Doom over crowdfunding?The first enforcement action involving a crowdfunding project was recently brought by the Federal Trade Commission. It involved the development of a board game which did not go well despite a successful crowdfunding campaign. This matter is interesting and instructive not only because it is the first such case, but also because it highlights some of the significant risks inherent in the crowdfunding process. The FTC’s official press release on this matter contains a good summary of the relevant events.

According to the FTC complaint, Erik Chevalier discovered an idea for a board game called The Doom that Came to Atlantic City! This game was designed to be a dark fantasy take on the traditional Monopoly board game. The game had originally been developed by two designers, but Chevalier planned to take their concept and produce and distribute a finished game. To raise money for this venture, Chevalier turned to Kickstarter, probably the best known crowdfunding platform. According to the FTC complaint, Chevalier represented to investors that the funds raised would primarily be used for the development, production, completion, and distribution of this game, and that participants would receive certain rewards, such as copies of the final game and action figures, in return for their participation in this campaign.

This crowdfunding campaign was very successful. Chevalier’s original goal was to raise $35,000, but this campaign raised more than $122,000 for the development of this game. Unfortunately, things went bad as the game development process encountered delays.

According to the FTC complaint, after 14 months Chevalier announced that the game production process would be terminated due to a shortage of funds and that the investors’ money would be refunded. Allegedly, very few investors received any of the promised items or their refunds. The FTC received numerous complaints from investors regarding this cancellation of the game and Chevalier’s failure to pay refunds or to deliver the items that they were promised. While they supposedly perform some review of crowdfunding situations, neither of the top two crowdfunding platforms (Kickstarter and Indiegogo) offer refunds to investors in a situation like this.

The FTC complaint alleged that Chevalier did not use the investors’ funds as promised, but instead used these funds for personal items such as rent for a personal residence, personal equipment, and licenses for a separate project. The FTC complaint also alleged that Chevalier promised to provide an accounting of his expenses to investors, but that accounting was never produced.

The FTC alleged that Chevalier’s actions in this matter constituted a deceptive act or practice in violation of Section 5(a) of the FTC Act, 15 U.S.C. § 45(a). To resolve this matter, the FTC and Chevalier entered into a Stipulated Order for Permanent Injunction and Monetary Judgment. While Chevalier did not admit or deny the FTC’s allegations, Chevalier agreed to pay an $111,793 fine (although this payment obligation has been suspended due to Chevalier’s current financial condition). Chevalier will also be subject to a number of ongoing reporting and compliance obligations and restrictions.

Although the FTC took the lead in this matter, I would look for the SEC to step into the primary enforcement role when the JOBS Act equity crowdfunding rules become effective – and when it’s clearer that a “security” is being offered than was the case here. A significant number of states (including Florida, where the rules are awaiting Governor Scott’s signature) have also recently enacted crowdfunding rules (see my blog post:  “States take the lead on crowdfunding”), but given the intrastate nature of these state rules it is likely that the state securities regulatory agencies will take the lead in enforcement in those situations.

This situation illustrates several important things about crowdfunding. A major problem with crowdfunding is that it is, by its nature, a free and open process. Crowdfunding campaigns often even have a kind of countercultural feeling. This is fine for some aspects of crowdfunding, but unfortunately it can sometimes facilitate the performance of bad acts and fraud by principals. The FTC’s actions in this matter are also instructive and should be closely watched by all crowdfunding participants. It is clear that the FTC (and, by extension, other regulatory agencies) are closely watching crowdfunding activity. The FTC’s very quick and decisive action in this matter shows that the regulatory agencies will not hesitate to use their enforcement powers in the crowdfunding arena.