Crowdfunding Fraud –Lessons from Elio Motors

A colleague suggested that the demise of Elio Motors would be a “teachable moment” for the crowdfunding industry. This lesson is necessary because too many people who are active in the crowdfunding arena would not know a scam if one bit them on the butt.

The lesson is that people who operate crowdfunding platforms or portals should have some background in corporate finance. The lesson is being paid for by the investors who made a $17 million investment in Elio and got nothing for it. These are losses that would have been avoided if the crowdfunding portal that listed Elio had operated correctly and refused to list it.

I raised questions about Elio when it was making its offering last spring. At the time it seemed to be a lot more hype than substance. That offering was ongoing at least until March.

By the end of September Elio was already bankrupt even if it has not formally filed the paperwork. Its balance sheet showed less than $5 million in current assets and more than $30 million in current liabilities. Elio had less than $100,000 in unrestricted cash on hand on September 30. Elio would likely have already closed its doors if it had not borrowed another $3 million at the end of last year.

Elio spent all of the money that investors put up and more in less than 6 months. That money was spent on “soft costs”, mostly administrative costs and R&D. Elio actually needs more money to get its vehicle into production now than before the offering.

Elio has been held out as one of the first great successes of the crowdfunding industry. It was one of the first offerings to file under the new Reg. A and one of the first to come to market. The offering was deemed a success because it raised $17 million from thousands of small investors.  Elio attempted to raise $25 million and raised $17 million. In the world of finance that is a failure, not a success.

Elio executives made the rounds at crowdfunding conferences last year, basking in that success and telling attendees how to raise money. Elio attracted investors the same way that Bernie Madoff did; by making promises about their future performance that they knew that they could not keep.

Elio has been taking deposits for its 3 wheeled, gas efficient vehicle and was first promising to deliver the vehicle before the end of 2014, then 2015 and then 2016.  Let’s be clear, there is no vehicle; certainly not one ready for production that could be delivered to the 65,000 people who put down a deposit to get one.  If you take someone’s money promising to deliver a product that you know you will not be able to deliver it is fraud.

Elio had also very publically promised to have its manufacturing facility in Shreveport, LA operational before the end of 2015 creating more than 1500 jobs. That promise of “we are getting ready to start production” was one way in which Elio bolstered its claim that it could deliver the vehicles. A lot of people in Shreveport were excited at the time, but those jobs never materialized. Today, a lot of people in Shreveport are very angry.

That same financial statement indicates that for the entire year of 2016, Elio spent about $1 million less than the year before on maintenance, insurance and property taxes for that Shreveport facility. Elio has been selling off manufacturing equipment at that facility to pay its bills, not gearing up to produce its vehicles. The financial report says that it still needs $300 million before it can start manufacturing. If it does not get substantial additional financing soon Elio admits that it may have to cease operations.

You can go to Elio’s website today and still put down a deposit believing that you are purchasing one of the vehicles at a reduced price. If a thousand people would each send me $100, I promise to send each of you a picture postcard from a beach in Bali. That is not much but it is more than you are likely to get from Elio.

At the time of the Reg. A offering, Elio represented that it hoped to obtain a $165 million loan from the US Department of Energy and still mentions that loan program in its recent financial statement. Elio does not qualify for that loan program, then or now.  Mentioning the program in the offering is what is known as “window dressing”; something that makes the company look more substantial or potentially successful than it is.

The fact that Elio did not qualify for the loan at the time of the offering and the fact that Elio had been taking deposits for a vehicle that it could not afford to manufacture should not have escaped the due diligence review conducted by StartEngine, the portal that listed Elio’s Reg.A offering.   The compliance director of StartEngine told me that they do not even attempt a due diligence review of Reg. A offerings based upon the mistaken belief that they are not required to do so.

Any crowdfunding portal that fails to conduct an adequate due diligence investigation does not care if investors who invest through their portal get ripped off.  I speak with start-ups that are interested in crowdfunding every month.  I only refer them to platforms or portals that follow the rules.

What will the regulators do about this? Perhaps nothing.  Regulators do not rectify every situation.

Still, as regards Elio it is not hard to imagine the conversation between someone in Shreveport who put down a deposit for a vehicle that will never be built who happens to share a duck blind with an Assistant US Attorney. As I said Elio is still taking deposits and apparently will continue to do so until some government agency stops them.

The SEC has already issued an order halting the Reg.A offering of Med-X, another offering listed on StartEngine. That case is still under investigation and it should be a lot easier for the SEC to prove that StartEngine did not act appropriately as the facts in the Med-X case are fairly clear cut.

FINRA recently expelled another portal claiming its offerings presented “impractical business plans.”  Exactly what FINRA meant by that would take another article. Suffice it to say that raising $17 million when you need $250 million and claiming most of the rest will come from a government program for which the company does not qualify is a business plan that is “impractical”.

Secondary market liquidity is an important aspect of Reg. A offerings. Companies that register their shares under Reg. A can also list those shares for trading in the OTCQX market. Investors who take a chance on these small companies have a way of selling their shares which investors in private placements cannot.

As of last Friday, the bid and asked for Elio shares was over $8 despite the fact the financial statements have been public for 2 months. Regulators might reasonably look at the liquidity and efficiency of that market as well.

Some people will tell you that crowdfunding is for start-ups most of which will fail anyway, so why bother to follow the rules and do it right? That is like saying everybody dies sometime, so why not drive around drunk.

The capital markets work because they are regulated. Regulation gives investors confidence.  If Elio turns into a well publicized scandal it is likely to scare investors away from the entire crowdfunding marketplace.

If you are operating a crowdfunding platform or portal and are too ignorant or too arrogant to follow the rules that keep scam artists out, please find another business. Neither the issuers nor investors want them around.

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