The German Bundestag has adopted the Small Investor Protection Act on 23 April 2015, which will enter into force in the coming weeks. By this Act the German legislator establishes for the first time – among other things – a regulation of the German crowdfunding market. This article describes the content of the act as relevant to crowdfunding, identifies its probable consequences, and examines the most important rules with respect to their regulatory effects. The authors conclude that despite some modifications that have been made in the course of the legislative process there still is an urgent need of improvement regarding some provisions.
Articoli Correlati: crowdfunding - Germania - diritto comparato - piccoli investitori
I. The German Crowdfunding and Crowdinvesting Market - II. Legal Situation Preceding the Small Investor Protection Act and Issuances - III. Comparative Law Environment - IV. Content - 1. Exemption from the Prospectus Requirement - 2. Investment Information Sheet - 3. Subscription Limits - 4. Advertisement - 5. Duties of the Portals - 6. Regulation of the Secondary Market - V. Critique - 1. Exemption from the Prospectus Requirement - 2. Investment Information Sheet and Signature and Confirmation Requirement - 3. Subscription Limits - 4. Advertisement - 5. Duties of the Platforms - VI. Suggestions for Improvement - NOTE
The promise of the Grand Coalition of the current German government to create a “reliable legal framework” for “new forms of financing such as crowdfunding” 1 is, supposedly, poised to be fulfilled. On 23 April 2015, the German Bundestag (Federal Parliament) passed the Small Investor Protection Act (Kleinanlegerschutzgesetz) in its second and third reading 2, which for the first time contains regulation specifically for project and company financing through specialized internet platforms (crowdfunding and crowdinvesting) 3. If the German Bundesrat (Federal Council) 4 approves the act – which is assumed to be the case – it will enter into force in the coming weeks 5. The first Discussion Draft 6 and the Draft Act of the German Federal Government 7, which successively had been circulated since July 2014, have engendered criticism not only from the part of the German crowdinvesting industry 8, but also from academic literature 9. The Finance Committee of the Bundestag (Finanzausschuss) has engaged in an attempt to address these concerns in a last-minute recommendation 10, which resulted in the adoption of the Small Investor Protection Act reflecting the proposed amendments 11. The crowdfunding and crowdinvesting market is interesting not only from a legal perspective but also from an economic point of view: In Germany there are now approximately 80 crowdfunding platforms through which companies, real estate acquisitions, and projects from various other business and consumer areas are financed. The market for internet-based company financing (crowdinvesting) 12 alone has reached an impressive volume 13: At 18 May 2015, German crowdinvestingportals such as Seedmatch, Companisto, and Innovestment had undertaken more than 174 financingswith a volume of almost € 41 million (excluding real estate and movie crowdinvesting). The following figures show the development of the market (Figure 1) as well as the distribution of the total issuance volume of the 174 financings (Figure 2). (Figure 1) Figure 1. – Development of the crowdinvesting market in Germany (as of 18 May 2015) (Figure 2) Figure 2. – Issuances in the crowdinvesting market (as of 18 May 2015) 14. Investors sometimes invest four-or even five-figure amounts in companies, most frequently they are content with smaller investments. The following overview, based on the [continua ..]
Before the adoption of the Small Investor Protection Act neither crowdfundingn or crowdinvesting were specifically regulated in Germany 17. Its legal framework was found in general laws governing banking, capital markets, and trade regulation 18. The parties involved in crowdinvesting tried to avoid falling within the scope of this regulation to the greatest extent they could. Initially, crowdinvesting platforms brokered silent partnership interests and profit-participation rights, these being investments as defined by the German Investment Act (Vermögensanlagengesetz – VermAnlG). As these offerings did not exceed the threshold of € 100,000 per year, they qualified for an exemption from the prospectus requirement, § 2 no. 3 lit. b) Investment Act (as valid prior to the amendment). Since about November 2012, the platforms have moved to brokering subordinated profit-participating loans, these being roughly defined as loans (1) for which the interest rate depends on profits or revenue of the borrower, (2) which give the lender no rights in management of the borrower, (3) through which the lender has no exposure to losses of the borrower, and (4) which rank below other debts in an insolvency proceeding 19 (partiarische Nachrangdarlehen). Because profit-participating loans did not qualify as investments under the Investment Act they permitted issuances in unlimited amount without a prospectus 20. Such offerings have experienced enormous demand in some cases. For example, the start-up Protonet took in € 200,000 in profit-participating loans in 48 minutes on 29 November 2012. Five issuers have taken in amounts of over € 1 million. Until now, crowdfunding and crowdinvesting platforms 21 have been subject only to trade regulation pursuant to § 34c para.1 no. 2 and § 34f of the German Trade Regulation Act (Gewerbeordnung – GewO). They are not required to obtain a banking license under the German Banking Act (Kreditwesengesetz – KWG) since they – even if they were to broker investments within the definition of the Investment Act – fall under an exemption from its ambit in § 2 para. 6 no. 8 lit. e) of the Banking Act 22. Likewise, the German Capital Investment Regulation (Kapitalanlagegesetzbuch – KAGB) does not cover typical crowdfunding or crowdinvesting models 23.
The German legislator does not enter virgin territory by regulating crowdfunding and crowdinvesting. Comparable regulation already exists in the United States (US), where the federal government has fashioned a tightly-knit legal fabric two years ago with the CROWDFUND Act (Title III of the JOBS Act) 24. At the center of this regulation is an exemption from the prospectus requirement for the offering of securities through defined “funding portals” up to an amount of US$ 1 million. In place of the prospectus requirement there are less stringent disclosure obligations depending on the amount of capital collected. In addition, the US legislation provides for strict subscription limits for investors and detailed duties of the “funding portals”, and prevents the development of a secondary market by a resale prohibition on shares issued without a prospectus for one year after the offering. Other national legislators have adapted and modified parts of this regulatory scheme, most prominently the United Kingdom, France, Italy, and Austria 25.
The German Small Investor Protection Act closely follows the basic approach taken in the US model. The centerpiece of the act with respect to crowdfunding and crowdinvesting is the newly created § 2a Investment Act (VermAnlG), which establishes an exemption from the prospectus requirement stipulated in § 6 Investment Act for investments as defined by the Act. This “crowdfunding exemption” is required, because § 1 para. 2 Investment Act as amended by the Small Investor Protection Act defines investments covered by the Act to include profit-participating loans, subordinated loans, and similar forms of financing – the forms of investment currently brokered by crowdinvesting platforms 26. The exemption applies only if the following conditions are fulfilled: – The offering must be of investments within the meaning of § 1 para. 2 no. 3, 4 or 7 Investment Act as amended by the Small Investor Protection Act, that is, of profit-participating loans, subordinated loans, or other similar financing forms and investments, which are subject to a prospectus requirement for the first time because of the revisions contained in the Small Investor Protection Act. – The aggregate value of these investments issued by the company must not exceed € 2.5 million 27. – The investments must be offered exclusively by means of investment consulting or investment brokerage via an internet platform. The exception does not extend to an issuer executing a direct offering without an internet brokerage platform (as was done in the case of the Bavarian company Giesinger Bräu). – The crowdinvesting platform must have a legal obligation to monitor the subscription limit described below; it must be an investment service enterprise within the definition of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG) or be subject to monitoring by general trade regulatory authorities under § 34f Trade Regulation Act (GewO) 28. – Finally, the exemption cannot be relied upon if an investment of the issuer is being offered publicly under § 2 para. 1 no. 3 Investment Act or if a previous investment offering of the company in reliance on the exception has not been fully satisfied and redeemed.
Despite the absence of a prospectus requirement, §§ 13, 14 Investment Act require the issuer to prepare an investment information sheet (Vermögensinformationsblatt – VIB) and to submit it to the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). The investment information sheet, thus, has the function of making essential information about the investment available to potential investors. § 13 para. 3a Investment Act requires that the investment information sheet contain a notice that no prospectus was prepared for the offering. Moreover, § 13 para. 6 Investment Act requires that the investment information sheet include a highlighted warning notice on its first page to be worded as follows: “The purchase of this investment is associated with significant risks and can result in a total loss of the money invested” 29. Under § 15 para. 1 Investment Act the issuer is required to provide every purchaser or potential investor with the investment information sheet as text and upon request in paper form. Pursuant to § 15 para. 3 Investment Act, every investor must confirm the understanding of the warning with a signature containing the place and date of signature and the investor’s first and family name on the investment information sheet itself. If – as is typical in the crowdfunding context – the investment contract is negotiated and concluded exclusively by means of distance communication, § 15 para. 4 Investment Act requires the investor to confirm the understanding of the warning in a manner legally equivalent to the signature requirement. Pursuant to § 15 para. 4 sentence 2 Investment Act, a confirmation is deemed to be legally equivalent if the investor submits such confirmation in a way that unequivocally reveals his or her identity 30. According to the legislative materials the investor shall specify his or her name, address, the number of his or her identity card or another adequate piece of identification, and the e-mail address or telephone number to reveal his or her identity 31. In § 15 para. 5 Investment Act the legislator authorizes the Federal Ministry of Finance in consultation with the Federal Ministry of Justice and Consumer Protection to prescribe by regulation the conditions under which a confirmation is legally equal to a signature.
As does the CROWDFUND Act, the exemption from the prospectus requirement in § 2a para. 3 Investment Act requires investors which are not corporate entities to stay within certain subscription limits. Unlike the US model, German law only limits the amount that an investor may invest in the same issuer (single issuer limit), but not the amount that an investor may invest in the entire crowdfunding market (aggregate limit). As under the US statute, the exact amount of the subscription limit depends on the investor’s freely available assets and monthly net income (§ 2a para. 3 Investment Act): If the investor provides a statement that he or she has freely available assets of at least € 100,000, he or she can invest up to a maximum of € 10,000 in an issuer. If the investor does not have that amount of assets, the limit is twice the investor’s monthly net income, but in any case not more than € 10,000. In all other cases (i.e. particularly if the investor does not provide the statement on assets and income), the investor is limited to a maximum investment of € 1,000. While the Draft Small Investor Protection Act did not make a distinction between potentially different types of investors such as, e.g., small and professional investors, the current subscriptions limits only apply to “investors which are not corporate entities”.
While the Draft Small Investor Protection Act provided for a strict regulation of advertisement for investment offers, the legislator dropped the major limitations in the course of the legislative procedure. The remaining provisions merely require notices and warnings, which have to be published together with the advertisement. Pursuant to § 12 para. 2 Investment Act, the issuer has the obligation to include the same warning notice underlining the risk of a total loss of the investment as in the investment information sheet 32. If the advertisement for an investment contains information on its return not consisting in a fixed interest rate, § 12 para. 3 Investment Act requires an additional notice stating that the promised return is not guaranteed. In the case of advertisements in electronic media containing less than 210 letters, the legislator, as a concession in particular to crowdfunding portals, reduced these requirements to the provision of a clearly highlighted link labeled “warning” and referring to a separate document with the warning notice. Finally, the Small Investor Protection Act expands the enforcement powers of the German Federal Financial Supervisory Authority (BaFin). § 16 para. 1 Investment Act authorizes BaFin to prohibit issuers and offerors certain types of investment advertising in order to address wrongful advertising practices.
Although German law has drawn strongly from the CROWDFUND Act in the preceding points, the crowdfunding portals remain almost entirely unregulated. The only new point is the duty to monitor the subscription limits in § 31 para. 5a of the Securities Trading Act 33.
The secondary market remains largely unaffected by the new regulation. In particular, the German legislator does not follow the US approach in establishing resale restrictions. Disclosure duties in the secondary market are regulated only in a very rudimentary fashion. Issuers of investments falling under § 2a Investment Act, in deviation from § 23 para. 2 no. 1 and § 24 para. 1-4 Investment Act, are neither required to publish a management report nor to audit their annual financial statements, unless stipulated otherwise (§ 2a para. 2 Investment Act). While new disclosure duties subsequent to the termination of the public offering have been introduced in § 11a Investment Act, these duties shall not apply to investments covered by the crowdfunding exemption (§ 2a para. 1 Investment Act).
The Small Investor Protection Act contains good ideas, but has significant deficiencies. Overall, it does not do justice to the economic potential of crowdfunding and crowdinvesting nor can it be expected that it will materially improve investor protection. Thus, the legislator is called upon to further improve the new legal framework.
It is welcome that the Small Investor Protection Act seeks to promote crowdfunding and crowdinvesting with an exemption from the prospectus requirement. Nevertheless, the increase of the maximum aggregate value of investments being exempt from the prospectus requirement from € 1 million according to the Draft Act to € 2.5 million will barely have a positive effect on the evolution of the already stagnating German crowdinvesting market. Until now, only three crowdinvestings exceeded € 2.5 million, indicating that the new ceiling does neither unleash nor restrict the volume of forthcoming issues. Furthermore, since earning an extraordinary return with crowdinvesting is rare and insolvencies are much more frequent, investors are not longer that keen on investing in this new asset class. It is nearly grotesque, however, that the exception from the prospectus requirement should be available only for profit-participating loans, subordinated loans, and similar investments 34. The only reason that might explain the restriction is that profit-participating loans, subordinated loans, and similar investments have not been subject to the Investment Act previously, so that § 2a Investment Act cannot be the basis for accusing the legislator of relaxing the prospectus requirement for investments generally. However, that justification is entirely unconvincing. On the contrary, the restriction of the crowdfunding exemption in § 2a Investment Act to profit-participating loans, subordinated loans, and similar investments is illogical, does not eliminate existing legal uncertainty, and creates risks for investors. The need for investor protection is not less for profit-participating loans, subordinated loans, and similar investments than for other investment types, for example silent partnerships or profit-participation rights. What matters are the specific terms of the investment and the information gap between investor and issuer. Under German law, a silent partner is typically even better protected than the creditor holding a profit-participating loan, because the silent partner has greater informational rights and is protected by the statutory default rules contained in §§ 230 ff. of the German Commercial Code (Handelsgesetzbuch – HGB). Profit-participating loans in contrast have no statutory regulation at all. Ironically, this form of investment is now to be excluded from the prospectus requirement [continua ..]
That issuers of investments must prepare an investment information sheet and submit it to the German Federal Financial Supervisory Authority (BaFin) even if they do not have to write and submit a prospectus is a welcome development. Also being required to send the information sheet to every investor and to any interested person upon request does no harm. In general, the same is true for the requirement of investors to confirm the understanding of the warning notice included in the investment information sheet by signature or – in the case of distance communication – by electronic confirmation legally equivalent to the signature. This provision is intended to ensure not only that investors have actual notice of the investment information sheet, but, above all, are aware of the potential risks associated with the investment, especially the risk of the total loss of the assigned capital. There was one major point of criticism on the signature requirement that both crowdfunding platforms 44 and legal literature 45 have addressed in the legislative process. The Draft Act did not provide for an exception from the signature requirement for investment contracts negotiated and concluded exclusively by means of distance communication 46. This invited strong criticism of causing “media disruption”, not taking account of the digital reality of crowdfunding 47 and causing high transaction costs 48. The newly introduced 49 exemption in § 15 para. 4 Investment Act 50 meets these concerns by permitting an electronic confirmation. It can be argued in favor of this rule that investors in capital markets are a prime example of persons who suffer from overoptimism and overconfidence, i.e., who regularly assume they will have more good luck (and less bad luck) than other people 51, who overestimate their own abilities 52 and judgment 53 and who, therefore, are quick to neglect warning notices – particularly when these warnings are presented in an impersonal manner without connection to the specific situation at hand 54. Eventually, there is a possibility that some of these investors might be motivated by the signature requirement to make better investment decisions. However, we should not expect too much of this new rule. Just as prevalent as overoptimism and overconfidence in one’s own judgment [continua ..]
The warning notice in combination with the signature or confirmation requirement under § 15 para. 3 and 4 Investment Act is only one leg of the investor protection in crowdfunding and crowdinvesting introduced by the Small Investor Protection Act. The second leg is the subscription limits under § 2a para. 3 Investment Act. Here, too, the legislator follows the path taken by the US government, but foregoes, rightly so, the introduction of a market-wide aggregate subscription limit – a rule that, firstly, is difficult to enforce and, secondly, can significantly restrict the investors’ ability to manage risk through portfolio diversification 60. Although well-established in other legal systems, the introduction of a subscription limit is not a self-evident rule 61. Seen from regulatory theory, it is a form of hard paternalism 62. It limits the freedom of the investor on the justification of protecting the investor from himself. This type of rule is foreign to capital markets regulation in principle. Rather, the guiding principle in securities regulation, as Louis Loss, the nestor of US capital markets regulation, already put it so pointedly, is that every investor “has the right to make a fool of himself” 63. Strongly paternalistic rules require special justification in a legal system based on individual freedom 64. There are several good reasons, however, that this requirement is met with respect to the crowdfunding market 65: the low quality of the information that issuers disclose when procuring investor money, the high risk of the investment, particularly for start-up companies, the tendency of investors to underestimate risk 66, as well as the danger of market bubbles developing, above all in crowdinvesting. Thus, there is no case for substantial criticism of the basic regulatory features of the Small Investor Protection Act, but there is a case as to some details: This would be, first of all, the amount of the subscription limits. If someone would like to invest more than € 1,000 in a project or company, the potential investor must disclose his assets and income. How many investors will actually do this cannot be seriously predicted. Assuming that not a few investors decline to do so for fear of losing confidentiality of their financial data 67, the subscription limit of € 1,000 will be a significant obstacle, and be such both [continua ..]
The provisions concerning the investment advertising demonstrate an astonishing turnaround by the German legislator. According to the Draft Small Investor Protection Act advertisement for investments would have been permitted only in the enumerated cases, in particular if it occurred in the press or in media “with at least an occasional concentration also on discussing business and economic topics and it the advertisement is made in connection with such a discussion” (§ 12 para. 1 no. 2 Investment Act in the version of the Draft Small Investor Protection Act). By this provision the legislator aimed to prevent that large-scaled advertising campaigns undermine the effects intended with the investment information sheet to enable investors to make an informed assessment of risks associated with the investments and, thus, to take investment decisions in full knowledge of the facts 73. The Small Investor Protection Act as adopted by the Bundestag, however, does not include any advertising limitations – except the requirement of warning notices and the expanded enforcement power of the German Federal Financial Supervisory Authority (BaFin) to prohibit certain types of investment advertising. On the contrary, most of the advertisements being prohibited previously – i.e. advertisements in electronic media containing less than 210 letters that do not occur in the press or in media with at least an occasional concentration also on discussing business and economic topics – are privileged now by the exemption clause requiring only a link labeled “warning” that refers to a separate document with the warning notice. The legislator hereby facilitates the direct approach of inexperienced investors, rather than channeling advertising to investors who are willing to delve into the information provided by the investment information sheet. In addition to that, it does not counter the confirmation bias and softens the effects intended with the investment information sheet and the signature requirement. By authorizing the German Federal Financial Supervisory Authority (BaFin) to prohibit certain types of investment advertising the legislator extends, at least, a flexible means to address the most extreme cases of unfair or fraudulent advertising.
It is a fundamental mistake of the Small Investor Protection Act that it leaves crowdinvesting platforms almost completely unregulated. General capital markets duties pursuant to §§ 31 ff. Securities Trading Act (WpHG) still do not apply to these platforms. As before, the exemption of § 2a para. 1 no. 7 Securities Trading Act applies to the exclusive consulting or brokerage of investments irrespective of the fact that profit-participating loans can be subsumed as investments under the Investment Act 74. There remains only the general register of duties under German Financial Investment Brokerage Regulation (Finanzanlagenvermittlungsverordnung – FinVermV) enforced by trade regulatory authorities. However, as classic gatekeepers, funding portals offer excellent regulatory access to ensure that the market functions properly 75. That is why their duties are one cornerstone of the CROWDFUND Act 76 and the UK equity crowdfunding regulation 77. The German government should also use this tool to create the conditions for effective competition over financing contracts and to keep snake oil peddlers off the market. The spectrum of possible duties is broad and extends from obligations of investor education and investor communication to unleash the wisdom of the crowd 78, to rules on data security and privacy of customer information, and to an obligation to undertake due diligence on the company investments brokered, in particular to carry out background checks on management personnel and the ultimate beneficiaries of the issuers 79.
1. The exception to the prospectus requirement pursuant to § 2a Investment Act should be granted to all investments within the definition of the Investment Act and to all securities within the definition of the Securities Prospectus Act (WpPG). 2. The legislator should replace or at least complement the subscription and confirmation requirement pursuant to § 15 para. 3 Investment Act by an investor education test developed by the German Federal Financial Supervisory Authority (BaFin) in cooperation with scholars and practitioners to clarify for investors the risks of crowdinvesting. 3. The legislator should raise the limit under § 2a Investment Act that investors can invest independent of their income and assets from € 1,000 to € 5,000. 4. The legislator should exempt professional clients within the meaning of § 31a para. 2 Securities Trading Act (WpHG) from the subscription limits under § 2a para. 3 Investment Act. In doing so, the definition of “professional client” should be adapted for crowdfunding in deviation from § 31 para. 2 sentence 2 Securities Trading Act (WpHG) so that, in particular, typical business angels come within the exemption. 5. The legislator should obligate crowdinvesting platforms to carry out the investor testing referred to in no. 2, to make available and maintain a website for communication among investors, as well as to establish minimum standards for due diligence by the crowdinvesting portals.
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