Crowdfunding fraud litigation and litigation-funding scams

Supported By:

Net Patrol International Inc.  Data Investigation and Forensic Services
Bankruptcy and Insolvency Trustees

There are different options for funding fraud recovery litigation and crowdfunding is a relatively new one.

The concept of crowdfunding is a phenomenon that has evolved as a result of e-commerce. It can be summarized as a website portal for individuals to offer financial contributions for projects that they believe in. The project creator sets a target for the funding, such as $250,000. If the target is reached the site takes a commission, such as 5%. In return for their respective contributions, investors are offered rewards instead of financial compensation. Contributions can be stipulated to be any amount the project creator deems reasonable.

So for example, if you fund the writing of a book you may receive a copy of the finished work before it is released to the general public. Some crowdfunding websites offer funding for ventures in such categories as the Arts, Design, Fashion, Film, Games, Music, Photography, Publishing, Technology, and the Theater. Essentially, it could be any idea, even the funding of litigation (although the Law Society of Upper Canada may have some concerns about ‘champerty’, an illegal agreement in which a person with no previous interest in a lawsuit finances it with a view to sharing the disputed property if the suit succeeds). And the compensation for investment can take many forms, including an equity position in the start up venture.

Fraudulent crowdfunding opportunities

Crowdfunding is susceptible, however, to fraud as funds could be requested by a company that has no intention of producing a product or of providing the services being promoted. As a result of this concern, on June 11, 2013, the Ontario Securities Commission (“OSC”) hosted an investor roundtable” to hear from investors and potential investors on investing in start-ups and small and medium sized enterprises (“SMEs”). This event focused primarily on an OSC concept idea that contemplates allowing businesses to sell shares through equity crowdfunding.

FAIR Canada’s Ermanno Pascutto represented investor interests on the OSC’s panel, along with long-time investor advocate and former OSC Commissioner, Glorianne Stromberg. Both voiced serious concern over this concept idea and opposed the introduction of equity crowdfunding in Ontario. Brian Koscak of the Exempt Market Dealers Association of Canada represented the industry perspective and spoke in favour of allowing crowdfunding if certain regulatory protections are put into place. While billed as an “investor” roundtable, the event was attended primarily by industry representatives, including those involved in running or servicing SMEs, and who stands to benefit from a potential crowdfunding exemption.

“No one in their right mind would want to invest on a platform that consistently wears the Scarlet letter of Fraud” – Alois, 2015 (Read more).

While the OSC has publicly stated that it has not decided on whether it will proceed with the crowdfunding concept proposal, it has taken a step in that direction by granting an exemption from know-your-client and suitability requirements to MaRS VX, permitting it to operate an online portal that will “bring together” accredited investors and issuers that are social impact and/or environmental impact issuers. This exemption was granted in the absence of public consultation, despite its direct relevance to the current debate about the appropriateness of current exemptions (especially the accredited investor exemption), crowdfunding, and investor protection. For further information, see the website.

If you have concerns that a crowdfunding opportunity may be a fraud, we refer you to the following links: 


Crowdfunding for funding fraud recovery

With respect to using crowdfunding to fund fraud recovery litigation, as mentioned above, the Law Society of Upper Canada may have concerns about “champerty.” The common meaning of “champerty” is buying into (or investing into, or betting on) someone else’s lawsuit. The concern of legal regulators is that it promotes and encourages vexatious litigation. However, in modern times, legal regulators have permitted contingency litigation to permit impecunious plaintiffs the option of retaining counsel to “invest” in their litigation. In other words, access to justice ideals trump vexatious litigation concerns. Most contingency litigation currently takes place in the personal injury bar where recovery is primarily sought from insurance companies. In fraud recovery litigation, recovery from insurers is often not available and therefore the risk is higher.

In April 2012, the government charged three people with cheating individuals out of $15 million through three litigation-funding scams. In the first scheme, a company promised its investors 15 percent of any plaintiffs’ recoveries from the suits. But rather than investing the investors’ money in litigation, they wired investors’ money to overseas bank accounts. Prosecutors say about 200 U.S. and Canadian investors lost $11 million from the scam. You can read more about the schemes in this article.

Other concerns relating to third party funding of fraud recovery litigation is whether the fraud victim’s solicitor-client privilege is waived by permitting others to invest in their litigation. This concern has been addressed in various cases such as Re Kaiser, where the Court held that the identity of the persons paying for the litigation was privileged and need not be disclosed. The downside for the investor is that as an outsider to the litigation, they are not provided access to the privileged communications of the lawyer and fraud victim, thereby making it difficult to analyze precisely the risks in what they are funding.

The global crowdfunding industry is growing and was responsible for between $3 and $5 billion in funding in 2013. It is one of those game-changing concepts that disrupts the traditional industries and players.