In December 2021, our post Federal Reserve and social media, highlighted sections of the Federal Reserve Financial Stability Report which demonstrated the Fed’s focus on the role of social media and retail investors in equity market volatility. In March 2022, the Board of the International Organization of Securities Commissions (IOSCO) followed suit, and also turned their attention to the role of social media and retail investors. The IOSCO Retail Market Conduct Task Force Consultation Report aimed to set out a toolkit of proposed policy and enforcement measures with guidance to help mitigate the potential risks of retail investor harm posed by online and cross-border marketing and distribution, and digital offerings. The findings of the report demonstrate both the global nature and the importance of these issues.
It is clear that social media is changing the way financial products are marketed and distributed, and that regulators are taking note. The IOSCO report highlights that developments in online marketing, including social media, will likely continue to evolve rapidly and discusses social media in the context of target ads, influencer marketing (“finfluencers”), challenges brought by the use of social media in digital offerings, inappropriate behavior, and regulatory and enforcement issues.
IOSCO views programmatic advertising, aka target ads, as an issue for both investment firms and retail investors. The survey in the IOSCO report shows that many investment firms outsource this function, but subcontracting such an important function without fully understanding the underlying algorithm can lead to reputational risk and possible liability if these advertisements end up on websites that an investment firm does not want to be associated with, or if it leads to the sale of a product that is not suitable for a particular investor. In fact, when you take the time to think it through and take a step away from legitimate investment firms, a nefarious actor in the market could create an algorithm specifically designed to target a distinct demographic with advertisements to purchase products that are meant to do nothing but defraud investors. Social media serves as a valuable resource for such bad actors, giving them an invaluable tool to reach millions of people with ease and speed, and at very low cost.
Some IOSCO members reported challenges regulating social media marketing by influencers. One such report, published by the Dutch Authority for the Financial Markets, was covered by our colleague Nikolai de Koning in his December 2021 post: AFM reminds ‘finfluencers’ of the applicable rules. Regulators across the globe are dealing with the same issues covered by the AFM’s report. Finfluencers are: (1) providing investment advice without being licensed; (2) not taking adequate care in making investment recommendations; (3) recommending risky products; (4) working with unlicensed firms; and (5) receiving referral fees for bringing in clients, which is tightly regulated in many jurisdictions. Among other risks, IOSCO identifies fake success stories by using influencers as one of the most commonly observed inappropriate behaviors.
On the other end of the spectrum from the famous finfluencer are fraudsters who use fake names and virtual offices to conceal their true identity and location. (And, who is to say a finfluencer is not a fraudster?) Many IOSCO members reported that information posted on websites and social media “may be deliberately inaccurate, partial, ephemeral or misleading by design, in order to conceal the true nature or scope of the product or service and to circumvent the regulatory perimeter.” Furthermore, the report notes that there are regulatory and evidentiary issues for IOSCO members attempting to build a case because the false or misleading marketing materials and communications used to solicit investors can be easily and inexpensively deleted or altered.
This demonstrates the interesting dynamic that regulators face as they try to balance free markets and freedom of speech, with appropriate controls. Existing rules and statutes are designed for a sales infrastructure and model that has become outdated. The speed and reach of the information spread by any one finfluencer is exponentially faster and larger than an entire boiler-room team could have hoped to reach if they dialed their phones for years, or even used newspaper or radio ads to try to reach in the past. Yet, in many of these jurisdictions finfluencers are treated as if they are amateur investors sitting around the dinner table having a conversation with friends. Here in the U.S., we are seeing the window for such impunity close. This can be seen in recent court decisions such as the one we discussed in our March 2022 post: Social media and cryptocurrency fraud, in which the Court of Appeals, Eleventh Circuit, reversed the lower court’s decision and held that that online marketers could be held liable under Section 12 of the Securities Act.
Technological developments have made social media and investment interactions more dynamic as content is created by regulated investment firms and unlicensed advertisers alike. This makes it difficult for retail investors to distinguish and/or choose between content from trustful regulated firms, content from legitimate amateur investors, and content from deliberate defrauders. It also makes it more likely that funds can be rerouted from legitimate investments to malicious pump and dump schemes. Yet, regulation and enforcement of social media is extremely difficult because social media communication is individualized and discrete. Simply put, my internet is different from your internet.
The limitless amount of social media posts, and the fact that not all social media posts are accessible to regulators is a challenge to those who would otherwise supervise misleading or illegal promotions. IOSCO members surveyed typically rely on consumer complaints for investigation and enforcement purposes of misleading and illegal promotions. Therefore, regulators often find themselves playing defense rather than offense, as they react to an infraction that has already occurred.
In conclusion, the IOSCO report also notes the risk of fraudulent offerings via online platforms and mobile apps, and expresses concern with the suitability of riskier products and crypto assets for retail investors. The exponential growth of social media marketing is increasingly influencing retail investors’ decisions as individuals monitor finfluencers’ posts, receive unsolicited algorithmic advertising, share investment tips, and seek information from a wide variety of sources – many of which are not monitored by regulators. This is troubling because as discussed social media can easily be used to promote scams. Furthermore, newer online trading platforms and digital apps use “gamification” techniques that may exploit behavioral biases to influence trading behavior. For all of the reasons stated above, the responsible use of social media in financial offerings increasingly becomes an important concern for regulators, investment firms, businesses who issue securities and crypto assets, and investors.
Paul Guirguis assisted in the preparation of this post.