Investor Protection Calls Grow for Crowdfunding Regulation

Germany’s Small Investor Protection Act is only a year old, but already consumer advocates want further regulation, including of crowdfunding platforms.
An Osram shareholders' meeting in Berlin. Calls are growing to protect investors in crowdfunding projects.

The bankruptcy of wind energy operator Prokon was a wake-up call for German politicians. Tens of thousands of investors, lured by big returns of Prokon’s profit-sharing model, lost €1.4 billion, or $1.6 billion.

So Germany’s ruling coalition — the center-right Christian Democrats, their Bavarian allies in the Christian Social Union and their junior partner, the center-left Social Democrats — last year came to an agreement on legislation to protect small investors.

The law is barely a year old now, but already it is coming under fire for not doing enough, especially when it comes to “crowdfunding,” the darling of small investors and startups worldwide.

Germany’s Small Investor Protection Act mostly targeted the so-called “gray capital” market — that area of financial trading that is far less regulated and controlled than, for example, publicly-listed stocks and bonds. In this area of financial markets, the new law provided more effective intervention rights for the German Federal Financial Supervisory Authority, or BaFin.

On the other hand, the law set out to not interfere much with the way promising startups raise risk capital via special financing platforms, known as crowdfunding.

Now a year after the law took effect, the German Advisory Council for Consumer Affairs is calling for changes.

The council consists of experts who advise the Federal Ministry of Justice and Consumer Protection. At least one member, Andreas Oehler, said exceptions for crowdfunding in the small investor law were unfounded.

Mr. Oehler, a professor of finance at Bamberg University, called for BaFin supervision not only of crowdfunding investments, but also of internet platforms through which they are financed. Currently only chambers of commerce and industry and trade supervisory boards are responsible.

The investment and financing forms of crowdfunding should be regulated as financial instruments. Andreas Oehler, German Advisory Council for Consumer Affairs

The platforms are treated like financial investment facilitators, “but in reality, their activities go far beyond that,” said Dorothea Mohn, also a member of the Consumer Advisory Council. “They not only broker investment projects, but they evaluate them and then present a screened selection on their platform.”

When the government coalition drafted the law it came to a compromise on crowdfunding, in order to not completely destroy the platforms’ business model. The obligation for producing a relatively expensive prospectus does not apply to investment projects below €2.5 million, for example. The exceptions are limited to financing through so-called profit participating loans and subordinated loans and comparable products.

Mr. Oehler doesn’t think much of this. “The investment and financing forms of crowdfunding should be regulated as financial instruments, according to the securities trading act and placed under supervision,” he said.

Exceptions in the act are also unclear and “therefore counterproductive in protecting investors,” Mr. Oehler said at an event in Berlin. Moreover, they only serve to make the comparison of capital investments more difficult.

Jamal El Mallouki, managing director of the CrowdDesk platform and chairman of the recently formed German Crowdfunding Association, sees it differently.

Current regulations should even be relaxed, he argued. It makes no sense in the long run, said Mr. El Mallouki, that exceptions are limited to profit-participating loans, subordinated loans and others.

“A number of platforms would like to use other mezzanine and equity instruments — for example, secured profit participation rights — to better position investors,” he said.



He also said the prospectus obligation threshold should be raised to €5 million.

“Instead of putting together a vast and comprehensive prospectus, we would rather contribute to financial education so investors better understand what they are investing in,” Mr. El Mallouki said.

He explained that private investors already must provide information about their investment experience before completing the investment. If their experience is limited, they are told: “You are not capable of making an adequate judgment of the investment.” But this doesn’t prevent him from investing.

Consumer council member Ms. Mohn believes crowdfunding is a great idea, “but is simply too risky for small investors.”

Private investors can invest up to €10,000 per project on crowdfunding platforms, she noted. “That is much too much,” Ms. Mohn argued.

Instead, she favors not actively offering gray market products to small investors. “The risks that investors must take here are only suitable for using expendable money,” she said.

Gerhard Schick, the finance policy spokesperson for the Green Party, also believes the current law is not strict enough. He cited an investigation by the consumer advice center in the state of Hesse, which found that 80 of 91 gray capital market products advertised lacked transparency.

“As expected, the federal government hasn’t succeeded in taming the gray capital market with its Small Investor Protection Act,” he said.

It remains to be seen whether the finance ministry and ministry for justice and consumer protection will act on concerns of the consumer affairs advisory council and others.

Junior consumer protection minister, Gerd Billen, cited an ongoing evaluation of the legislation. Results are expected at the end of the year.

In Mr. Billen’s opinion, the act has basically proven successful. “We have to learn in Germany that we must let a delicate flower grow a bit,” he said.

This isn’t a matter of neglecting consumer protection, but is more of a cultural exercise. “We shouldn’t always first look to see what we can regulate. But instead also have a greater willingness to sometimes allow things to happen,” he said.

Lawmakers should be flexible, said Mr. Billen, a former chairman of the Federation of German Consumer Organizations. Private investors should already be aware that crowdfunding includes risk, he said.

Tamo Zwinge, founder and managing director of the crowdfunding platform Companisto, underscores this. Investors, he said, are constantly made aware that their involvement can result in a total loss.

Companisto is one of the major financing platforms in Germany. Mr. Zwinge is campaigning to keep exceptions for crowdfunding in the Small Investor Protection Act.

There are hardly any others providing services like Companisto, he noted: “We have observed a systemic failure in the financing of innovative ideas in Germany.”

And there is room to grow. According to the industry website, the volume of financing for crowdfunding in Germany was only about €50 million in 2015. Experts, however, expect 30 percent annual growth in the market.


Frank Drost reports on the banks and politics from Berlin, Katharina Schneider is a finance correspondent for Handelsblatt. To contact the authors: [email protected], [email protected]