The Difference Between Crowdsourcing and Crowdfunding — And Their Application to the Healthcare Industry

Although similar sounding, "crowdsourcing" and "crowdfunding" have different meanings.

Crowdsourcing is soliciting ideas and solutions, where crowdfunding is soliciting monetary funds through widespread, web-based mediums. Arbitrarily interchanging crowdsourcing and crowdfunding can have consequences. Therefore, participants in the healthcare industry, whether a provider, entrepreneur or medical device/pharmaceutical company, should become familiar with the application and utilization of each term.

Initially coined by Jeff Howe of Wired magazine1, crowdsourcing is defined as:

"The act of a company or institution taking a function once performed by employees and outsourcing it to an undefined (and generally large) network of people in the form of an open call. This can take the form of peer-production (when the job is performed collaboratively), but is also often undertaken by sole individuals. The crucial prerequisite is the use of the open call format and the larger network of potential laborers."

Considered an "effective model for inexpensively solving difficult problems in corporate research and development,"2 crowdsourcing can be applied to a multitude of scenarios in the healthcare industry.

As Larry Laufman, MD, an assistant professor in the Department of Medicine at Baylor College of Medicine recently explained to me:

"Crowdsourcing is oriented to obtaining direct information for purposes of real-world decision-making and problem solving. Not so different from surveys in general, except for (1) the immediacy that social media and the Internet provide; and (2) traditional survey research tends to be oriented to developing policy rather than immediate problem-solving. Crowdsourcing may have an application in studying some 'empirical ethics' questions about how health care providers actually do their real-world ethics decision making."

Ethics decisions is one area that crowdsourcing may apply. Soliciting answers to problems can be beneficial, but can raise other legal and regulatory issues. For instance, is protected health information being transmitted in the process in violation of HIPAA or the HITECH Act? Are there any Food and Drug Administration regulations and/or protocols that may apply to biomedical research? Are their disclosure requirements on the part of the institution? What if an individual's contributed idea solves a problem that becomes patented or sold and make a lot of money — is that individual entitled to a portion of the proceeds or royalties? These are just some of the questions that arise in the context of the healthcare industry, which may not have similar applications in other industries.

While crowdsourcing may lead to crowdfunding, the terms are fundamentally different. Crowdsourcing can generally be viewed as more broad and one entity "throwing out" a question or hypotheiss to attract input from a larger pool of individuals in hopes of finding a solution or an answer. Crowdfunding, and more specifically "equity crowdfunding," has a particular application to the Jumpstart Our Business Startups Act3 and related Securities and Exchange Commission regulations4.  Crowdfunding, "raising capital by receiving small investments from a large cross-section of people (the crowd) in an Internet community"5 is the conduit to Title III of the JOBS Act's "funding portals."6

Title III of the JOBS Act adds the new Section 3(h) to the Exchange Act which requires the SEC to exempt, conditionally or unconditionally, an intermediary operating a funding portal from the requirement to register with the SEC as a broker. The intermediary, though, would need to register with the SEC as a funding portal and would be subject to the SEC's examination, enforcement and rulemaking authority. The funding portal also must become a member of a national securities association that is registered under Section 15A of the Exchange Act.

A funding portal is defined as a crowdfunding intermediary that does not: (i) offer investment advice or recommendations; (ii) solicit purchases, sales or offers to buy securities offered or displayed on its website or portal; (iii) compensate employees, agents, or others persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; (iv) hold, manage, possess, or otherwise handle investor funds or securities; or (v) engage in such other activities as the SEC, by rule, determines appropriate.

In July 2013, the SEC adopted the final rules removing the prohibition against general solicitation and advertising in select offerings in order to implement Section 201(a) of the JOBS Act. Essentially, Rule 506's amendment makes it permissible for an issuer to generally solicit or advertise, "provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors."7 Rule 144A was also amended to allow agents of qualified institutional buyers to engage in these transactions, as long as the seller reasonably believes they are doing so. In relation to a Rule 506 offering, Form D was also revised, requiring issuers to select if they are engaging in the general solicitation or general advertisement. If a seller is considering the use of crowdfunding in the context of a securities offering, all of the other steps must be in order when offering or selling securities.

With more physicians investing in entrepreneurial businesses,8 crowdfunding may be a viable option to explore. Importantly, providers need to make certain that their investments fall within the safe harbors of the federal anti-kickback statute,9 Stark Law exception and that they meet the federal securities laws’ definition of an accredited investor.10 Like most areas of law, there are exceptions. And, Section 4(a)(5) of the Securities Act of 1933 (1933 Act) sets for the accredited investor exception. Specifically, this section "exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million."11 There is nothing express in the JOBS Act that addresses this exemption, rather, as an article in Forbes explains:

"Historically, a Regulation D, Rule 506 offering has been exempt from SEC registration provided that the offering is not publicly advertised and that the purchasers are largely qualified institutions or 'accredited' investors – those whose net worth is greater than $1 million (excluding a primary residence) or whose individual income exceeded $200,000 ($300,000 for couples) for the past two years with the expectation for that level of income to continue in the current year. Title II of the JOBS Act called for the SEC to lift the ban on mass marketing these offerings, provided that the issuer reasonably believes and has taken reasonable steps to verify that the buyers of the private securities are in fact accredited."12

Before the implementation of the JOBS Act, it would have been impermissible to generally solicit or advertise. Still, investors are subject to the antifraud applications of the securities laws. And, they should make certain that the crowdfunding intermediary or portal is registered in accordance with the SEC regulations. Title II of the JOBS Act came into effect on September 23, 2013, while Title III regulations have yet to be promulgated. In sum, the JOBS Act may provide another viable option for providers looking to invest or to raise capital, but careful attention must be given to both healthcare and securities laws and regulations to insure compliance and mitigate liability.

Rachel V. Rose, JD, MBA, is a Houston-based attorney advising on federal and state compliance and areas of liability associated with a variety of healthcare legal and regulatory issues including: HIPAA, the HITECH Act, the False Claims Act, Medicare issues, women’s health, as well as corporate and security regulations. Ms. Rose is affiliated faculty at Baylor College of Medicine – Center for Bioethics and holds an MBA from Vanderbilt University and a law degree from Stetson College of Law. She can be reached at rvrose@rvrose.com.

1 Howe, J. The Rise of Crowdsourcing. Wired Magazine, available at, http://www.wired.com/wired/archive/14.06/crowds.html?pg=1&topic=crowds&topic_set=.
2 Graber, M., Graber, A., Internet-based crowdsourcing and research ethics: the case for IRB review, J Med Ethics 2013; 39: 115-118.
3 Pub. L. No. 112-106, sec. 201(a), 126 Stat. 306, 313 (Apr. 5, 2012).
4 Securities and Exchange Commission, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, 17 CFR 230, 239 and 242, Final Rules (July 10, 2013).
5 Crowdfunding Definition, www.initialcrowdoffering.com.
 6 www.sec.gov.
 7 Supra n. 4, p. 1.
 8 Becker S., Walsh A., Werling K., Investing in Health Care – A Story of Political Clout, Successful Niches and Market Cycles. Richmond, VA: Mcguire Woods, April 17, 2007; www.mcguirewoods.com/news.resources/news/2516/asp.
42 CFR §411.350 et seq., 42 CFR §1001.951 et seq., and 42 CFR §1001.952(a)(2)
10 See Rule 501 of Regulation D, available at, www.sec.gov (defining the criteria for an accredited investor in accordance with the Securities Act of 1933)
11 www.sec.gov.
 12 http://www.forbes.com/sites/realspin/2013/10/08/the-jobs-act-isnt-all-crowdfunding/.

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