Category Legal Affairs

Regulating Crowdfunding in South Africa?

18 August 2016 Lerato Lamola, Portia Mashinini, Webber Wentzel
Lerato Lamola, a Senior Associate at Webber Wentzel.

Lerato Lamola, a Senior Associate at Webber Wentzel.

Portia Mashinini, a Candidate Attorney at Webber Wentzel.

Portia Mashinini, a Candidate Attorney at Webber Wentzel.

Crowdfunding is a way of soliciting funds from the public on an online platform; money is raised in small amounts usually in the form of donations or investments. It is essentially a vehicle to source funds from individuals or organisations to fund different causes ranging from business ideas to charity initiatives. For businesses, crowdfunding promises capital for inventive entrepreneurs in need of funding while for charity causes it promises a helping hand. The crowdfunding model has the potential to impact on the growth and development of small businesses and in most jurisdictions including South Africa, crowdfunding is seen as an innovative way to facilitate funding for small and medium sized enterprises and finance start-up companies, with a goal of promoting economic growth.

Crowdfunding is not a new concept; however, in South Africa the crowdfunding model of financing is still in its infancy stage, it is a concept which is not clearly understood or trusted by most, and a financing model which has proved to be difficult for the Regulator (the Financial Services Board) to forthright regulate. As it stands, the activity of crowdfunding is not regulated in South Africa, there is no specific mention of "crowdfunding" in any piece of legislation, nor is there any proposal of legislation in the pipeline.

Crowdfunding has been argued to raise potential risks to the investing public within the financial services industry such as fraud, money laundering, platform failure and business failure as funding does not guarantee returns, lack of due diligence and disclosure risks such as lack of liquidity and the inability to obtain a return on the investment. It is because of such potential risks that a need for regulation arises in order to protect the unsuspecting crowd, but also further promote the certainty within the general public.

The Financial Services Board has noted the activity of crowdfunding in South Africa and has highlighted that despite the absence of regulation, crowdfunding activities may already be subject to or find application within existing legislation, to that end it has advised that a person interested in crowdfunding activity either by offering it or as an investor must first contact the Financial Services Board to establish whether the activity falls within the sphere of existing legislation or otherwise falls foul of the law. The following are examples of legislation which may be applicable to crowdfunding activities (depending on the structure of the online platform):

• Companies Act, 71 of 2008;
• The Banks Act, 94 of 1990;
• National Credit Act, 34 of 2005;
• Financial Advisory and Intermediary Services Act;
• Financial Markets Act, 19 of 2012; and
• Collective Investment Schemes Control Act.

In light of the highlighted risks and the approach adopted by the Financial Services Board, the question that arises is whether it is credible to assimilate the model of crowdfunding with activities that are generally regulated under existing legislation while keeping in mind that crowdfunding may be associated with a number of elements such as investment management, consumer protection, client credibility, tax implications and intellectual property or is the way to go for the Financial Services Board to propose a specific piece of legislation designed to cater for all the identified needs, risks and uncertainties.

This may therefore be an opportune time for the Financial Services Board to engage with the industry on a way forward, because not only is crowdfunding a great alternative to financing businesses, it has made a mark in different markets within the financial services industry. Without losing sight of the benefits of crowdfunding particularly in respect of the economic policy of South Africa which is to promote economic growth, job creation and innovation through encouraging the development of small businesses, there is a need for regulation to protect the "crowd" that will be investing in these businesses or projects. Therefore the Financial Services Board's challenge will lie in striking a balance between encouraging crowdfunding, which promotes easy access to capital for businesses, and protecting investors.

The adoption of the Twin Peak model of regulation in South Africa will see the creation of two regulatory authorities, the Prudential Authority and the Financial Conduct Authority. Seeing that risks associated with crowdfunding predominantly relate to conduct, it is likely that crowdfunding regulation may fall within the perimeters of the Financial Sector Conduct Authority whose objective will be to protect financial consumers through supervising market conduct.

No doubt crowdfunding has made a mark in the financial services industry within many jurisdictions, and as much as there may be a need for regulation, sight must not be lost for what appears to be the main objective of crowdfunding which is to facilitate easy access to capital and alternative means of financing.

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