The Use of Social Media for Investment Advice. The Struggle Between Employee Privacy Laws and Investor Protection

The landscape of communication has changed drastically in the past decade.  Information has the capability of widespread reach through the use of various sources.  In particular, social media has become an important channel of communication.  As such, the SEC has recently issued new guidance that allows financial firms to disseminate market related news via social media so long as firms alert investors which social media platforms will be used to deliver such information.  Financial firms’ use of social media must be in compliance with Regulation FD which “requires companies to distribute material information in a manner reasonably designed to get that information out to the general public broadly and non-exclusively…to ensure that all investors have the ability to gain access to material information at the same time.” 

Another emerging issue in the height of social media is employee privacy.  Recently, various states have made efforts to curtail employers’ attempts to monitor employees’ personal Facebook and Twitter accounts.  California, Illinois, Maryland, and Michigan adopted social media privacy laws last year while a similar law in Utah takes effect in May.  Variations of social media privacy laws have been introduced in 35 states since the beginning of 2013.

Securities regulators, however, have requested states to carve out exceptions in such state laws so that certain financial firms can maintain a close watch of the social media accounts of its employees in order to monitor whether personal accounts are being used to give investment advice. Regulators such as FINRA worry that social media networks can create new channels for Ponzi schemes and other frauds and ultimately put investors at risk. According to a survey conducted by American Century Investments, approximately one third of financial advisers use some form of social media several times a week to interact with investors.

Before California’s employee-privacy laws took effect at the start of the year, FINRA and other related groups requested that either the law be vetoed or an exception carved out for financial firms.  California rejected this request.  California’s law prohibits employers from requiring or requesting employees’ to: (1) disclose his or her username or password for the purpose of accessing social media; (2) access personal social media in the presence of the employer; or (3) divulge any personal social media.  Employees cannot be disciplined, terminated, or retaliated against for non-compliance if an employer makes such a request.     

Some state laws provide a narrow exception for employers to conduct legitimate checks of an employee’s personal social media accounts during a formal investigation of an employee’s alleged misconduct.  Nevertheless, securities regulators and financial firms would rather get in front of the issue and monitor employee’s conduct before it rises to the level of a formal investigation or before the potential harm to investors has been done. 

Securities regulators believe current employee-privacy laws are at odds with existing rules that require financial firms to monitor any investment advice that is posted or tweeted by employees.  Financial firms have found themselves between a rock and a hard place when it comes to the issue of employee privacy and compliance with regulations and will likely be faced with deciding whether to violate state law or SEC and FINRA regulations.    

Courts have yet to decide whether FINRA rules will supersede state law on this matter.

For further guidance on how financial firms can work within the bounds of state laws while maintaining its obligations to FINRA contact the experienced attorneys at Cosgrove Law Group, LLC. 

Second Circuit Finds That SEC is Immune from Lawsuit by Bernie Madoff Victims

In Molchatsky, et al. v. United States, 11-2510-cv(L), the Plaintiffs sought to hold the United States liable for SEC employees’ failure to detect Bernard Madoff’s Ponzi scheme and for the financial losses that Plaintiffs claim they suffered as a result. The Plaintiffs’ principal allegation was that the SEC negligently failed to uncover Madoff’s fraud despite receiving numerous complaints over a sixteen-year period. Plaintiffs claim that the SEC’s clear negligence exposes the agency to liability under the Federal Tort Claims Act (“FTCA”).

The FTCA is an exception to the rule that the United States is typically immune from suit. The district court determined that the Discretionary Function Exception (“DFE”), an exception to the exception to the rule of United States immunity, barred Plaintiffs’ claims. The DFE suspends the FTCA from applying to:

[a]ny claim based upon an act or omission of an employee of the Government, exercising due care, in the execution of a statute or regulation, whether or not such statute or regulation be valid, or based upon the exercise or performance or the failure to exercise or perform a discretionary function or duty on the part of a federal agency or an employee of the Government, whether or not the discretion involved be abused.

28 U.S.C. § 2680(a).

The Second Circuit Court of Appeals agreed with the district court. The court of appeals stated that the DFE is not about fairness, it “is about power,” National Union Fire Insurance v. United States, 115 F.3d 20 1415, 1422 (9th Cir. 1997); the sovereign “reserve[s] to itself the right to act without liability for misjudgment and carelessness in the formulation of policy,” id. “[T]he DFE bars suit only if two conditions are met: (1) the acts alleged to be negligent must be discretionary, in that they involve an ‘element of judgment or choice’ and are not compelled by statute or regulation and (2) the judgment or choice in question must be grounded in ‘considerations of public policy’ or susceptible to policy analysis.” Coulthurst v. United States, 214 F.3d 106, 109 (2d Cir. 2000) (quoting United States v. Gaubert, 499 U.S. 315, 322-23 (1991)) The court of appeals noted that Plaintiffs bear the initial burden to state a claim that is not barred by the DFE. See Gaubert, 499 U.S. at 324-25.

The court of appeals concluded that in the case before it, the Plaintiffs failed to make the necessary showing. The conduct Plaintiffs sought to challenge was “too intertwined with purely discretionary decisions” made by SEC personnel. Gray v. Bell, 712 F.2d 490, 515 (D.C. Cir. 1983); see generally id. at 515-16.

While the court expressed sympathy for Plaintiffs’ predicament (and at the same time expressing antipathy for the SEC’s conduct), it found that Congress’s intent to shield regulatory agencies’ discretionary use of specific investigative powers via the DFE was fatal to Plaintiffs’ claims. See Berkovitz by Berkovitz v. United States, 486 U.S. 531, 538 & 538 n.4 (1988) (quoting H.R.Rep. No. 1287, 79th Cong., 1st Sess., 616 (1945)). The court found that the first prong of the DFE was satisfied because the SEC retains complete discretion over when, whether and to what extent to investigate and bring an action against an individual or entity. See 15 U.S.C. § 78u(a)(1); 17 C.F.R. § 202.5(a)-(b). It also found that the second prong of the DFE was satisfied by virtue of the SEC’s choices regarding allocation of agency time and resources being sufficiently grounded in economic, social and policy considerations. See Bd. of Trade of City of Chicago v. SEC, 2 883 F.2d 525, 531 (7th Cir. 1989); cf. Coulthurst, 214 F.3d at 108-11.

The court concluded that the SEC’s actions, along with its “regrettable inaction,” were shielded by the Discretionary Function Exception, and affirmed the district court’s dismissal of Plaintiffs’ claims for lack of subject matter jurisdiction.