Securities Regulator Issues Guidance to Firms and Brokers as to Communications on Social Networking Web Sites

By James Eccleston

INRA (the Financial Industry Regulatory Authority) recently announced new guidance as to the obligations of financial services firms and their brokers related to their use of social networking sites such as Facebook, Twitter, LinkedIn and blogs to communicate with the public. Regulatory Notice 10-06 is meant to protect the public and addresses important areas such as suitability of investment recommendations and accurate and balanced communications. Let's highlight two key aspects of the guidance.

First, regarding suitability of investment recommendations, the notice states that if a firm or its personnel recommends a security through a social media site, that recommendation does trigger the requirements of Rule 2310 regarding suitability. If so, the firm and the broker are required to affirmatively determine that the investment is suitable for the particular customer based upon his or her investment objectives, risk tolerance, financial condition and other factors.

To determine whether a particular communication constitutes a "recommendation", FINRA refers to its previous Notice to Members 01-23 as the governing guidance. NTM 01-23 stated that "[w]hether a particular transaction is in fact recommended depends on an analysis of all the relevant facts and circumstances." At the time, the securities regulator provided several examples of what would constitute a "recommendation". Examples included:

Sending a customer a specific electronic communication to a targeted customer or targeted group of customers encouraging the particular customer(s) to purchase a security; and

Sending customers an email stating that customers should be invested in stocks from a particular sector (such as technology) and urging customers to purchase one or more stocks from a list with "buy" recommendations.

In short, the securities regulator has focused upon any communication about a security that reasonably can be viewed as a "call to action" and that is directed or appears to be directed at a particular individual or group or individuals.

Second, FINRA's Regulatory Notice 10-06 discusses the "greater challenges" that firms face in supervising communications relating to the recommendation of specific investment products. As FINRA puts it, "These communications must often include additional disclosure in order to provide the customer with a sound basis for evaluating the facts with respect to the product." FINRA notes that it has brought disciplinary actions regarding interactive electronic communications that contained misleading statements about investment products that the communication recommended. The example cited involved a broker who held put options for himself and issued unapproved bulletin board messages that urged investors to sell the underlying stock, omitting to disclose the fact that he owned puts and that such sales would cause his puts to increase in value.

More broadly, FINRA previously has issued a host of guidance related to the kinds of material information that must be disclosed in connection with a recommendation. As an example, consider the relatively new but popular investment product, exchange traded funds (ETFs), in particular leveraged and inverse ETFs. FINRA's Regulatory Notice 09-31 reminded firms that they "must understand the terms and features of the funds, including how they are designed to perform, how they achieve that objective, and the impact that market volatility, the ETF's use of leverage, and the customer's intended holding period will have on their performance." The picture presented to customers must be "fair and balanced." In particular, FINRA stated: "an advertisement for a leveraged or inverse ETF that is designed to achieve its investment objective on a daily basis may not omit that fact and must specifically disclose that the fund is not designed to, and will not necessarily, track the underlying index or benchmark over a longer period of time." The regulatory notice also reminded firms that "providing risk disclosure in a prospectus or product description does not cure otherwise deficient disclosure in sales material, even if the sales material is accompanied by or preceded by the prospectus or product description."

As one can see, while social networking web sites are new from a technology standpoint, fundamental investor protection concerns of suitability and disclosure of material facts are nothing new.

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About the Author: James J. Eccleston leads the Securities group at the Chicago law firm of Shaheen, Novoselsky, Staat, Filipowski & Eccleston, P.C., where he represents investors in recovering investment losses and financial services professionals in disciplinary, employment, and compliance matters. He has held numerous securities licenses and Chicago Bar Association leadership positions and serves as an arbitrator and mediator. He is a recipient of Martindale-Hubbell's highest rating (AV) for legal ability and ethics and is named to the Illinois Super Lawyer and Leading Lawyer lists.

JEccleston@snsfe-law.com, 312.621.4400, www.snsfe-law.com, www.financialcounsel.com