Social media issues for fund managers
February 2013 | TALKINGPOINT | INVESTMENT FUNDS
FW speaks with Eva Marie Carney and James Q. Walker, partners at Richards Kibbe & Orbe LLP, about social media issues in fund management.
FW: In what ways are fund managers using social media in their businesses?
Carney: Fund managers are just starting to use social media in their businesses. Some use it to provide business associates and potential contacts with business contact information – for example, mailing addresses, email addresses and telephone numbers; to assist fund managers in the recruitment of analysts, traders and other personnel; to research trading ideas; or to gather information on important industry players. Some are venturing into using social media to enhance relationships with prospective clients and business partners. At the same time, concerns about their ability to effectively monitor social media use to ensure compliance with regulatory requirements has caused fund managers to avoid the use of social media to directly promote their businesses, and in many instances to ban all use of social media by their personnel. We anticipate that US-registered fund managers may begin to explore controlled uses of social media – for example, permitting use of Twitter by designated employees in order to update clients on their activities, limiting the communications to pre-approved ‘tweets’ – once the US Securities and Exchange Commission (SEC) rules under the JOBS Act are finalised.
FW: Could you outline the basic regulatory rules and guidance documents that may apply to social media use within the fund management process?
Walker: A range of regulations apply to social media use, and both the SEC and the Financial Industry Regulatory Authority (FINRA) have provided guidance relevant to social media use by fund managers. Rule 206(4)-7 under the Investment Advisers Act of 1940 (Advisers Act) prohibits an investment adviser registered with the SEC from providing investment advice unless the adviser has adopted and implemented written policies and procedures reasonably designed to prevent violation of the Advisers Act. Registered fund managers who use social media for business must adopt policies and procedures to supervise and catalogue that use that are reasonably designed to ensure compliance with the Advisers Act. Additional guidance can be found in the National Examination Risk Alert on Investment Adviser Use of Social Media, issued by the SEC’s Office of Compliance Inspections and Examinations in January 2012, and in regulatory notices 10-06 and 11-39 issued by FINRA in 2010 and 2011, respectively. In addition, last year the US Congress, in Section 201(a)(1) of the JOBS Act, directed the SEC to amend Rule 506 under the Securities Act of 1933 to exempt offers and sales of securities under Rule 506 –the private offering rule, part of the SEC’s ‘Regulation D’ – from the prohibition on general solicitation or advertising in Rule 502(c) when all purchasers are accredited investors. The proposed rules, which remain subject to revision before the SEC finalises them, require that in Rule 506 offerings that use general solicitation or general advertising, the issuer take reasonable steps to verify that purchasers of the securities are accredited investors. This revised scheme would permit the use of social media – the embodiment of general solicitation – in connection with a Rule 506 offering.
FW: How will the JOBS Act and the SEC’s new rules affect fund managers’ use of social media? What additional compliance-related considerations should firms keep in mind as a result?
Carney: Under the JOBS Act and the much-anticipated SEC rules implementing the JOBS Act, issuers of an offering of unregistered securities, such as limited partnership interests in the fund manager’s fund, will be able to offer these interests publicly, including through social media. The ability to speak and write publicly about a private fund and its strategies is something quite new. To date, many fund managers have not been comfortable even with their most senior personnel speaking at conferences and giving interviews during which they identify their funds and the strategies they employ, out of concern that these presentations could be seen by the SEC as ‘general solicitations’ that would threaten the funds’ private offering/Regulation D exemption. The JOBS Act and the new rules should put those concerns to rest so one can expect to see more funds with a social media presence once the SEC rules are in effect. At the same time, fund managers who use swaps for hedging but do not otherwise trade in commodities – and therefore rely on the US Commodity Future Trading Commission (CFTC) de minimis rule exception from the commodity pool operator/commodity trading advisor registration requirements that came into effect at the end of 2012 as part of the Dodd-Frank Act reforms – will not be able to take advantage of the relaxation on the publicising of their funds to potential investors.
To qualify for that exception, managers may not publicly offer their fund interests. Further, all fund managers remain responsible for ensuring that their confidential trading, position information, and their investors’ identifying information are protected. Permitting social media communications by fund management personnel will present a new avenue by which fund managers can risk ‘leakage’ of such confidential information or implicate themselves in an insider trading inquiry. All fund managers will also remain subject to the requirement that the statements made by fund manager personnel through a social media venue, as in any traditional forum, are accurate and not misleading. These ongoing requirements suggest that fund managers continue to retain firm control over their personnel’s use of social media. Moreover, because many forms of social media, such as Twitter with its maximum 140 character tweets, do not permit caveats, explanations and disclaimers, these constraints counsel that, once the JOBS Act implementing rules are in effect, fund managers confine social media use to limited, brand-focused communications.
FW: To what extent do data privacy laws intersect with social media issues? What considerations do fund managers need to address in this regard?
Walker: Fund managers should consider that there may be privacy law limitations on the fund's ability to monitor social media communications by employees. To ensure the fund manager's ability to conduct real-time monitoring of email communications and texts, fund managers can look to regulatory obligations and firm policies that make very clear that their personnel have no reasonable expectation of privacy over electronic communications sent from a work computer. Fund managers should be mindful, however, of a developing body of law that protects employee social media communications to the extent that the communications concern the terms and conditions of employment. See, for example, Pietrylo v. Hillstone Restaurant Group, Civil Case No. 06-5754 (FSH), 2009 WL 3128420 (D.N.J. Sept. 25, 2009); Hispanics United of Buffalo, Inc. & Carlos Ortiz, NLRB Case No. 3-CA-27872 (Sept. 2, 1011). Moreover, an increasing number of states are passing laws that prohibit employers from requesting and requiring employees and job applicants to provide social media usernames and passwords, with laws enacted in four states and pending in 11 others.
In fact, during the California legislative process, representatives from FINRA and the Securities Industry and Financial Markets Association (SIFMA) raised the concern that the proposed California legislation would conflict with employers’ compliance obligations and requested an exemption. Although California did not include an exemption, other states have included specific exemptions in their social media laws that permit fund manager compliance staff to obtain information about an employee’s social media account and monitor communications. This includes Maryland, where social media protection law exempts employers who are conducting an investigation to ensure ‘compliance with securities or financial law regulations’; Michigan, where current law exempts from social media protection law employers conducting an investigation in order to ensure compliance with laws or regulatory requirements; and Delaware where pending law allows employers subject to financial regulators, specifically including the SEC and FINRA, to request usernames and passwords in order to comply with the supervision requirements of those and other financial regulators.
FW: What kinds of penalties might fund managers expect to face if their social media activities are found to involve data misuse or data leaks?
Carney: Data misuse that is in the nature of disclosing fund trading information for a personal benefit to another who trades on it, would be insider trading. Insider trading, when prosecuted successfully in the US by criminal authorities, can result in penalties, per offense, of $5m in fines and 20 years imprisonment for individuals, and $25m in fines for companies. Civil insider trading penalties exacted by the SEC can be as high as three times the profit gained or loss avoided by the trading. Beyond insider trading, misuse of investor data or the failure to maintain the confidentiality of investor data can result in actions brought by individual state prosecutors; civil actions by a fund investor or investor group seeking significant penalties and causing even more significant reputational damage; and the flight of investors from the fund.
FW: What are the risks of engaging in social media across various platforms – for example, ‘hyperlinking’, ‘following’ and ‘liking’ third-party content?
Walker: A fund manager whose personnel engage in social media across platforms by ‘hyperlinking’, ‘following’ and ‘liking’ social media content runs the risk that regulators will deem the reference to third-party content as an adoption of those communications. Thus, the fund manager assumes responsibility not only for the communications that it makes itself, but also those that the manager and its personnel ‘hyperlink’, ‘like’ or ‘follow’, and runs the risk that one or more of those referenced third-party communications include content that violates the securities laws. Further, the SEC has indicated that ‘liking,’ ‘following’ and ‘hyperlinking’ may be considered testimonials, which are prohibited under the Advisers Act.
FW: What challenges can fund managers expect to face when trying to monitor and archive the social media activities of their firm representatives, including communications with investors and colleagues via social media?
Carney: The number of social media venues continually expands. Keeping tabs on social media activities of a firm’s personnel is daunting, and likely can be accomplished only if a firm, first, strictly limits the number of social media platforms on which its representatives are authorised to have a presence and/or communicate with investors and colleagues on the firm’s behalf; and second, provides clear direction on the types of business-related information that may be conveyed through social media and under what circumstances such communications must be pre-cleared by legal and compliance staff. Archiving social media activities remains challenging, given the readily-deleted and readily-editable nature of social media. What is viewable at one moment can be deleted, hidden from view, or modified, the next.
FW: Do social media postings fall neatly into corporate communications such as email and text messages, or is it a far more complex medium?
Walker: Social media communications do not fall as neatly into corporate communications such as email and text messages, but they can constitute corporate communications and therefore are subject to the same recordkeeping obligations. Advisers Act Rule 204-2 addresses the range of books and records to be maintained by investment advisers. The recordkeeping obligations include all forms of business-related communications regardless of the medium or platform through which the communication is exchanged, and the obligations include advertising communications and investor complaints. If a fund’s business-related communications are conducted through social media, the recordkeeping and monitoring requirements under the Act apply with equal force as to standard email communications, including the retention, indexing and retrieval requirements. Privacy laws also may prohibit the access needed for reliable monitoring, and monitoring social media communications in order to comply with these requirements is difficult because such communications are ephemeral.
Indeed, much of the complexity that has caused fund managers to ban the use of social media for fund business stems from the fact that social media communications are more complex than email or text communications. Unlike social media, email and text communications are directed to a specific recipient or group of recipients, and can be monitored in real-time fairly easily. Many forms of social media, by contrast, are by their nature ‘social’, directed to an unspecified public, and are complicated by the existence of walls, privacy groups, and passwords that raise important considerations under privacy law and ethics. Therefore, monitoring of social media communications by fund manager compliance staff is a daunting task logistically, ethically and legally. Often, procedures that have been implemented to monitor email and text communications cannot be applied to social media communications.
FW: What are your suggestions to funds on effectively managing the process of introducing social media use to their business, while keeping in mind compliance concerns?
Carney: Our main suggestion is to proceed with caution – do not permit personnel to engage in business-related communications, through social media, on the fund managers’ behalf, that the fund cannot supervise effectively and archive as required. If, after the JOBS Act rules are effective, a fund manager decides to host a social media site, we suggest that the manager start with the objective of exerting control to the greatest degree possible over the nature of communications posted to the site. Exerting this control might include pre-approving the content posted by the fund managers’ personnel; posting explicit guidelines with regard to others who are authorised to post content, and posting disclaimers with respect to posted content that the manager and its supervised persons do not post; and monitoring the site regularly to ensure that postings are appropriate. In addition, it will involve ‘cleaning-up’ the site regularly to remove inappropriate content.
FW: What are your predictions for the use of social media by fund managers in the years ahead?
Walker: Fund managers will always seek to meet the needs of their investors. Investor-demand for best-in-class service, including convenient communication with their advisors, will contribute to fund managers’ efforts to adapt their businesses to social media. Fund managers are likely to seek training with regard to the business use of social media sites, as well as guidance on permissible uses and best practices. The ongoing development by vendors of monitoring and archiving programs and services will soon allow fund managers’ compliance personnel to keep up with the social media activities of fund personnel, as long as those activities are sufficiently limited in scope in relation to the number of compliance personnel available to conduct the monitoring.
Eva Marie Carney is a partner in the Washington DC office of Richards Kibbe & Orbe LLP. She focuses her practice on SEC regulatory enforcement, investment adviser and fund compliance, and legal policy issues, drawing on more than a decade of work in these areas at the US Securities and Exchange Commission. Ms Carney can be contacted on +1 (202) 261 2975 or by email: firstname.lastname@example.org.
James Walker is a partner in Richards Kibbe & Orbe LLP’s New York office. He concentrates on internal investigations, civil litigation and professional liability. Mr Walker has a wealth of experience representing companies and institutions in criminal and regulatory investigations – and related civil litigation – as well as advising on conflicts and loss prevention. Mr Walker can be contacted on +1 (212) 530 1817 or by email: email@example.com.
© Financier Worldwide
Eva Marie Carney
Richards Kibbe & Orbe LLP
James Q. Walker
Richards Kibbe & Orbe LLP