Considerations for Crowdfunding Service Providers Applying for Professional Indemnity Insurance

By 31 May 2022Blog

The digital age has made it easy to raise funds for business ideas through online crowdfunding service providers (CSPs). Four types of CSPs are available to a business, two of which – debt and equity-based funding – fall under regulations t hat require a CSP to have professional indemnity Insurance (PII).

Key underwriting considerations and questions when reviewing a CSP for insurance

1. What due diligence is undertaken by the crowdfunding service provider before allowing companies to raise capital? Are the companies legitimate

Crowdfunding is becoming more and more popular worldwide. Client money is in some cases held by the CSP, increasing its operational risks. Risks include failure of the investment, fraud, and money laundering.

Underwriters must ensure that a CSP undertakes thorough due diligence to mitigate its risks and avoid liability. Due diligence should comprise background checks, site visits, credit checks, cross-checks, account monitoring, and third-party proof on funding projects.

2. Insurers must confirm that companies raising capital through CSPs are not from crypto or cannabis industries.

Cryptocurrency is still excluded by most insurers, although demand for cover is increasing and insurance is becoming available. However, insurers need more clarity to develop policies.

Like crypto businesses, cannabis firms still don’t have many options when it comes to insurance, as major insurers are staying out of the market because cannabis is still illegal in most territories. That said, some insurers do offer cover.

3. What are the responsibilities of a CSP? Does the CSP assume the role of a nominee shareholder on behalf of the investors?

This question is relevant when the CSP is an equity-based crowdfunder.

Equity-based crowdfunding is where funds are invested by a large number of people, each putting in a small amount in return for shares.

Most crowdfunding platforms offer nominee shareholding. This is where the platform is a limited company solely for the purpose of holding shares on the funders’ behalf.

While this makes life much easier for businesses because they can involve their shareholders in decisions, it is highly risky for the CSP and opens it up to complaints/claims, not only from the business raising funds, but also from the individuals/investors. This makes it hard for insurers to consider covering CSPs that assume the role of nominee shareholder on behalf of the investors.

4. Is the CSP involved in the transfer of funds between the investor and the capital-raising company?

Most CSPs facilitate the collection of funds between the investor and the capital raising-company. Even though it is considered as a high risk from the insurer’s point of view, it can be insured as long as the CSP has its own payment initiation service provider (PISP) licence or uses payment services of an authorised PISP.

5. Confirmation that KYC (know your customer) and AML (anti-money laundering) procedures are in place.

Underwriters expect CSPs to be fully compliant with AML regulations and to conduct a reasonable investigation of their onboarding companies to make sure they are legitimate before joining their platforms. CSPs must check fundraisers and follow AML and KYC procedures to prevent suspicious activities on their platforms. These checks enable potential threats to be detected and potential crimes to be prevented.

Available insurance coverage for CSPs
Elmore has developed a ‘package’ insurance policy that comprises a range of different policies for different scenarios that may arise when running the platform. A key area is professional indemnity insurance (PII), which covers the legal costs incurred as a result of claims from third parties for a failure in the provision of the technology platform’s services. Cyber risks, management liability and external and internal theft are also included as part of the overall package — in one policy document.

We recommend buying a package policy to minimise the risk of claims falling through the gaps between policies, particularly for claims relating to privacy and security breaches, which can result from professional negligence covered by a PII policy and can also be covered by a cyber insurance policy. General liability, including public, products and employers’ liability, should also be purchased for damage to goods and bodily injury to the public and the business’s employees.

About Elmore Insurance Brokers
Elmore Insurance Brokers Limited advises its clients to actively manage risk to optimise insurance. Insurance is a partnership between businesses and insurers, and it depends on clear and focused engagement. Elmore is committed to helping its clients understand current and evolving risks and promote best practices in risk management.

Written by Francisco Monteiro – EU Managing Director of Elmore Lda.

Elmore Insurance Brokers Limited.

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