the general public to meet their

fundraising objectives. That might be music to the ears of hungry ECGS excited to disrupt

conventional investing, yet there is some fine print to consider and critics argue that it has the

potential to expose naïve and vulnerable backers to fraud and other undue risk. Others however,

think that the critics’ attitudes are patronizing. They feel that individual backers can make

informed decisions and on the off chance that an ECGS is soliciting non-accredited backers, then

they have a cap of $1,000,000 in a 12-month time frame on the amount of capital that can be raised

or that an individual can contribute, so that risk of losing the “farm” per say, is less likely should

the campaign fail. In the event that that amount meets the needs of the campaign, then this

exemption paves the road for a very fast approach to raising capital. If not, it can still be valuable

11 | P a g e

when utilized in conjunction with more conventional fundraising techniques; however, there are

still some restrictions to consider relating to the backers of the securities offerings. Those

restrictions include the fact that those individuals who make less than $100,000 a year can only

contribute the greater of 5 percent of their yearly income or $2,000; and individuals who make in

excess of $100,000 a year can only contribute up to 10 percent of their yearly income not to exceed

$100,000 in one year and all fund exchanges must be conducted through an intermediary that is

either registered as a broker dealer with the Financial Industry Regulatory Authority (“FINRA”)

or a funding portal. A funding portal must be registered with the SEC, and be subject to the SEC’s

examination, enforcement and rulemaking power. Additionally, for EGCS that raise in excess of

$500,000, significant disclosures in the form of financial audits are required. This can result in a

recurring cost of $10,000 each year for years. Finally, for those EGCS conducting a securities

offering, in addition to the offering documents, they are required to disclose (1) data relating to

those officers, executives and owners who possess 20 percent or more of the company, (2)

depiction of the EGCS’ business and utilization of the funds, (3) the cost for each security, the

target offering amount and if they will accept more than the target amount, (4) any related party

fund exchanges, (5) the EGCS’ current monetary wellbeing and (6) either reviewed, or audited

financials relying on the offering. This being said, there are still some EGCS who are ineligible

to utilize Title III including non-US EGCS, those companies who neglected to comply with the

annual reporting requirements amid the two years immediately following the filing of the securities

offering, and companies with no particular business plan or have disclosed that their business plan

is to take part in a merger and/or acquisition with an unidentified company.

Title III is expected to have a moderate ramp up as portals, investors and business visionaries

adjust and get used to the new law. Meanwhile, the long wait for Title III has motivated

approximately 30 states to make their own exemptions permitting crowdfunding inside their state

borders, which may offer backers a more appealing alternative.

12 | P a g e

Potential Risks Associated with Crowdfunding

Although crowdfunding has been around for centuries, in the financial world, the use of online

platforms to raise funds is fairly new and fertile territory for suspicious activities. Consequently,

rules and regulations to oversee it are still in the developmental stages and have not been clearly

defined, allowing most crowdfunding campaigns to operate with limited or no supervision to

minimize the accompanying risks associated with crowdfunding. Crowdfunding platforms do not

raise deposits and consequently, they are not regulated or supervised by the FDIC or the Federal

Reserve. Despite that the SEC is expected to regulate only equity-based crowdfunding; it is still

vague as to who will oversee the entire industry leaving the financial industry open to risks of

fraud, money laundering and terrorist financing.

As crowdfunding gets to be the standard, the potential for fraud, money laundering and terrorist

financing will increase. It appears that each new day is greeted by a scathing article or opinion

piece cautioning that we have to shield the overall population from the approaching attack of boiler

room con-artists. The risk issues of crowdfunding has transformed the process toward legitimizing

it into an exhausting, intricate and antagonistic process as regulators, industry partners and special

interests wrangle over guidelines intended to protect all unsuspecting backers.

Fraud Risk

13 | P a g e

Since crowdfunding is based on trust, it’s very susceptible to fraud. Today, initiators solicit

funding from strangers through one of the many popular platforms for various projects, ideas or

personal financial needs, and are only as good as their promises, whereas in the past, family or

friends could vouch for their credibility before committing to making a contribution.

Unfortunately, those promises today don’t always deliver.

Fraud through crowdfunding occurs when:

A crowdfunding campaign solicits or accepts funding from backers while deliberately and

deceptively concealing or misrepresenting the true nature of the project and the expected

results.

Backers commit to financing a project, business or cause with all intents of canceling and

backing out of the campaign or to extract returns not offered to other backers.

An intermediary attempts to help or participate in the above behaviors, or purposely

neglects to complete the transactions.

An initiator launches multiple one-day campaigns that are tied to the same deposit account.

Then the campaigns are funded from the same IP address by numerous stolen credit cards

and the funds are then moved to the deposit account.

Because of the nature of crowdfunding fraud and the difficulties and troubles in proving particular

cases, the crowdfunding industry may require an alternative taxonomy to describe various

situations that emerge in crowdfunding campaigns. As a result of a survey conducted by

Crowdfund Insider’s, a leading online news and information site that covers the ever changing

worldwide industry of problematic finance, relating to 30-40 possible fraud cases that they state

fall into a gray area based on disputed facts and or claims, the following taxonomy of fraud in the

context of crowdfunding has been recommended:

Preempted Fraud – In “preempted fraud”, a crowdfunding campaign with

suspicious qualities is shut down by the platform before any funds are exchanged.

The observation and monitoring of these campaigns are often done by members of

the site (many of whom observe only and make no contributions or investments).

These observers alert platform administrators of any suspicious or unusual

discussions they witness on various public forums and social media sites resulting

in the platform shutting down the campaign and protecting the backers.

Stillborn Fraud – “Stillborn fraud” happens when a campaign is filtered out and

dismissed by the platform before it’s ever launched, possibly for a variety of

reasons including but not limited to technical errors, deficiency, or those that

convey a risk of fraud.

Attempted Fraud – “Attempted fraud” occurs when a crowdfunding campaign

utilizes an internet protocol (IP) address, among other information, not belonging

to them, meaning they may have used a copyrighted IP.

14 | P a g e

Perceived Fraud – the genesis of “perceived fraud” begins when the promised

perks and rewards from contributing to a campaign are drastically delayed or not

delivered at all.

Backer fraud – “Backer fraud” occurs when a contributor, donor or investor who

has committed to funding a campaign deliberately does so with the intent of

withholding those funds or filing a claim to have their funds returned.

Broker/Portal Fraud – “Broker/portal fraud” occurs when the crowdfunding

platform operators are involved with fraud or enable the fraud.

Money Laundering Risk

The Financial Crimes Enforcement Network (“FinCEN”) Suspicious Activity Report (SAR) Stats

Technical Bulletin of October 2015, states that SARs filed based on illicit financial activity related

to crowdfunding are minimal but have increased since the first ones regarding rewards-based

crowdfunding were submitted and recorded in 2012, followed by 14 such filings in 2013, 25 filings

in 2014 and 38 through mid-2015 representing a 171 percent increase over all since 2013. Wide

availability, usability and minimal fraud controls can make rewards-based crowdfunding platforms

defenseless to financial abuse. SAR review and analysis shows crowdfunding platforms being

utilized as a layering and comingling tool in money laundering, typically prior to the funds being

withdrawn or moved further through the financial system.

Since crowdfunding is primarily an internet marvel, this additionally implies that there is a better

chance of money laundering and terrorist financing due to the anonymity that the web offers and

its worldwide scope. In any case, to exploit the lower costs connected with technology, most

platforms work exclusively through an internet portal or website with practically no protection.

The platforms creators need to guarantee that they have sufficient technical capacity and expertise

to conduct customer due diligence on initiators and backers alike. The platform creators should

also offer data transparency in regards to information on their officers, executives and owners to

counteract potential conflicts of interest. This would require that the platform implement KYC

and sanctions screening policies and procedures. In addition, they could utilize or become a

licensed payment service provider (“PSP”), typically a bank which is subject to an Anti-Money

Laundering (“AML”) under the Payment Services Directive (“PSD”), in order to process monetary

exchanges amongst initiators and backers. Shockingly, there are instances where even these steps

are not enough and money laundering occurs. In fact, FinCEN states that an analysis of BSA

collected data between January 2010 and May 2015 identified 79 SARs aggregating to

$27,915,574.50 submitted by financial institutions and money service businesses (“MSBs”) that

referenced rewards-based crowdfunding activity. The lion’s share of these SARs identified the

suspicious activity as falling under money laundering, fraud or other suspicious activity with

additional identification to include suspicion concerning the source of funds, structuring,

15 | P a g e

suspicious debit/credit card activity, transactions or exchanges with no apparent economic

business or lawful purpose.

Money laundering through crowdfunding may manifest itself in numerous ways, including but not

limited to:

An initiator may conspire with potential backers to trade funds for securities in a fictitious

business under the façade of a business transaction. More specifically, a fake backer

looking to purchase narcotics in bulk could crowdfund a fake company owned by a drug

cartel. The fake backer would receive the funds electronically disguised as a legitimate

crowdfunding transaction, which would then be easier to integrate into the financial system

than if it were a cash transaction.

The initiator could utilize a crowdfunding campaign to funnel funds out of the country to

finance a terrorist act. On the off chance that fifty fake backers crowdfund a fictitious

business that indicates they do charitable work abroad, the backers could transfer funds

derived from illegal activities to the business by purchasing worthless equity, and the

business would transfer the funds out of the country under the disguise of a legitimate

transaction.

Initiators received funding from backers through crowdfunding sites, followed by

structured cash withdrawals from the accounts.

Terrorist Financing Risk

Reports of terrorist financing through crowdfunding are minimal; however, the technology used

by terrorists is forever evolving to allow them to more easily evade being detected or captured by

law enforcement. Studies have identified a variety of electronic, online and other payment

methods with vulnerabilities that may multiply over the short term as they become more popular

and the general use develops. These payment methods can be accessed globally and can be utilized

to move funds rapidly; many of them are anonymous by design, making them appealing to

terrorists. Individuals and businesses are utilizing social media to disperse their propaganda and

raise funds, misusing opportunities found across peer-to-peer or crowdfunding networks.

Crowdfunding has been identified as an emerging tool being used for terrorist financing due to the

ease of use, making it susceptible and vulnerable to exploitation for unlawful purposes; including

cases where the genuine explanation behind the funding campaigns are concealed as terrorist

groups may solicit funds for terrorism and extremism support from unsuspecting backers, claiming

that their campaign is in support of a legitimate charitable or humanitarian project, and may create

nonprofits specific to these projects. Shutting down social media and crowdfunding apps and sites

for terrorists is extremely challenging as they often recreate accounts and campaigns under new

names to replace those that have been identified and shut down.

16 | P a g e

The diagram below delineates the quantity of SARs demonstrating each Suspicious Activity

Category. (Note: a solitary SAR can identify numerous suspicious activity categories, which

is why the total indicated below exceeds the 79 total SARs filed.)

Case Examples

1) The Federal Trade Commission (“FTC”) recently settled its first crowdfunding fraud case

against a crowdfund campaign initiator who misled and cheated backers out of more than

$122,000. He utilized his business name The Forking Path Co., and solicited funding

through the popular platform Kickstarter, to back a board game called The Doom of

Atlantic City, which was designed by two conspicuous board game artists. Approximately

1,250 backers pledged a minimum of $75 to get a replica of the game or one of its prized

character figurines. He provided intermittent updates on the progress over a 14-month

span, but then later announced that he was cancelling the project. In spite of the fact that

he had guaranteed to return the contributions, based on the complaint by the FTC, he

neither returned the funds nor distributed any promised rewards. Rather, he spent the

contributions on unrelated personal expenses including rent, relocation costs, personal

equipment and licenses for an entirely different project.

2) An Iowa woman solicited funds through the GoFundMe platform to raise money to pay for

her daughter’s cancer treatments. After raising thousands of dollars, it was found that her

daughter was in fact healthy. The woman was charged with child endangerment.

3) The SEC filed fraud and money laundering charges in the state of Nevada against

Ascenergy, a company in the oil and gas industry, demanding them to cease the ongoing

fraud being committed by the company and its CEO. It was stated that the company had

been soliciting funds under Title II of the JOBS Act, looking for accredited investors to

fund a new business. Ascenergy utilized several equity crowdfunding platforms,

17 | P a g e

Equitynet, Fundable and AngelList. They had raised approximately $5 million from 90

backers globally, of which a minimum of $1.2 million of the contributions had been spent

with only a few thousand dollars of that being used for oil and gas related expenditures.

Instead, the majority of the funds were distributed to the company’s CEO or companies he

managed, or for expenses unrelated to the oil and gas business, including foreign travel,

various restaurants, Apple stores and apps, health supplements and other personal care

products.

4) The Nafir al Aqsa Campaign was created with the purpose stated as “to equip the Mujahdin

of Beit al Maqdis.” The campaign included a saying attributed to Islam’s prophet

Muhammad, interpreted as “giving money to those waging jihad is as good as doing it

yourself.” This campaign also solicited funds on YouTube.

5) A French charity campaign created under the name of “Pearl of Hope” was shut down after

two of its senior leaders were identified and charged with financing terrorism in Syria. The

campaign’s site played on the emotions of unsuspecting backers by featuring poignant

images of wounded children and solicited for funds to help promote the health and

education of sick and deprived Syrian and Palestinian children. Although the campaign’s

posts on YouTube and Facebook show that it actually did transport food and medical

supplies to Syria, an investigation also found that they used many of those deliveries as a

front to funnel funds to jihadist groups and had connections to the Syrian al-Nusra Front.

6) Individuals connected to the Islamic State of Iraq and the Levant (“ISIL”) solicited funds

utilizing Twitter and asked backers to contact them via Skype. Upon connection the

interested backers were instructed to purchase international prepaid cards and then to

provide them with the number(s) of the prepaid cards. Then, the individuals would send

those card numbers to one of their followers in a neighboring country from Syria, who

would then sell the card numbers at a much lower price and give the proceeds to ISIL.

Conclusion

Crowdfunding is an inventive way for individuals and emerging growth companies to acquire

financing for their personal projects or startup operations. With this comes the associated risk for

fraud, money laundering and terrorist financing. Although the funding portals utilize third-party

payment facilitators who in turn utilize banks to process deposits and withdrawals of funds

collected for the campaign from various backers, currently most transaction monitoring of popular

funding portals focus primarily on protecting the backers. But…what about the risk to the financial

institution related to these illicit activities? How should the financial institutions that bank these

funding portals carefully and critically examine and monitor the activities of the parties involved?

Most financial institutions are limited to what they can do, as they are simply the beneficiaries of

dollars in and out for the funding portal, their customer. The identifying information, including

names, card members, sites and messages and so forth don’t flow through to the banking system

as part of the relationship as this data is housed by the platform and their facilitator. That being

18 | P a g e

said, it raises the question of how these different players in the crowdfunding process, each holding

a different piece of information with the biggest pieces held by the facilitator and funding portal,

are going to work together to ensure AML risks are appropriately identified and alleviated? By

incorporating AML requirements in its recent and ongoing regulations, the SEC has guaranteed

that funding portals won’t become the obvious focus for potential criminals. It is imperative that

funding portals and their facilitators comply with these federal AML rules and regulations,

including implementing and maintaining an effective and efficient AML program. This will give

financial institutions that are responsible for performing the due diligence and monitoring of the

facilitators the full picture; allows information sharing under the 314(b) regulations; provides a

larger data set on the players that would not normally be accessible to the financial institutions;

and formalizes and implements a standard for monitoring and reporting suspicious activities. In

conclusion, with so many players involved in various levels of the crowdfunding process it would

be beneficial for regulators to outline the risks of each involved in these types of transactions and

the roles they play in the payment process and consider what each could contribute to the overall

mission of protecting themselves from being a participant or victim in any illicit activity.

19 | P a g e

Works Cited

A brief history of crowdfunding - LendingCrowd. (2015). Retrieved from

https://www.lendingcrowd.com/blog/a-brief-history-of-crowdfunding/

Advantages and disadvantages of crowdfunding. (n.d.). Retrieved from

https://www.nibusinessinfo.co.uk/content/advantages-and-disadvantages-crowdfunding

Ascenergy LLC et al. (Release No. LR-23394; October 28, 2015). (n.d.). Retrieved from

https://www.sec.gov/litigation/litreleases/2015/lr23394.htm

Barach, C. (n.d.). Regulation Crowdfunding. Retrieved from

http://www.slideshare.net/CaseyBarach/equity-or-regulation-crowdfunding

Bijkerk, W. (n.d.). Risks and Benefits of Crowdfunding. Retrieved from

https://www.iosco.org/research/pdf/20140410-Risks-and-Benefits-of-Crowdfunding.pdf.

Crowd Funding: Arts Patronage by the Masses. (n.d.). Retrieved from

https://www.berklee.edu/bt/194/crowd_funding.html

Crowdfunding Fraud: How Big is the Threat? - Crowdfund Insider. (2014). Retrieved from

http://www.crowdfundinsider.com/2014/03/34255-crowdfunding-fraud-big-threat/

Crowdfunding Project Creator Settles FTC Charges of Deception. (n.d.). Retrieved from

https://www.ftc.gov/news-events/press-releases/2015/06/crowdfunding-project-creator-settles-

ftc-charges-deception

FATF-GAFI. (n.d.). Retrieved October, 2015, from http://www.fatf-

gafi.org/media/fatf/documents/reports/Emerging-Terrorist-Financing-Risks.pdf#page=35

JOBS Act Deals Dominate Depositary Receipt Initial Public Offerings in 2015. (n.d.). Retrieved

from http://www.businesswire.com/news/home/20160112006421/en/JOBS-Act-Deals-

Dominate-Depositary-Receipt-Initial

Kuruvilla, C. (n.d.). Iowa mom faked child’s terminal cancer to collect donations: Cops.

Retrieved from http://www.nydailynews.com/news/crime/iowa-mom-faked-child-terminal-

cancer-collect-donations-cops-article-1.1913828

Proskauer Rose LLP. (n.d.). 2015 IPO Study. Retrieved from

http://www.proskauer.com/files/uploads/Documents/2015-IPO-Study.pdf

Quarterly Research. (n.d.). Retrieved from http://www.crowdnetic.com/reports/sep-2015-report

SAR Stats. (2015, October). Retrieved from

https://www.fincen.gov/news_room/rp/files/SAR02/SAR_Stats_2_FINAL.pdf

20 | P a g e

Spirer, G. (2013). Crowdfunding - The Next Big Thing. Hamburg: CreateSpace.

United States. National Park Service. (n.d.). Joseph Pulitzer. Retrieved from

https://www.nps.gov/stli/learn/historyculture/joseph-pulitzer.htm

Woods, S., & Raymond, S. (n.d.). Crowdfunding: A Comprehensive Guide for Beginners.

Hamburg: Createspace.