What’s the News?

The Federal Trade Commission (FTC) recently announced the settlement of a complaint alleging deceptive trade practices in relation to a crowdfunding campaign. According to the FTC, the campaign’s organizer failed to live up to various promises made during the campaign, including promises pertaining to the rewards that individuals contributing funds (commonly known as “backers”) would receive in return for their contributions and how donated funds would be used. The case—the FTC’s first involving crowdfunding—is a clear signal to those engaging in the popular fundraising strategy of the importance of making good on all promises and representations made to backers.

More on Crowdfunding and the Settlement

As background, crowdfunding is the practice of funding a business venture by raising small monetary contributions from a large number of people. Crowdfunding relies upon online platforms that allow project creators to set up a home page through which they can advertise their project and solicit funds. Crowdfunding has become an increasingly popular way of raising money for a business venture. Notably, the hundreds of crowdfunding platforms collectively raised about $5.1 billion in 2013 alone. In return for these contributions, it is customary for the creator of a crowd-funded project to offer backers some type of reward.

In May 2012, Erik Chevalier launched a crowdfunding campaign to develop a board game through Kickstarter.com (Kickstarter), a popular online platform. Chevalier represented that money raised through the campaign would be used to fund the creation and distribution of the game, and that donors would receive specific rewards if the campaign reached its funding goal of $35,000. The promised rewards, which varied depending upon the amount given, included a copy of the board game and pewter figurines related to the game.

The campaign, which ended in June 2012, raised more than four times its goal. According to the FTC complaint, however, Chevalier never provided backers with the promised rewards. In fact, the FTC alleges that the entire crowdfunding campaign was a sham. Notably, the FTC claims that Chevalier never initiated the creation of the board game, instead using the funds for personal gain. In July 2013, Chevalier announced on his Kickstarter page that the project was being shelved. While Kickstarter’s terms of use require an organizer to refund contributions anytime a promised reward is not delivered, the FTC claims that Chevalier refunded few, if any, of his backers.

Last week, Chevalier agreed to settle the FTC complaint, which contained allegations of deceptive business practices in relation to the misrepresentations discussed above. The settlement orders Chevalier to refrain permanently refrain from misrepresentations related to (1) the rewards consumers will receive in return for crowdfunding contributions, (2) how he will use funds obtained through crowdfunding contributions, and (3) any other facts pertinent to a consumer’s decision to participate in a crowdfunding campaign.

The Takeaway

Crowdfunding is a popular, and often successful, way to secure the initial funding needed to get a project off the ground. As the Chevalier settlement shows, however, improperly conducting a crowdfunding campaign can raise serious legal concerns. To help crowdfunding campaigns avoid legal liability, the FTC recently outlined two basic ground rules to follow. First, if you make a promise in relation to a crowdfunding campaign (e.g., a promise to provide a reward or refund), you must keep that promise. Second, if you raise money for a specific project, use the funds only for that project—not for any other project, and especially not for personal gain.

The FTC is not the only authority cracking down on crowdfunding. State regulators have also expressed concerns about deceptive crowdfunding campaigns and, as discussed in a previous Arent Fox alert, last year Washington’s attorney general prosecuted the organizer of a crowdfunding campaign for fraudulent practices. Accordingly, in addition to following the basic FTC guidelines discussed above, crowdfunding campaign organizers should also ensure compliance with any relevant state laws.