Earlier this year, the Federal Trade Commission (FTC) held its first FinTech Series forum exploring the benefits, risks, and regulatory issues applicable to the FinTech industry. The forum, which took place on June 10, 2016, focused on marketplace lending. The second forum in the series took place on October 26, 2016, and focused on crowdfunding platforms and peer-to-peer (P2P) payments. The half-day forum featured opening remarks by FTC Commissioner Terrell McSweeny, panel discussions on crowdfunding and P2P payments, a presentation by the FTC's Office of Technology, Research, and Investigation, and closing remarks by Malini Mithal, the Acting Associate Director of the FTC's Division of Financial Practices.
At the second FinTech Series Forum, the FTC discussed its planned regulatory direction for the crowdsourcing and P2P payments industries, and the level of compliance flexibility regulators expected to provide early-stage fintech companies (spoiler: not much). The FTC made clear that although FinTech-specific regulation is still taking shape, the agency will monitor this sector aggressively and expects compliance with long-standing consumer protection laws, including its guidance on unfair or deceptive acts or practices (UDAP).
Crowdfunding is the practice of funding a project by raising monetary contributions from a large number of people, typically through an online platform. Crowdfunding platforms host websites where projects are advertised and facilitate the flow of funds from donors to recipients. Crowdfunding can take a number of different forms, including:
- Donation-based crowdfunding, where participants support a cause without a return benefit;
- Reward-based crowdfunding, where participants support a project or invention in return for a reward, such as project-themed merchandise, early access to the finished project, or similar benefits; and
- Securities-based crowdfunding, where participants acquire equity in a start-up company.
The FTC's forum focused on donation-based and reward-based crowdfunding, which are the forms most likely to fall within FTC jurisdiction. Securities-based crowdfunding is more likely to be regulated by the Securities and Exchange Commission; however, FTC panelists did not rule out the potential for the FTC Act's UDAP prohibition to apply to securities-based crowdfunding platforms.
While crowdfunding has created a new system for individuals and groups to raise money for personal and business projects, the FTC believes such platforms also create a potential for fraud and other abuse. The panelists noted that consumer understanding is always a source of risk and commented that some issues may be driven by consumers viewing crowdfunding platforms (particularly reward-based platforms) as online stores, rather than as an investment in a not-yet-extant product.
According to the panelists, fraud on the part of the project creator is also a key source of risk to consumers. Although panelists agreed that crowdfunding potentially enabled fraud on a larger scale, a common theme emerged that "the mode is new, but the scams are old." In addressing such risks, the panelists largely took expected positions, with consumer advocates calling for increased government oversight, and industry participants supporting ongoing self-regulation.
For its part, the FTC stated it would continue to take action against fraud by project creators, recalling the 2015 Forking Path case (discussed here), in which the FTC asserted that a project creator's claims constituted UDAP in violation of Section 5 of the FTC Act. Crucially for crowdfunding platforms, however, the FTC also suggested platforms may be held responsible for the behavior of scammers if the platforms did not have proper security mechanisms in place. FTC participants stated that platforms should provide appropriate disclosures about the risk that projects may fail (for a variety of reasons) and that there is no guarantee of success or a return of a consumer's funds. Furthermore, the FTC expects platforms to develop dispute resolution mechanisms that would allow consumers who fund a project to bring disputes against project creators. Panelists also expressed a desire for crowdfunding platforms to develop additional self-regulatory and best-practices efforts.
The FTC's expectations for crowdfunding platforms are reminiscent of similar regulatory efforts to outsource law enforcement functions to financial intermediaries, including the FTC's own enforcement actions against payment processors for facilitating payments for fraudulent merchants. Crowdfunding platforms should closely monitor these developments and consider developing any policies and procedures that may be necessary to comply with the FTC's expectations.
P2P money transfers refer to the electronic transfer funds between individuals, without needing to resort to traditional payment methods such as cash, monetary instruments, or wire transfers. The primary benefits from this technology include speed and simplicity, as most consumers have moved away from checks and many no longer use cash regularly. P2P transfers are especially popular with millennials and are marketed to younger consumers as cash replacements.
But to make use of this technology, consumers have to give app platforms sensitive financial information, including security credentials for more traditional payment methods, including bank account or payment card information. Similar to crowdfunding, fraudsters have also applied old methods to new technology, with some P2P platforms suffering from imposter scams, bait-and-switch scams, and other techniques. Furthermore, consumers may have an even more difficult time disputing payments, requesting refunds, or obtaining other forms of redress than with traditional payment systems, given the increased anonymity offered to users on P2P platforms and the unclear application of consumer protection laws.
While the solution may seem as simple as ensuring that consumers are not being confused, deceived, or robbed through the P2P system, P2P platforms vary in their use of fund transfer mechanisms: some rely on automatic clearing houses, others rely on credit or debit cards, and still others use prepaid cards. The chain of legal liability in using any of these mechanisms is complex, and both platform providers and consumers may have difficulty understanding and applying these frameworks to unexplored technologies.
During the forum, one panelist emphasized that regulations that govern existing funding mechanisms should apply to P2P payment with equal force. Indeed, there are multiple overlapping legal and regulatory frameworks that could apply to P2P payment systems, depending on how they are set up, including the Bank Secrecy Act and anti-money laundering regulations, money transmission laws, laws applicable to prepaid programs, payment card network rules, and NACHA rules, to name a few. In addition to such existing regulations, the CFPB's Prepaid Rule, discussed here, will also likely apply to many P2P transfer systems in the near future.
- Although industry representatives pressed for self-regulation to avoid stifling innovation, the FTC appears to believe the potential for fraud in connection with crowdsourcing and P2P transfers warrants aggressive monitoring and, as necessary, enforcement action.
- Crowdfunding platform liability: Crowdfunding platforms should take note of the FTC's comments suggesting platforms will be responsible for taking measures to prevent fraud by project creators. The FTC has already suggested that platforms should include appropriate disclosures and dispute resolution mechanisms.