Crowdfunding enables fledgling businesses to tap into a vast online pool of investment dollars, but it also has a dark side, offering a lucrative new venue for scam artists.
On Thursday the Federal Trade Commission announced its first-ever crowdfunding case, alleging that more than 1,200 investors were duped into funding the creation of a board game that never came to be.
The case may signal a new era of closer government scrutiny for crowdfunding, an umbrella category that includes not only websites like Kickstarter, where funders often do not hope to get their money back, but also peer-to-peer lending platforms, where investors do expect to be repaid.
Helen Wong, an FTC attorney, said in an interview Thursday that the agency is looking to stamp out fraud across different types of crowdfunding.
"We hope to deter fraudulent actors from misusing these platforms," she said. "And we are currently looking at all of the different crowdfunding models."
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So far, the P-to-P lending industry in the United States has avoided the taint that comes with fraud. Other countries, including China, have not been so fortunate.
But with the number of U.S.-based loan platforms now estimated to be in the hundreds, some observers believe that cases of fraud here are inevitable.
"I think it's just a matter of time," said Rick Eckman, a partner at the law firm Pepper Hamilton. "In my mind there's no doubt that there could be instances where bad actors get involved with the business."
Arguably, investor-protection rules have limited the growth of U.S. peer-to-peer lending, which is sometimes called marketplace lending.
In order to sell their loans to anyone other than accredited investors who generally have a high income, a net worth of $1 million or more, or both loan platforms must undergo an expensive and time-consuming registration process with the Securities and Exchange Commission.
Some in the marketplace lending industry have called for streamlined regulations. Any instances of fraud could complicate that effort.
In the case announced Thursday, an Oregon man named Erik Chevalier allegedly raised more than $122,000 on Kickstarter, purportedly to fund the production of a board game called "The Doom That Came to Atlantic City." The game's players were supposed to compete against each other by trying to destroy New Jersey's beachfront gambling mecca.
The game's financial backers were promised various gifts, depending on the size of their donation. For example, those who pledged $100 or more were promised a copy of the game, along with eight pewter miniature figurines. In a number of online updates, Chevalier stated that he was making progress on the game, according to a complaint filed Wednesday in U.S. District Court in Oregon.
But "Doom" was never made, and the FTC alleged that Chevalier used most of the money on unrelated personal expenses, including rent.
"Many consumers enjoy the opportunity to take part in the development of a product or service through crowdfunding, and they generally know there's some uncertainty involved in helping start something new," Jessica Rich, director of the FTC's consumer protection bureau, said in a news release. "But consumers should be able to trust their money will actually be spent on the project they funded."
As part of a settlement order, Chevalier faces an $111,000 judgment that is suspended because of his inability to pay. He is also prohibited from making misrepresentations about any crowdfunding campaign.
Chevalier could not be reached for comment Thursday. In July 2013, when he announced that the game's creation was being canceled, he wrote on the Kickstarter page: "I never set out to con anyone or to perpetrate a fraud, but I did walk into a situation that was beyond my abilities and for that I'm deeply sorry."
The Federal Trade Commission's case left unanswered questions about whether crowdfunding platforms like Kickstarter bear any responsibility for fraud that others perpetrate. Analogous questions could arise in peer-to-peer lending if a borrower lied on the loan application and later defaulted on his obligations.
In a Twitter chat Thursday, the FTC was asked about the platform's responsibilities, and gave a noncommittal response: "This case is specific to the project creator's deception. Can't speak to platform's liability generally."