Sahar Iqbal
Akhund Forbes, Karachi
sahar.iqbal@akhundforbes.com

Introduction

Crowdfunding is the process of raising large amounts of money from a large number of individuals to finance a new project, and it has completely changed the financial industry. Even while it has democratised currency access and disrupted long-standing financing norms, its introduction into developing countries such as Pakistan poses moral, legal and financial challenges, especially with regard to the crucial problem of asset tracing and recovery in the event of a crisis. Legal professionals must understand how crowdsourcing operates within Pakistan’s institutional, legal and financial frameworks in order to fully appreciate both its advantages and disadvantages, particularly with regard to safeguarding contributors’ money and guaranteeing a feasible recovery route.

Fundamentally, there are four types of crowdfunding: debt-based (often referred to as peer-to-peer or P2P lending), equity-based, rewards-based and donation-based. Different legal considerations are invoked by each model, ranging from consumer protection, anti-money laundering (AML), taxation and securities regulation. The risk of fraud, investor abuse and financial system instability has made thorough regulatory regulation of equity and debt crowdfunding models necessary on a global scale. In countries such as Pakistan that have expanding capital markets and changing regulatory frameworks, these issues are just as important, if not more so.

As a financial model, crowdfunding is not a primitive practice but quite a recent one. The most prominent example was observed in 1997 when a British rock band, Marillion, raised USD 60,000 through its loyal fans when the band was unable to tour the US.^[1] There is a reason why this incident is attributed to crowdfunding, and it is because it was the first time where people’s attention was drawn in and they thought ‘this can be done’, and hence, the concept has gained traction since then.^[2]

Regulatory framework in Pakistan

Securities Exchange Commission of Pakistan

The most important of them is the Securities and Exchange Commission of Pakistan (SECP), the primary regulatory body overseeing corporate finance and securities markets. The increasing importance of crowdfunding has been acknowledged in the SECP’s Fintech Roadmap 2019 and other consultative documents. However, as of right now, there is not a clear and thorough legal framework that considers the special traits and risks of crowdfunding websites. Because there are no obligatory criteria for record-keeping, client fund segregation or regulatory cooperation, it is difficult to follow the money trail in a fraud investigation. This regulatory void is the biggest barrier to effective asset recovery.

Securities Act 2015

The Securities Act 2015 is crucial for controlling securities issuance and ensuring investor protection. Equity-based crowdfunding may fall under this Act depending on its structure, particularly if public offer thresholds are surpassed. This has important regulatory ramifications for platforms hoping to facilitate capital raising through share issuing. Even though the Act gives people the legal right to sue for deception, it does not provide any useful advice for tracking down assets that have been quickly lost due to intricate digital transactions. If the decision cannot be executed against identified assets, it is a pointless legal win.

Anti-Money Laundering Act 2010

The Anti-Money Laundering Act 2010 (AMLA) must also be followed by platforms that deal with money. To stop illegal money flows, this regulation mandates stringent Know Your Customer (KYC) protocols, customer due diligence and the reporting of suspicious transactions (STRs). Although it is frequently reactive, this law is an essential asset tracing tool. Theoretically, these actions ought to give investigators an audit trail. In reality, though, uncontrolled crowdfunding platforms frequently lack strong compliance frameworks. In addition to serving as conduits for illegal finance, platforms that neglect to conduct adequate AML checks put victims and investigators at a loss when attempting to track the movement of embezzled money.

State Bank of Pakistan

Moreover, the State Bank of Pakistan (SBP) oversees businesses involved in lending and financial intermediation. Any crowdfunding platform that participates in peer-to-peer (P2P) lending or similar debt-based models would likely fall under the SBP’s regulatory jurisdiction under current or prospective non-banking financial company (NBFC) rules. For both operators and investors, the absence of a particular licensing system for these types of enterprises creates uncertainty. This uncertainty puts investors in a legal bind in the event of a platform failure, leaving them unsure of their creditor rights and without a clear supervisory authority to manage the platform’s liquidation and loan portfolio recovery.

Crowdfunding in light of the Companies Act 2017

Section 84 of the Companies Act 2017

Section 84 of the Companies Act 2017, which prohibits the taking of deposits from the general public, has significant legal implications for the structure and operation of crowdfunding platforms, particularly those engaged in debt-based or peer-to-peer (P2P) lending models. This provision clearly forbids companies, unless they are specifically exempt, from asking, accepting or renewing deposits from members of the public. Although the Act defines ‘deposit’ broadly, it excludes funds acquired through debentures, bank loans or company advances. Without a particular regulatory framework for crowdfunding, any company operating a platform that accepts public funds for lending or investing could inadvertently violate this regulation. Asset recovery is severely impacted by this; money given to an illicit business may be difficult to recover since it may be mixed up with other illegal profits, making civil recovery cases more complex and making it more difficult for victims to identify and recover their individual contributions. Although the sanctions – fines and jail time for officers – are harsh, they do not always establish a system for giving victims their money back.

Section 42 of the Companies Act 2017

Section 42 of the Companies Act 2017 offers a potential legal means to structure some crowdfunding initiatives, particularly those with social welfare or charitable purposes, even if it is expressly forbidden to receive public deposits. The SECP is authorised to give licences to non-profit associations under this clause. This strategy is especially relevant to crowdfunding platforms that rely on donations from Pakistan. By operating under a section 42 licence, these sites can gain credibility and legal legitimacy. Importantly, recovery risk is naturally decreased by this paradigm. The money is held in trust for a charity purpose since equity or lending-based crowdfunding is irrelevant in this case. Any theft would be a blatant violation of a fiduciary duty, giving authorities a solid legal foundation to track down and retrieve money from the company’s assets or from its officers. As a result, this model offers an example of how effective governance can protect resources and streamline recovery.

A prime example of section 42 is the Edhi Foundation, founded by Abdul Sattar Edhi in 1951, and is evidence of the effectiveness of grassroots philanthropy in Pakistan. The foundation, which runs solely on private donations and volunteer labour, has expanded into the largest welfare organisation in the nation, offering a variety of services such as emergency medical aid, orphanages, homeless shelters and rehabilitation facilities. It has gained both a national and a worldwide reputation for its dedication to serving humanity without discrimination.

The Edhi Foundation offers an excellent illustration of the principles outlined in section 42. Despite being established prior to this law, the Edhi Foundation scrupulously adheres to its regulations in its operations. The Foundation serves as an example of how crowdfunding can effectively assist humanitarian initiatives because it relies on donations from the general public. The best-case scenario for asset security in a crowdfunding model is achieved by the Foundation’s transparent use of funds for social welfare, which makes donor money traceable and accounted for.

The Edhi Foundation business practices closely follow section 42’s requirements, which include using funds for social welfare and reinvesting any profits back into the organisation’s humanitarian endeavours, despite being established before the law was put in place.

Because the Foundation depends on donations from the general population, crowdfunding has the potential to be a successful way to support humanitarian causes in Pakistan. The Edhi Foundation and other similar organisations may continue to grow their services without relying on government support by using the combined donations of individuals. In addition to encouraging community involvement, this strategy guarantees a certain amount of independence and receptivity to societal demands.

Potential risk

The near-impossibility of victims’ asset recovery is the main operational and legal problem caused by Pakistan’s lack of a clear regulatory framework for crowdfunding. Since uncontrolled platforms can raise money without responsibility and vanish, fraud is the biggest risk. The main issue for victims becomes the unsolvable challenge of tracking these platforms down and getting their money back. This undermines the public’s trust in crowdfunding as a legitimate model.

Furthermore, the lack of investor protection measures exacerbates these vulnerabilities. If there is default or fraud, contributors have little to no legal recourse. It is pointless to start an asset recovery claim in the absence of standardised contracts or recourse options. This deters potential investors as well as actual entrepreneurs from entering the market. In terms of AML and financing of terrorism (CTF) regulations, the unregulated flow of money also poses significant regulatory challenges. Without clear KYC regulations, crowdfunding platforms may turn into ‘black boxes’, where money is laundered and illicit gains are mixed with legal contributions, greatly increasing the complexity of asset recovery and forensic accounting.

Because of the legal issues, platforms and companies are much more at risk. With a primary focus on asset protection and recovery, Pakistan urgently needs a clear legal framework to ensure the integrity, transparency and sustainability of crowdfunding.

The SECP must put in place a methodical, tiered regulatory structure in light of the risks associated with crowdfunding in Pakistan’s unregulated status. This framework ought to make a distinction between various crowdfunding types and implement the appropriate compliance standards. A licence system would increase trust and formalise operations. Strong disclosure regulations, investment thresholds, and – above all – accessible recourse mechanisms for asset recovery must all be a part of the system. In order to ring-fence contributor monies from platform operating funds and facilitate recovery in the event of fraud or insolvency, this involves requiring the segregation of client cash. A regulatory sandbox might also assist the SECP in risk assessment and recovery protocol creation.

Conclusion

In conclusion, it is clear that the Companies Act 2017 allows crowdfunding to be accomplished remotely even if Pakistan lacks a suitable legal structure to control it. In a certain sense, the Act makes place for it, even though it does not entirely clear the way. These incidental clauses, however, cannot take the place of a specific regime created with asset recovery and protection in mind. Given how quickly this practice is expanding globally, the creation of a regulatory sandbox may not be far off. For this to be successful, the emphasis must shift from merely promoting innovation to creating a safe ecosystem where contributors’ rights are upheld and victims of fraud or poor management have a practical and efficient way to track down and retrieve their assets.