Submission to Financial Services and the Treasury Bureau on Public Consultation on Regulation of Crowdfunding Activities

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1. The Consumer Council (the “Council”) is pleased to submit views concerning the Financial Services and the Treasury Bureau’s (FSTB) Public Consultation on Regulation of Crowdfunding Activities (Public Consultation).  

2. The Council notes the FSTB’s recommendation to establish a Crowdfunding Affairs Office (“CAO”) dedicated to processing and coordinating regulatory and administrative matters related to crowdfunding activities and monitoring the conduct of such activities, as well as the various regulatory measures proposed, for effective oversight and regulation of crowdfunding activities. 

3. Given the Council’s statutory purview of protecting and advancing the interests of consumers of goods and services, the submissions herein focus on reward/pre-sale crowdfunding, where fund contributors give funds to fundraisers to help them develop or produce specific physical goods or services while receiving in some form the goods or services in return for the funds given.  The observations herein may also apply to specific cases of donation-based crowdfunding where the fund contributor donates funds to the development of consumer goods or services with the view of eventually being able to purchase them in the market as a consumer.

4. Paragraph references in this submission are to paragraphs of the consultation document, unless otherwise stated.

A.  Key Considerations

5. The following considerations underlie the suggestions made in this submission:

1. In a crowdfunding project whether emanating from Hong Kong or elsewhere, funds may be raised from various jurisdictions, including Hong Kong.  In other words, these transactions may well be cross-border in nature.  The cross-border nature of crowdfunding projects may give rise to complex jurisdictional issues.  For example, the extent to which and how a fundraiser would cope with different regulatory requirements of various jurisdictions; whether the funds raised should be kept in one jurisdiction and how their use could be monitored; if a fundraiser fails to deliver on its promises, misuses funds or engages in fraudulent activities, the avenues of redress and the recourse available to aggrieved consumers in particular when the fundraiser is located outside Hong Kong (“Fundraisers Outside HK”); and the difficulties of investigating into as well as taking enforcement action against Fundraisers Outside HK.

2. In addition to the risks identified in Paragraph 1.17, crowdfunding projects entail risk of failure, in particular those involving innovation or creative ideas.  Consumers (in particular those inexperienced in crowdfunding projects) may be carried away with the fundraiser’s claims and representations and do not appreciate the associated risks involved.  The Council notes that according to a study of the Wharton School of the University of Pennsylvania commissioned by Kickstarter (an online crowdfunding platform) in 2015, 9% of Kickstarter projects failed to deliver rewards, 8% of funds went to failed projects and 7% of fund contributors failed to receive their chosen reward[1]. 

3. As highlighted in paragraph 1.17(c), from time to time, there were also reported cases of misuse of funds or perpetration of fraud that resulted in investigation and legal action taken by the US authorities against fundraisers[2].

4. On the other hand, whilst regulation should enhance consumer protection and may also reduce the risk of scams and uncreditworthy projects, over-regulation may disincentivize fundraisers or platforms from raising funds from Hong Kong on genuine, worthy or large-scaled innovation and technological projects, thus limiting consumer choice and potentially hindering the city’s development as an incubator of innovation.  In making policy decisions and establishing the approval processes, a balance would need to be struck between maintaining free market and healthy consumer choice on one hand and providing adequate consumer protection on the other. 

5. A substantial number of crowdfunding projects are rolled out each year.  According to a report[3], nearly 6,455,080 crowdfunding campaigns happened in 2020 and was estimated to reach 12,064,870 by 2023.  It is necessary to be mindful of the potential volume of work involved in discharging the CAO’s proposed functions and consider effective implementation mechanisms to avoid delays in the approval process that could discourage fundraising from Hong Kong or result in consumers “missing out” on worthy projects.

B.  Suggestions of the Council

6. It is noted that the consultation document focuses on the approval process of a crowdfunding application and the CAO’s duties and powers in overseeing compliance with the proposed regulatory regime and its dealings with the fundraisers, crowdfunding platforms (if any), financial institutions and other stakeholders involved in a crowdfunding project. 

7. From the consumer protection perspective and taking the key considerations into account, a comprehensive regulatory regime should also provide for the following matters, whether by way of legislation or administrative measures.

8. Information transparency

1. To ensure that fundraisers have thought through and conceived concrete proposals for development of the products/services and reduce risk of fraud at the time of application, the information stated in Paragraphs 2.5 and 2.16 that an applicant should provide should include the fundraisers’ proposed advertising material.  Such advertising material should set out the product/services specifications (including whether images displayed are of prototypes or mock-ups), project timeline, budgetary plan, milestone dates, project risks (including as relevant details of financial risks, risk of an innovation failing to materialize, risks inherent in the business and industry, and compliance / regulatory risks) and possible ensuing consequences including delays.  For effective monitoring of the conduct of crowdfunding activities, depending on the scale of the project (for instance, in terms of amount of funds, number of fund contributors and duration of the project), disclosures to the CAO should be audited according to specified requirements or at least be certified as authentic and/or true and correct by a professionally qualified person such as an accountant in the relevant jurisdiction.  Fundraisers should be required to keep proper records relevant to a project (for instance, on fund flow) for a specified period of time (e.g. 7 years).

2. To ensure that consumers are able to make informed choices and monitor progress of projects backed by them, the fundraiser should also make available such information and updates to the public and fund contributors respectively.  The level and frequency of disclosures required may depend on the project size, nature and risks involved.  These obligations should not be considered overly onerous in light of prevailing practices, as evidenced from the project information provided by fundraisers on crowdfunding platforms such as Kickstarter and Indiegogo, which terms of use also require them to provide project updates to fund contributors. 

3. In this regard, in relation to the proposed database (Paragraph 2.7(e)) (“Database”) to facilitate ease of public access to such information, suitable disclaimers should be included to avoid potential misunderstanding of endorsement by CAO of the published projects and information.

9. Control over proper use of funds

1. Paragraph 2.24 proposes that funds collected in Hong Kong (“HK Funds”) should be paid into a designated account with a local bank, primarily to minimize the risk of money laundering.  

2. The Council understands that, once the fundraising campaign has reached the target amount, the entire funds would normally be released to the fundraiser to pursue the project.  To mitigate against the risk of fraud or misuse of funds, consideration should be given to whether, in larger scale projects and/or in respect of a Fundraiser outside HK, the HK Funds should be placed in a local escrow account and managed by an escrow agent.  This will provide better assurance of return or donation (as the case may be) of the funds if the target amount is not reached and enhance consumers’ ability to seek actual recovery against funds remaining in the escrow account if a dispute arises in course of an ongoing project.  On the other hand, the inability of the fundraiser to flexibly utilize the funds in pursuing a project may jeopardize its viability to the detriment of all consumers.  In considering whether and if so the circumstances in which an escrow arrangement should be imposed, further research and consultation on the cost and practicality of such arrangements may be required. 

3. In addition, with the proliferation of e-commerce, online payment mechanisms and consequential risk of cyber-fraud, consideration should be given to imposing proven technology and security standards / measures for prevention of malicious hacking, data breaches and unauthorized fund transfers. 

10. The role of crowdfunding platforms

In relation to the proposed establishment of a registration system for online crowdfunding platforms and for a list of registered platforms to be publicly accessible (Paragraph 2.19), the Council understands that some major crowdfunding platforms currently host projects which are raising or have raised funds from inter alia Hong Kong.  Consideration should be given to the following matters:

1. Given the prevalence of such platforms targeting the global community, whether mandatory registration may disincentivize them from operating in Hong Kong and the possible alternatives, such as authorizing them to operate in Hong Kong without the need for registration. 

2. Given the difficulties of investigation or enforcement against Fundraisers outside HK, whether fundraisers seeking to raise funds from Hong Kong should be required to do so through registered/authorized crowdfunding platforms.

3. Given the sheer number of crowdfunding campaigns launched each year, whether establishing an accreditation scheme may facilitate more effective allocation of the CAO’s resources.  Crowdfunding platforms possess substantial knowledge, expertise and experience[4] and could play an important role in self-regulation of the industry and facilitate smooth regulation by the CAO.   Under an accreditation scheme, accredited platforms could play an important role in approving and monitoring the conduct of crowdfunding activities for compliance with Hong Kong’s regulatory requirements and periodically report (as well as report irregularities) to the CAO.  Whilst commercially driven, such platforms share the common interest of upholding the credibility of the industry through continuous review of its terms of use and due diligence conducted on fundraisers.  It is also conceivable that, through early engagement with major crowdfunding platforms and working together with such platforms, the Government may be able to identify and pursue practical means and measures for effective implementation of the regulatory regime.

11. Data protection measures

1. The Council agrees that the power of the CAO to issue guidelines to ensure proper handling of personal information is pertinent (Paragraph 2.7(f)).  With the proliferation of e-commerce globally, security of consumers’ personal and financial data is paramount.  This is in particular given that fund contributors’ personal data may be disclosed and used for various purposes amongst various stakeholders, including the fundraiser, crowdfunding platform, financial institutions and the CAO (Paragraph 2.14).  The Council suggests that the guidelines should, in consultation with the Privacy Commissioner as necessary, provide for mandatory terms of personal information collection statements to adequately inform consumers and mandatory encryption or comparable security measures required of fundraisers, crowdfunding platforms and other stakeholders to prevent improper disclosure and misuse.

2. Similarly, the CAO should also consider adopting state-of-the art technology to ensure security of its approval and monitoring processes, as well as integrity of data maintained on its Database.

12. Unlawful crowdfunding activities

1. The Council suggests that due consideration should be given to setting out in clear terms the legal requirements for criminalisation of fund contributors, as opposed to the fundraiser, and the statutory defences available to them.  Given the scope of “unlawful crowdfunding activities” (Paragraph 2.22), the Council is concerned that unwary and genuine consumers who contributed funds in return for promised products or services in a crowdfunding project, which transpired to be unlawful, may find themselves at the receiving end of an investigation or prosecution by regulatory authorities (Paragraph 2.23(f)). 

2. The Council considers that, before any investigative or prosecution action is initiated against a fund contributor, there should be evidence giving rise to reasonable cause for suspecting his/her involvement in unlawful activity and proof of his/her criminal intent.  Consideration should also be given to whether fund contributors should be criminalised for contributing funds to projects without a consent notice per se.  In addition, the CAO should be responsible for taking reasonable steps to ensure that a notice of unlawful crowdfunding activity is drawn to the attention of fund contributors concerned and provide proper guidance on how they should act in relation to the project.

3. In addition to Paragraph 2.22(f), consideration may be given to the criminalisation of disclosure of false or misleading information by fundraisers inducing fund contributions, akin to the offence of market misconduct arising from disclosure of false or misleading information inducing transactions in securities and futures contracts prohibited by the Securities and Futures Ordinance (Cap 571) (“SFO”).

4. As recognized in the consultation document (Paragraph 1.1), crowdfunding activities are commonly held by using communications technology or online platforms.  It is hoped that the current work of the Law Reform Commission on cybercrime (including cyber-dependent and cyber-enabled crimes) would facilitate enforcement work by regulators in the crowdfunding industry.

13. Consumer redress

1. The Council welcomes the enforcement powers to deal with crimes proposed in Paragraph 2.29, including in particular seeking return of property arising from unlawful crowdfunding activities.  Given that a fundraiser may be outside Hong Kong and/or the funds raised may have been transferred outside Hong Kong, it is likely that the average consumer would lack the means or avenue of seeking redress on their own.  Further, whilst a group of consumers is likely to be affected in a crowdfunding project, there is current no class action regime in Hong Kong to enable effective pursuit of civil action.  It is likely that these consumers will have to rely on the regulators’ efforts, their investigation/enforcement powers and the various cross-border mutual legal assistance arrangements in place in obtaining recourse for them. 

2. The Council further suggests that the remedies that a regulator may seek on behalf of aggrieved consumers should also include restitutionary orders and orders for disgorgement of profits made by the fundraiser as a result of its unlawful conduct, similar to that under ss213 and 257(1)(d) of the SFO.  Fundraisers should not be unjustly enriched at the expense of consumers.

3. Given that online crowdfunding arrangements constitute a form of distance contract, consideration may also be given to requiring a mandatory cooling-off period to safeguard consumer interests.  In the presence of information asymmetry (Paragraph 1.17(b)), fund contributors have to rely on the information provided by fundraisers in their decision-making and may not have access to all relevant information at the time of transaction.  A reasonable cooling-off period (say 7 or 14 days) should provide a safe harbour for consumers to review their decisions.

14. Consumer education

1. Lastly, given the potentially serious implications for consumers and publicity of crowdfunding arising from the proposed regulatory regime, sufficient consumer education needs to be arranged by the CAO both on the regime and on crowdfunding risks and benefits generally.  As CAO accumulates data on crowdfunding matters in time, information technology could be leveraged and AI-based analytics could be performed to provide pinpointed information to the public on such matters as fundraisers’ creditworthiness and risk level of various types of projects.  The Council looks forward to offering further views on the design and content of relevant education materials to enhance consumer awareness.

2. In the long run, as crowdfunding gains traction in Hong Kong, the CAO may also consider facilitating consumers’ convenience by establishing an electronic platform that provides an easy-accessible channel for consumers to look up their portfolio at any time, similar to the e-Enquiry of Personal Account maintained by the Mandatory Provident Fund Schemes Authority.   

C.  Conclusion

15. The Council is grateful for the FSTB’s consideration of consumer interests in reward/pre-sale crowdfunding towards enabling consumers to make informed choices and providing adequate protection of their funds and means of recourse.  Given the proliferation of established crowdfunding platforms and their knowledge and expertise gained over the years on one hand and the sheer number of crowdfunding projects that continues to rise on the other, the Council considers that such platforms could play an important role in the effective implementation of the proposed regime.  On the other hand, the Council expresses concern that unwary and genuine consumers may be subject to investigation or prosecution for unlawful crowdfunding activities perpetrated by the fundraiser.  The Council looks forward to further work and contribution to the establishment of the regime and consumer education in due course.