In a “Dilbert” cartoon, a twenty-something employee tells the nerdy engineer that the younger generation does their work on phones and tablets, not the “grandpa box.” Dilbert volunteers defensively that he has a laptop in addition to his desktop computer. The twenty-something employee offers to text the nineties and let them know.
Marketing to prospective clients and communicating with existing ones, requires investment advisors to undergo a paradigm shift. It has become clear that social media is no longer the exclusive province of teenagers walking the mall with smart phones in hand. Even in airplanes, passengers of all ages are texting and checking e-mails long after the Captain has ordered them to turn off cell phones and other electronic devices. Though we hope IARs have not become addicted to their iPad, or smart phone, even technophobic advisors must recognize that social media is here to stay.
Social media is an inexpensive and effective way to communicate with established and prospective clients. Nevertheless, when RIAs utilize social media to promote their advisory practices, they risk creating compliance problems for their firms. Therefore, it is vitally important that RIAs address compliance issues arising from the use of social media before permitting IARs to utilize any of these tools for business purposes.
How RIAs Are Using Social Media
Although there are many definitions of social media, the term is commonly defined as online content and technological tools used to communicate and connect with others. Among its many uses, social media is utilized for personal, political, career advancement, and business purposes. IARs have already begun using social media such as Facebook, LinkedIn, YouTube, Twitter, and blogging sites for business communication.
The danger for advisory firms is that IARs will violate compliance rules while using social media to communicate with current and prospective clients. Although communications with current clients are not usually viewed as advertisements, the possibility does exist that they could be classified as such. If circumstances suggest that the purpose of a written communication is to offer additional advisory services or attract new clients, it may be viewed by the SEC as an advertisement, and subject to Rule 206(4)-1 under the Investment Advisers Act of 1940. Advertising rules for state-registered RIAs are usually very similar to Rule 206(4)-1.
As mentioned previously, all communications with clients must be thorough, complete, accurate and not misleading—this includes social media. A firm’s CCO, or designated compliance person, should be reviewing the ways in which IARs are communicating with clients as well as what they are communicating. Unless the firm’s compliance personnel are able to review these communications, IARs should not use social media for business-related matters.
Whether a communication is between a client or prospect, it is subject to retention requirements of the Books and Records Rule found in Rule 204-2 under the Investment Advisers Act. State-registered investment advisors are subject to similar records retention requirements. Therefore, advisory firms should put policies and procedures in place, ensuring compliance with books and records rules.
For example, all communications with clients using Twitter are subject to CCO review and must be retained in accordance with the Books and Records Rule. Twitter, a free social messaging utility, enables an IAR to send and receive messages via the Twitter website. “Tweets” is the term that describes instant messages sent on Twitter. All tweets must be made available for review by the advisory firm’s CCO, or compliance designee, and should be captured on the RIA’s server.
Although the SEC has not implemented a rule specifically addressing social media, the Commission published guidance for RIAs on January 4, 2012. Guidance contained in the National Examination Risk Alert arises from observations made during RIA exams by staff members of the SEC’s Office of Compliance Inspections and Examinations. While these observations are not legally binding upon RIAs, firms should consider them in order to satisfy their obligations under the securities laws. State-registered advisory firms will also benefit from heeding the SEC’s advice. The risk alert was issued in conjunction with an administrative proceeding brought against an Illinois-based investment advisory firm, which allegedly used social media to exploit investors.
The SEC’s risk alert observed that many RIAs have policies and procedures, which specifically apply to the use of social media by the firm, IARs, and solicitors. A number of RIAs, however, have implemented multiple procedures applicable to advertisements, client communications, and electronic communications without specifically referring to social media. SEC examiners found that these policies and procedures were not specific enough regarding which forms of social networking are permitted or prohibited. Furthermore, firms’ policies and procedures sometimes overlap and may be contradictory. The SEC observed that some RIAs who use solicitors to market their services did not specify what social media constraints were placed on those individuals.
Potential Violations of Rule 206(4)-1 under the Investment Advisers Act
It is a best practice to classify all social media which directly or indirectly markets the RIA, any IAR or services offered by the firm, as an advertisement. A major concern is whether any form of social media expressly or implicitly violates Rule 206(4)-1(a)(1), which prohibits testimonials. A testimonial is a statement relating to a client’s experience with, or endorsement of, an RIA.
To illustrate a potential compliance problem, IARs who post their profile on LinkedIn, a professional networking website, might unintentionally violate the rule prohibiting testimonials. LinkedIn profiles typically contain recommendations from other individuals. This website allows an IAR to accept recommendations and publish them. Any published recommendation referencing the IAR or the firm may be construed as a testimonial, whether solicited or not.
There may still be a violation of Rule 206(4)-1, even if the person giving the recommendation is not a client. These recommendations may be false or misleading, if solicited from a friend, relative, or business associate. In fact, these recommendations may be a quid pro quo for recommending someone else. Furthermore, they paint a one-sided picture of the IAR, since negative comments are unlikely to be published. As such, these recommendations might violate Rule 206(4)-1(a)(5), barring any false or misleading advertisement in any way. A conservative course of action is for IARs to hide all recommendations relating to their investment advisory services from public view.
Social media terminology makes it appear that an IAR is beloved by people who may be clients. On Facebook, contacts are referred to as “friends.” Persons who sign up to receive tweets are called “followers,” a term that might be construed as an implied endorsement. One possible solution is for RIAs and IARs to include a disclosure stating that social media terminology should not be construed as a testimonial or endorsement. Another option is for RIAs to restrict or even prohibit employees from using social media for business purposes, such as marketing the firm or the IAR. Certainly, legal issues may arise if an RIA attempts to restrict employees’ personal use of social media on their own time.
Facebook’s “like” feature received special attention in the SEC’s January 4, 2012, National Examination Risk Alert. According to the risk alert, RIAs who permit third-party postings on their social media sites should consider having policies and procedures for preventing testimonial posts about the firm, its IARs, or solicitors. Depending on the facts and circumstances, the use of “social plug-ins,” such as the “like” feature, might be construed as a testimonial. The risk alert cited the example of an IAR inviting the public to “like” his or her profile posted on a social media site, and warned that this election to “like” the profile could be viewed as a testimonial. In a footnote, the SEC stated that some social media sites do not permit an RIA to disable the “like” button or a similar feature. Therefore, RIAs should develop a system to monitor these sites and remove third-party postings if necessary. Otherwise, examiners may disapprove of RIAs’ social media policies.
False or Misleading Content Involving Social Media
Even if social media content is not a testimonial, it may still be in violation of Rule 206(4)-1(a)(5). As is the case with email and text messaging, IARs may send quick messages via social media in haste, increasing the risk of sending false or misleading information. Furthermore, a tweet is limited to 140 characters, which limits the possibility for clear communication. These messages often use abbreviations, which may be difficult to comprehend. In addition, due to space limitations, tweets may omit important information, including disclosures. Aside from these potential problems, a tweet may post links to websites and articles that contain false or misleading information.
All profiles on LinkedIn, Facebook, and other social media should be scrutinized ensuring they are not false or misleading in any way. Content must be consistent with the RIA’s Form ADV, advisory contract, and other advertisements, including websites.
Some IARs are using social media to communicate subtle and less-than-subtle references to their firm’s performance. All references to performance may be subject to the guidance published in the Clover Capital no-action letter. This no-action letter requires that performance results be presented on a net-of-fees basis. Clover Capital also requires that advisers make numerous disclosures when providing performance results. In addition, RIAs may inadvertently be violating Rule 206(4)-1(a)(2) under the Investment Advisers Act, which restricts advertisements referring to specific recommendations made by an investment adviser that were or would have been profitable to any person.
Policies and Procedures for Social Media
If an RIA permits the use of social media for communicating with clients or marketing purposes, the firm should adopt robust policies and procedures to reduce the risk of harm. Since regulators frown on boilerplate policies and procedures, they must be tailored to how social media is being used by a firm. Those procedures should require the firm’s CCO to monitor IARs’ use of social media. They should also mandate that communications and advertisements using social media be retained in accordance with the Books and Records Rule.
If social media is treated as an advertisement, IARs must comply with the RIA’s advertising policies and procedures. It is a best practice for an RIA’s advertising policies and procedures to require the firm’s CCO to approve all advertisements before they are published, sent, or posted on the firm’s website. For example, the firm’s CCO’s should pre-approve an IAR’s LinkedIn page if a reference is made to the RIA. If IARs are dually registered with a broker-dealer, they must also comply with the brokerage firm’s policies and procedures relating to client communications, social media, electronic communications, and advertising, as well as applicable FINRA rules and guidance.
Social media tools, like Facebook, allow RIAs and other advertisers to post targeted ads on profiles which appear in response to specified demographic information. CCOs should pre-approve the marketing criteria utilized, as well as the content of the advertisements. Meta tags and keywords also need to be reviewed by the firm’s CCO prior to their utilization and must not be false or misleading in any way.
The Big Picture
Like it or not, advisors may need to become more comfortable with using social media for communicating with existing and prospective clients. If they do decide to use social media for those purposes, advisors should thoroughly read the SEC’s January 4, 2012 publication (http://www.sec.gov/about/offices/ocie/riskalert-socialmedia.pdf).
Even though there are no regulations currently in place, it is clear that the SEC is looking over the shoulders of investment advisors. Recent document request letters from the SEC have asked RIAs to produce information relating to their use of social media. Furthermore, the SEC’s risk alert encouraged IARs and RIAs to report activity that potentially violates the securities laws and may harm investors.
Since IARs and other supervised persons may already be active users of social media, CCOs and other compliance personnel should develop policies and procedures to address the potential problems. The SEC’s risk alert advised RIAs to identify social media risks in view of the firm’s business model and operations. The RIA should then test whether policies and procedures effectively address those specific risks.
Certain forms of social media have the potential to be misleading because of their brevity. A client might easily misconstrue a tweet, especially since it will be 140 characters or less, and text messages may not fit the bill either.
More than likely, examiners will look at the facts and circumstances surrounding an RIA’s use of social media. If an RIA or IAR’s social media content contains one or more glowing endorsements that could not have been written better by the firm’s marketing department, examiners will suspect that the advisor had a hand in creating the content. Examiners may also determine that an RIA has adopted the noncompliant content as its own by permitting it to remain posted on the social media site.