Does your Investment Adviser Firm Have a Social Media Policy?

Social media such as Facebook, Twitter, LinkedIn, or blogs have become popular mechanisms for companies to communicate with the public. Social media allows companies to communicate with clients and prospective clients, market their services, educate the public about their products, and recruit employees. Social media converts a static medium, such as a website, where viewers passively receive content, into a medium where users actively create content. However, this type of interaction poses certain risks for investment advisers and this topic has been a hot button for securities regulators. 

The SEC previously issued a National Examination Risk Alert on investment adviser use of social media. As a registered investment adviser, use of social media by a firm and/or related persons of a firm must comply with applicable provisions of the federal securities laws, including the laws and regulations under the Investment Advisers Act of 1940 (“Advisers Act”). The Risk Alert noted that the various laws and regulations most affected by social media are anti-fraud provision, including advertising, compliance provisions, and recordkeeping provisions. Advisers Act Rule 206(4)-7 requires firms to create and implement social media policies, and periodically review the policy’s effectiveness. 

Anti-fraud provisions with respect to advertising are probably most affected by the use of social media. All social media use and communications must comply with Rule 206(4)-1. While advertising policies should already be included in a firm’s compliance manual, such policies may not be sufficient enough to address some of the concerns with advertising in the context of social media. Establishing a specific policy to address social media may be prudent.

The area of advertising that has caused the most confusion is the prohibition on the use of testimonials. The SEC has previously defined testimonial to include a statement of a client’s experience with, or endorsement of, any investment adviser. Firms and IARs must ensure that third-party comments on their social media sites do not constitute a testimonial. Furthermore, the SEC vaguely discussed whether the popular “like” function on many social media sites would be deemed a testimonial:

[T]he staff believes that, depending on the facts and circumstances, the use of “social plug-ins” such as the “like” button could be a testimonial under the Advisers Act. Third-party use of the “like” feature on an investment adviser’s social media site could be deemed to be a testimonial if it is an explicit or implicit statement of a client's or clients' experience with an investment adviser or IAR. If, for example, the public is invited to “like” an IAR’s biography posted on a social media site, that election could be viewed as a type of testimonial prohibited by rule 206(4)-1(a)(1).

The types of policies that firms must create concerning advertising and testimonials depend greatly on the function of a specific website. For instance, approving the firm or IARs use of certain websites may turn on whether that website allows for review and approval of third-party comments before such comments are posted on the site or whether the “like” function can be disabled. A firm’s monitoring capabilities and the latitude it wants to provide employees with respect to personal use of social media cannot be ignored either.

The SEC has outlined various factors that should be considered by an investment adviser when evaluating the effective of their compliance program. These factors are:

• Usage and content guidelines and restrictions on IAR use of social media whether on behalf of the firm or for personal use
• Mechanisms for approval of social media use and content;
• Monitoring of social media use by the firm and IARs and the frequency of monitoring;
• Consideration of the function or risk exposure of specific social media sites;
• Establishing training and requiring IAR certification;
• Whether access to social media poses information security risks; and
• Firm resources that can be dedicated to implementation of social media policies.

There are various considerations firms must take into account when establishing social media policies or evaluating the effectiveness of its existing policies. If your firm needs assistance, the Cosgrove Law Group, LLC can assist with creation or review of such policies.

Who has the Right to Enforce Your Promissory Note?

A customary practice in the securities industry is for financial advisors to receive a transition bonus above and beyond an advisor’s standard commission compensation upon joining to a new firm. The bonus amount is usually determined using a certain percentage or multiplier of the advisor’s trailing 12-month production. These are usually referred to as “promissory notes” or Employee Forgivable Loans (“EFL”). Promissory notes are often used to solicit new employees/contractors from another brokerage firm. However, this “incentive” is usually cloaked with many restrictions. Typically these loans are forgiven by the firm on a monthly or annual basis but the advisor has to commit to the firm for a specified number of years or be required to pay the balance back to the firm should the advisor leave before the end of the term. 

Brokerage firms can enforce promissory notes through FINRA arbitration. Promissory note cases are one of the most common types of arbitration and the brokerage firms experience a high success rate with these cases. These proceedings are governed, in part, by FINRA Rule 13806 if the only claim brought by the Member is breach of the promissory note. This rule allows the appointment of one public arbitrator unless the broker rep. files a counterclaim requesting monetary damages in an amount greater than $100,000.  If the “associated person” does not file an answer, simplified discovery procedures apply and the single arbitrator would render an Award based on the pleadings and other materials submitted by the parties. However, normal discovery procedures would apply if the broker rep. does file an answer. Thus, if a broker wants to make use of common defenses to promissory note cases and obtain full discovery on these issues, the broker should ensure that he or she timely files an Answer.    

  

A recent trend with promissory notes is that the advisor’s employer does not actually own the Note. Sometimes this entity holding the note upon default is a non-FINRA member company, such as a subsidiary of the broker-dealer or holding company set up specifically to hold promissory notes. Many believe the practice of dumping promissory notes into a subsidiary is to circumvent the SEC requirement that brokerage firms hold a significant amount of capital (one dollar for each dollar lent) to protect against loan losses.  By segregating promissory notes into a separate entity, firms likely can retain much less to meet its capital requirements. 

Because a non-FINRA member firm may ultimately attempt to enforce the promissory note, questions arise as to how an entity can use FINRA arbitration to pursue claims against an agent.  The Note likely contains a FINRA arbitration clause but this may create questions of the enforceability of the arbitration clause. Furthermore, non-FINRA member entities cannot take advantage of FINRA’s expedited proceedings for promissory notes under Rule 13806 as this rule only applies to “a member's claim that an associated person failed to pay money owed on a promissory note.”

However, in order to make use of the simplified proceedings under Rule 13806, some member-firms have started a practice of sending a demand letter to the broker requesting full payment be made to the broker-dealer, rather that the entity that actually owns the note.  Broker-dealers have also attempted to simply add the Note-holder as a party to the 13806 proceedings. Reps should immediately question the broker-dealer’s standing to pursue collection or arbitration, the use of Rule 13806 to govern the arbitration, and potentially consider raising a challenge to a non-FINRA member firm attempting to enforce its right through FINRA arbitration. 

If you have recently received a demand letter seeking collection of a promissory note or are party to an arbitration, you may wish contact the attorneys at Cosgrove Law Group, LLC for legal representation.