Legal Risks of Crowd Funding Platforms (Mainland China)

Li-kang Weng
Crowd equity funding has been generally understood as primarily referring to an intermediary platform by which an entity, through the use of an electronic intermediary platform such as the Internet [1], engage in a small-scale public equity funding from investors. Since there is currently no law or regulation that specifically regulates crowd equity funding in China, in order to avoid running afoul of the current provision in the Securities Law that “no organization and individual may publicly offer securities to the public without legal permission,” and avoid being deemed as “offering securities to non-specific targets,” this activity is referred to as “Internet-based non-public equity financing” [2] to more accurately reflect the crowd funding practices under the current laws of China.
With respect to crowd equity funding, the current regulatory documents that have referential value in practice are the self-regulatory Administrative Measures for Private Equity Crowd Funding (Pilot) (Solicitation for Opinions) prepared by the Securities Association of China in 2014 and the parts regarding crowd equity funding in the Guiding Opinions on the Healthy Development of Internet-based Financing jointly promulgated by ten ministries and commissions, including the People’s Bank of China, in 2015. The former expressly notes the private placement nature of crowd equity funding and sets down rules on platform quality, qualification of investors and platform self-governance and management, but the draft Solicitation for Opinions has not yet been finalized officially. The latter requires crowd funding to be done through an intermediary platform, the party seeking financing must be a micro enterprise, it must faithfully disclose key information to investors through such intermediary, and it shall not mislead or defraud investors. In addition, crowd equity funding shall be regulated by the China Securities Regulatory Commission. As a result, the China Securities Regulatory Commission is expected to issue management regulations regarding crowd equity funding and should therefore be closely watched.
Because the legal nature and positioning of crowd equity funding platforms remain unsettled before dedicated regulatory measures are released, the popularity of crowd funding activities has also led to a substantial number of legal disputes arising out of misunderstandings among the participants regarding their roles. This article seeks to discuss the rights and obligations associated with crowd equity funding platforms with the following three major approaches.
1. Legality of raising capital through equity financing platforms
If one desires to conduct crowd equity funding activities in compliance with existing laws, the main thing is to avoid crossing the line into “illegal absorption of deposit from the public” and “illegal offering of securities” as discussed below:
(1) Illegal absorption of deposit from the public
According to the interpretation of the Supreme People’s Court, an act that constitutes illegal or de facto absorption of deposit from the public under Article 176 of the Criminal Law should meet all four of the following conditions:
(i) Absorption of funds without the approval of the relevant agencies or failure to conduct through a legally compliant method of operations.
(ii) Promotion to the public through the media, promotional events, flyers, SMS or other channels.
(iii) A promise to return the principal plus interest, or rewards provided, within a specific period of time through cash, in-kind of equity.
(iv) Absorption of funds from the public at large, i.e., nonspecific targets.
Therefore, to avoid being deemed as illegal or de facto absorption of deposit from the public, conduct such as public promotions, promises to repay investments or provide rewards, or accepting funds from nonspecific targets should all be avoided.
(2) Illegal offering of securities
Article 10 of the Securities Law provides that a public offering of securities requires an approval from the China Securities Regulatory Commission, and the presence of any one of the following circumstances will be deemed a public offering:
(i) Offering of securities to non-specific targets.
(ii) Offering of securities to an aggregate of over 200 specific individuals.
(iii) Other acts of offering under laws and regulations.
A non-public offering of securities may not use advertising, public solicitation and methods that are de facto public offering.
Pursuant to the above requirements, if a platform targets “specific” investors with no more than 200 investors per financing project and do not employ advertising, public solicitation and methods that are de facto public offering, it will not be deemed to as have engaged in a “public offering of securities” per Article 10 of the Securities Law.
The First Intermediate People’s Court of Beijing rendered a closely-watched second instance decision [3] at the end of 2015 on the first crowd equity funding lawsuit, in which Beijing Fit Network Technology Co., Ltd. (the platform) had a dispute with Beijing Nomido Food and Beverage Management Ltd. (the party seeking financing) over their intermediary contract. The decision recognized the legality and validity of the “Agreement on Consigned Financing Services” entered between the parties on the ground that relevant regulatory documents do not prohibit the crowd equity funding conduct involved in this matter.
2. The legal relationship among the party seeking financing, the platform and the investor
In general, a platform facilitates transactions and plays a role more similar to that of an intermediary. In the aforementioned case involving the dispute between Nomido Co. and Fit Network Technology, the First Intermediate People’s Court also concluded that the legal relationship reflected in the “Agreement on Consigned Financing Services” between the party seeking financing and the platform party is that of an intermediary contract. In practice, however, the investor does not only expect a platform to be a mere “information intermediary” but also be a guarantor of sorts as a “trust intermediary”.
From the platform’s perspective, it is difficult to switch between the roles of a “information intermediary” and a “trust intermediary”. If a platform enters into an agreement in its own name with an investor directly, it is very likely that the legal relationship between the platform party seeking financing would be deemed as “agreement with a third party under one’s own name as authorized by the consignor”, which, under Articles 402 and 403 of the Contract Law, entitles the investor to assert rights against the platform if the party seeking financing fails to perform its obligations [4].
Currently, most crowd equity funding platforms adopt the “lead investment plus follow-on investment” model, which means that a professional investment institution will serve as the lead investor after doing its due diligence, and individual investors will then follow to share the risks and benefits with the institution. So the crowd equity funding platform not only helps in coordinating information but also become more involved in the matter as well, such as using the fee from the party seeking financing to directly invest in that party, thereby becoming the lead investor. However, such deep involvement from the platform is prone to giving a false impression to investors that the platform is a guarantor, which would inadvertently increase the risks assumed, thus it must be done in caution.
3. Obligation of a platform to disclose information to investors
In practice, investors often participate in a crowd equity funding scheme due to trust in the platform rather than the party seeking financing. In case of any problem with the party seeking financing, the investors are likely to blame the platform first. Case in point, in June 2016, a crowd equity funding platform named was reported to have suffered complaints from investors because the numbers in the latest financial statements disclosed by Hongli Energy, an entity recommended by to investors, were drastically different from those at the time of a private placement at the end of last year. As a result, was plunged into “allegations of fraud” over crowd equity funding [5]. Therefore, it is imperative for a platform to pay more attention to the regulatory aspect of recommendations and information disclosure to avoid disputes with its investors over any crowd funding project.
In this regard, Articles 8 and 9 of the Administrative Measures for Private Equity Crowd Funding (Pilot) (Solicitation for Opinions) sets out the relevant obligations and prohibited conduct for platforms, including the necessary examinations on the legality of a financing project; measures taken to prevent fraud and, in case any fraud or any other circumstance that undermines the interest of investors is detected, the timely announcement of such and the termination of the relevant financing activities; the prohibition against making external guarantees or hold shares in trust; and the prohibition against leveraging the platform’s own advantages to obtain investment opportunities or mislead investors.
In conclusion, before the relevant regulations for crowd equity funding are released by the China Securities Regulatory Commission, they can only be legally conducted in practice by staying within the scope of “internet-based non-public equity financing.” The platform should take care to avoid crossing into prohibited areas such as “illegal absorption of deposit from the public” and “illegal offering of securities.” In addition, the platform shall disclose the relevant information faithfully and stay away from becoming deeply involved in the projects, which means playing the role of an “information intermediary” rather than a “trust intermediary.”
[1] Please compare the Guiding Opinions on the Healthy Development of Internet-based Financing promulgated by the People’s Bank of China, the Ministry of Industry and Information Technology and the Ministry of Public Security on July 14, 2015.
[2] Compare the Circular Special Inspection of Institutions that Conduct Internet-based Equity Financing Activities (Zheng Jian Ban Fa [2015] No. 44) adopted by the General Office of the China Securities Regulatory Commission on August 3, 2015.
[3] The second instance civil decision in the matter involving the disputes between Beijing Nomido Food and Beverage Management Ltd. and Beijing Fit Net Technology Co., Ltd. over their intermediary contract [2015-One-Chong-Min-(Shang)-Zhong-No.0922].
[4] Wei Chen and Chongying Li, Analysis of Focused Issues of Internet-based Non-public Equity Financing Business and Prevention of Legal Risks Ð Perspectives from Recent Disputes over Financing Projects Involving Some Platforms, published in the WeChat ID for the Hot Legal Topics on Legal and Commercial Net on June 29, 2016.
[5] Feifan Li, Plunged into the Vortex of “Alleged Fraud” for Equity Crowd Funding Projects, published on TMT post ( on June 13, 2016.