Fraud and False Promise

The following article deals with fraud in crowdfunding. See the main article for an overview of the Disputes in Crowdfunding.

Fraud is a deception deliberately practiced in order to secure unfair or unlawful gain. As crowdfunding becomes mainstream, the potential for fraud will inevitably increase. In order for it to become a viable and lasting means of funding for emerging companies, fraud has to be limited; unsuspecting contributors, donors and investors must be protected. In crowdfunding there can be differentiated three major types of scams: fraud from the creator or fraud from the backer and false promises from the creator.

File:Schema fraud.pdf

Creator fraud

With a crowdfunding campaign the creator asks for money from backers. In case of fraud from the creator, he is using deliberately misleading pretenses about the project or the expected outcomes.

“Stillborn Fraud” occurs when a campaign that is submitted for launch is summarily rejected by the platform. While campaigns are rejected for a variety of reasons ranging from technical errors to merely being incomplete, there are certainly many that get rejected because they carry a risk of fraud. They are filtered out before they are ever launched. crowdfunding platforms avoid suspicious projects as they can be damaging its reputation badly.

In cases of “attempted fraud” a creator will try to use a crowdfunding platform to attract money from unsuspecting backers. They are good examples of how the transparency and public nature of crowdfunding platforms attract these attempts at fraud. The effect of the Wisdom-of-the-Crowd does an effective job of “outing” most attempts before money changes hands. The platform shuts down a suspicious crowdfunding campaign before any money changed hands. It is often discovered by members of the site, many who are just observers as opposed to contributors. Discussion often happens in public forums and the platform administrators are alerted. In these cases, the nature of fund exchange proved an important safeguard for those backing a campaign.

Kobe Beef Jerky

Kobe Beef Jerky

On crowdfrauds.com the article “Kobe Beef Jerky – Biggest Crowdfunding Scam Yet?” talks about such a fraud from a creator. This case is referred as “one of the biggest frauds in Kickstarter’s history.” The backers luckily discovered the scam just in time. The project quickly raised more than $120,000 in funding, nearly 50 times the campaign’s financing goal. That is when backers and other members of the site began to grow suspect. The scam started to unravel when the “Kickstarted” documentarians hired a private investigator to look into the campaign’s creator, Magnus Fun Inc.. They found several strange details about the company and published their findings. Soon after, the suspicions went viral, and users began to flag the campaign. Kickstarter eventually shot down the project before its conclusion and prevented an astronomical fraud of $120,309.

Backer fraud

Fraud in crowdfunding is not limited to project creators. There has been at least one reported case where a contributor has deliberately pledged money to crowdfunding campaigns with the intent to withhold the funds or to file a claim to get their money refunded. The backer mostly pledges a high amount. After the campaign was successfully founded and once his rewards had shipped, he rescinds his money through credit card chargebacks, receiving both the reward and the money. These cases are very difficult to bring to court because the backer can easily stay anonymous. But the damage for the creators can be immense. Officially their project got funded, so they have to provide their backers with their product.

Victims of Backer Scam

A Kickstarter donor, Encik Farhan, appears to have been pledging large amounts of funds, only to withdraw the cash after he received the rewards. Farhan used a system known as the credit card chargeback, scamming more than 100 Kickstarter project owners in the process. Farhan just changed the way that Kickstarter operates its funding and rewards program. The credit card chargeback was created to protect buyers from fraud and merchant negligence. The credit card company investigates, and in most cases, the credit card owner gets his money back. When a chargeback is rendered, the bank immediately refunds the proceeds to the winning party.

False Promise

In case of a false promise the project creator fails to deliver the promised reward to the backers after they paid money via crowdfunding campaign. Often these cases are not brought to court because the money each backer invested is not worth the effort.

In the Terms of Use of Kickstarter is written” if a creator is unable to complete their project and fulfill rewards, they’ve failed to live up to the basic obligations of this agreement. To right this, they must make every reasonable effort to find another way of bringing the project to the best possible conclusion for backers.” This reasonable effort includes among others showing by updates on the page of Kickstarter what work has been done, how funds were used, and what prevents them from finishing the project as planned and they offer to return any remaining funds to backers who have not received their reward (in proportion to the amounts pledged), or else explain how those funds will be used to complete the project in some alternate form. And later on: “The creator is solely responsible for fulfilling the promises made in their project. If they’re unable to satisfy the terms of this agreement, they may be subject to legal action by backers.”

Asylum Playing Cards

Asylum Playing Cards

This dispute is apparently the first consumer protection lawsuit involving crowdfunding. The project was launched on Kickstarter in 2012 and funded successfully by 810 backers. Over two years passed after the completion of the Kickstarter campaign and the transmission of the funds but not a single consumer has received the promised reward. The Kickstarter campaign raised funds to create a set of Asylum playing cards, and the campaign promised the retro-horror-themed playing cards, posters and signed sketches from a Serbian artist as rewards. In May 2014 the attorney general for the state of Washington has filed a lawsuit against Altius Management and owner Edward Polchlepek III, also known as Ed Nash. Several backers had tried to contact the project creator over the two years. Kickstarter’s terms of use require creators to fulfill all rewards of their projects or refund backers. Backers have a legal recourse if creators do not fulfill their promises.