Securities regulators like the state administrator are perpetually concerned with the communications registered persons distribute to investors (especially retail investors). In today’s digital age, it’s fairly easy to engage a significant number of people with a social media post or an online advertisement. What if an untrue or fraudulent piece of information is shared in those messages? The Uniform Securities Act (USA) has clear guidelines related to these communications, plus the North American Securities Administrators Association (NASAA) has created numerous orders and rules to further enforce those guidelines.
In general, public communications are broken down into two categories: correspondence and advertising. While federal securities laws define them very specifically, the USA tends to refer to them in generalities. Correspondence is direct communications with a client or prospective (potential) client. This type of communication can be meant for one person (e.g. an email or letter) or written for a group of clients (e.g. an email to all clients). Advertising is a general communication intended for a broad audience.
The USA has some general rules related to engaging investors, all of which could be applied to public communications:
It is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly:
- To employ any device, scheme, or artifice to defraud, or
- To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or
- To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person
In a nutshell, don’t lie to or manipulate any investor when discussing securities! Additionally, it’s important to offer all material facts when necessary.
Omitting a material fact in a public communication may be unintentional, but would still be unlawful and potentially subject to civil liabilities and penalties. If it was willful (on purpose), the financial professional may additionally be subject to criminal penalties. Non-material facts are not required to be disclosed.
NASAA rules relating to correspondence and advertising are further broken down into rules for:
NASAA rules state the following regarding communications with the public:
[It’s unethical and unlawful to use] any advertising or sales presentation in such a fashion as to be deceptive or misleading. An example of such practice would be a distribution of any nonfactual data, material or presentation based on conjecture, unfounded or unrealistic claims or assertions in any brochure, flyer, or display by words, pictures, graphs or otherwise designed to supplement, detract from, supersede or defeat the purpose or effect of any prospectus* or disclosure
*A prospectus is an issuer-created document that discloses material information related to an investment and its inherent risks. For example, here’s AirBnB’s prospectus for their initial public offering in December 2020. Discussing information related to a security that contradicts its prospectus (or any other disclosure form) would be unlawful.
Broker-dealers and agents may not lie or mislead an investor in any way, but the standards imposed on these persons are not as stringent as with investment advisers and IARs. The reason relates to fiduciary duties.
Broker-dealers and agents are not held to a fiduciary standard when executing unsolicited transactions. A trade is considered unsolicited if the action was an investor’s decision without influence from a financial professional. The majority of trades executed by broker-dealers are not due to the result of recommendations from agents, and are therefore not subject to fiduciary rules. What exactly does this mean? Broker-dealers and agents don’t have to be as careful with their communications as investment advisers and IARs.
With a lack of fiduciary duty in most circumstances, broker-dealers and agents can advertise their transaction-related services and execute trades without discussing all material facts. Additionally, the state administrator is less likely to enforce suitability standards* on these registered persons. If an investor purchases a security on an unsolicited basis that’s too aggressive for them, broker-dealers and agents are typically not held liable. However, fiduciary duties come into play if a recommendation is made.
*Suitability standards relate to pursuing punitive actions against registered persons for making unsuitable recommendations.
Virtually all of the same communications rules applied to broker-dealers and agents also apply to investment advisers and IARs. A number of additional regulations are applied as well. Because advisers always have a fiduciary duty to their clients, they are held to higher standards. NASAA rules prohibit any of the following from appearing in an investment adviser or IAR’s public communication:
Testimonials of any kind
You’ve seen them before. A celebrity endorses a product or service of a business in hopes of getting you to buy it. While they may seem harmless, testimonials for advisers could be interpreted as a performance guarantee of sorts. If a wealthy superstar had a good experience with their investment adviser, will that necessarily translate to other investors? Maybe, maybe not.
To avoid the ethical dilemmas related to testimonials, NASAA rules forbid investment advisers and IARs from using endorsements of any kind. However, there’s no rule against broker-dealers or agents using them. Remember, they’re not subject to the same standards because of their business model (transaction execution vs. making recommendations).
Reference to specific past recommendations
Let’s take a look at the specific language in the NASAA rule relating to this prohibition:
[It’s prohibited to refer] to past specific recommendations of the investment adviser or IAR that were or would have been profitable to any person
In other words, advisers may not make reference to any specific recommendation that resulted in a client profiting. However, they do provide some exceptions:
[Advisers] may furnish or offer to furnish a list of all recommendations made by the investment adviser or investment adviser representative within the immediately preceding period of not less than one year if the advertisement or list also includes both of the following:
- The name of each security recommended, the date and nature of each recommendation, the market price at that time, the price at which the recommendation was to be acted upon, and the most recently available market price of each such security
- A legend on the first page in prominent print or type that states that the reader should not assume that recommendations made in the future will be profitable or will equal the performance of the securities in the list
Investment advisers and IARs may disclose their recommendations publicly if they disclose all recommendations over a specific time period of at least a year. For example, an adviser may post all recommendations they made in 2019 given it’s been at least one full year since those recommendations have been made. The adviser cannot be selective with what they disclose either; if they want to publish their recommendations, they must disclose the good and the bad ones.
Additionally, information related to the recommended securities must be provided. And last, it’s always important to balance public statements with reality. While some of the recommendations made by the adviser may have been profitable in the past, that’s no indication of future performance. This type of language should be displayed in any communication referencing past recommendations in order to balance out the risks and rewards of investing.
Overstatement of the importance of charts and formulas
Again, let’s look at the specific language in the NASAA rule relating to this topic:
[It’s prohibited to represent] that any graph, chart, formula, or other device being offered can in and of itself be used to determine which securities to buy or sell, or when to buy or sell them; or which represents, directly or indirectly, that any graph, chart, formula, or other device being offered will assist any person in making that person’s own decisions as to which securities to buy or sell, or when to buy or sell them, without prominently disclosing in such advertisement the limitations thereof and the difficulties with respect to its use.
In plain English, advisers shouldn’t put too much emphasis on the importance of a chart, formula (e.g. calculating the historical return of an investment), or anything similar. Charts display historical performance, and we already know the past doesn’t necessarily dictate the future. Formulas, especially complex ones, can sometimes provide false indicators of success. Bottom line - while they can be used as a part of a larger conversation, investment advisers and IARs should never make a recommendation solely based on charts, formulas, or anything similar.
An offer of free services that aren’t actually free
According to the same NASAA rules:
[It’s prohibited to represent] that any report, analysis, or other service will be furnished for free or without charge, unless such report, analysis, or other service actually is or will be furnished entirely free and without any direct or indirect condition or obligation.
Obviously, false advertising is prohibited across all businesses, both in and out of the finance industry. However, investment advisers and IARs must go a step further. If a product or service is being marketed as “free,” it must truly be free. For example, it would be prohibited for an investment adviser to offer a free financial plan if an investor moved their investment accounts under the adviser’s control. If the “free” product requires another action, then it cannot be marketed as free.
False information
This one is pretty simple. Don’t lie in advertisements, correspondence, or any interaction with a client! Although this is part of the investment adviser & IAR section, this rule applies to all registered persons and issuers.
As our world evolves further into the digital age, social media becomes more prevalent. The financial industry is no exception. Now, more than ever, financial firms are engaging their clients and marketing their services online. Virtually all financial representatives have a digital footprint on social media. Investors are hungry for information and share investing stories on message boards and their timelines. Accordingly, securities regulators have created a number of relevant guidelines and rules.
Good news - generally all of the regulations we discussed in this chapter apply to social media communications. Publicly available communications meant for mass audiences are generally treated like advertising, while private chats are typically considered a form of correspondence. Financial professionals are prohibited from making false, misleading, or exaggerated statements. Omissions of material fact are strictly forbidden. Whether the communication is on paper, a billboard, or on Twitter, the same general rules apply.
Firms must have a robust supervisory system in place when representatives create business-related social media posts. Many brokers, advisers, and representatives engage potential and current clients through internet platforms. Just like all other forms of communication, firms must ensure regulatory compliance through proper supervision.
Prior to a representative utilizing a social media platform, it must be properly vetted and reviewed by a registered principal (supervisor). The primary purpose of the review is to ensure relevant rules and guidelines are capable of being followed on the platform. You can assume most of the major platforms - Twitter, Facebook, Instagram, TikTok, and YouTube - are already reviewed by most firms. If a representative wants to try out a new platform, they must gain principal approval prior to utilizing it.
Social media posts are broken down into two general categories:
Static content
This type of social media content is defined as:
Typically posted for the longer term and lacks the immediacy of a real-time conversation
Examples of static content include blogs and social media profiles. NASAA treats these communications similarly to advertising.
Interactive communications
This type of social media content is defined as:
Typically real-time and involve a dialog with third parties
Examples of interactive communications include posts on interactive forums (e.g. Reddit), use of chat rooms, Tweets, Facebook posts, comments on other social media posts, and direct messages (DMs). NASAA treats these communications similarly to correspondence.
Sometimes financial firms and their representatives repost third-party content and link to third-party websites. For example, a brokerage firm tweets a link to an article on market activity on Yahoo Finance. Accordingly, securities regulators maintain policies for these types of social media posts. If a firm adopts or entangles itself with third-party content, the communication is treated as if it were the firm’s own creation.
Adoption occurs when a firm endorses or approves third-party content
An example of adoption would include a firm retweeting a financial blog with commentary (e.g. “Check out this interesting piece on the current state of the market”)
Entanglement occurs when the firm involves itself with the preparation of the third-party post
An example of entanglement would include a firm sharing a paid review of its products or services on TikTok.
Whether a firm adopts or entangles itself with third-party content, the shared material must be vetted, reviewed, and treated essentially as if it were created by the firm.
A registered person’s personal social media is not regulated by the same set of rules. Don’t worry - there’s no need to have your firm keep a record of the cute Instagram posts of your kids or pets. However, it’s quite possible a post could be considered a business use of social media. For example, if a representative created a TikTok discussing the products and services of their firm. To ensure employees of securities businesses understand the “line in the sand” between personal and business posts, their employing firm must provide ongoing education (typically in the form of training modules or videos). If the state administrator were to consider a registered representative’s personal social media crossing into “business territory,” they and their firm could both face punitive actions.
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