Robert Heim Argued Before the U.S. Supreme Court in Lorenzo v. SEC

On December 3, 2018 Robert Heim argued the case Lorenzo v. SEC before the U.S. Supreme Court.  Mr. Lorenzo’s appeal raises important legal questions about whether the SEC can sanction a person for alleged fraudulent misstatements even though that person didn’t make the misstatements at issue.  This issue comes up in many SEC enforcement cases and it has split the circuit courts of appeals.

Mr. Lorenzo, who is a former investment banker, appealed from a 2017 decision by the DC Circuit Court of Appeals that held that while Mr. Lorenzo did not make the statements at issue he could nevertheless be held liable for those statements under a fraudulent scheme legal theory.  Mr. Lorenzo has argued that the DC Circuit Court’s ruling is contrary to a 2011 US Supreme Court decision in the case Janus Capital Group, Inc. v. First Derivative Traders.

A recording of Mr. Heim’s Supreme Court oral argument can be heard here:

The U.S. Supreme Court Granted Certiorari to a Meyers & Heim LLP client in an Important SEC Enforcement Case

On June 18, 2018 the U.S. Supreme Court agreed to hear an important case on behalf of Francis Lorenzo, a client of Meyers & Heim LLP.   Robert Heim is Mr. Lorenzo's lead attorney and the appeal raises important legal questions about whether the SEC can sanction a person for alleged fraudulent misstatements even though that person didn’t make the misstatements at issue.  This issue comes up in many SEC enforcement cases and it has split the circuit courts of appeals.

Mr. Lorenzo’s appeal is from a 2017 decision by the DC Circuit Court of Appeals that held that while Mr. Lorenzo did not make the statements at issue he could nevertheless be held liable for those statements under a fraudulent scheme legal theory.  Mr. Lorenzo has argued that the DC Circuit Court’s ruling is contrary to a 2011 US Supreme Court decision in the case Janus Capital Group, Inc. v. First Derivative Traders.  Oral argument at the Supreme Court is anticipated to take place in November 2018.

SEC Statement on Cryptocurrencies and Initial Coin Offerings

On December 11, 2017 SEC Chairman Jay Clayton published a Statement on Cryptocurrencies and Initial Coin Offerings. This statement contains information about how the SEC will analyze whether the offering of cryptocurrencies and Initial Coin Offerings is legal.  Both investors and market participants should review the SEC's statement prior to investing in or offering cryptocurrencies.  The statement is available here: 

SEC Statement on Cybersecurity

On Septemeber 20, 2017 SEC Chairman Jay Clayton published an important statement on Cyberysecurity. Broker-dealer, Registered Investment Advisors and publicly traded companies should review the statement and become familiar wih what steps the SEC expects regulated entities to take.  The full statement can be found here:

SEC Investor Bulletin Concerning Initial Coin Offerings

On July 25, 2017 the SEC published an investor bulletin concerning Initial Coin Offerings.  In that bulletin the SEC discussed its report of investigation under Section 21(a) of the Securities Exchange Act of 1934 describing the SEC investigation of The DAO, a virtual organization, and its use of distributed ledger or blockchain technology to facilitate the offer and sale of DAO Tokens to raise capital. The Commission applied existing U.S. federal securities laws to this new paradigm, determining that DAO Tokens were securities.  The Commission stressed that those who offer and sell securities in the U.S. are required to comply with federal securities laws, regardless of whether those securities are purchased with virtual currencies or distributed with blockchain technology.

The complete investor bulletin is available here:

Legal Developments in Securities Law

FINRA Settles with the SEC: Accused of Doctoring Documents
Today, FINRA settled civil charges by the SEC which stemmed from accusations that FINRA had doctored certain documents requested by the SEC. The Wall Street Journal reported:

According to the SEC, the director of Finra’s regional office in Kansas City altered in August 2008 the minutes of three internal staff meetings, editing or deleting certain information hours before providing the “inaccurate and incomplete” documents to the SEC’s inspection team.

The Finra director wasn’t identified in documents released by the SEC on Thursday. The SEC said the person resigned in 2010 after the alleged offenses were exposed.

The 2008 incident was the third time in eight years that an employee of Finra or predecessor the National Association of Securities Dealers provided altered or misleading documents to the SEC, it said. See article here.

The settlement provides, in part, for remedial measures, such as educating its staff members on “document integrity.”

Interestingly, in August of this year, an SEC employee accused the SEC of destroying thousands of documents concerning investigations into Wall Street banks and hedge funds. The SEC countered that it follows a system of periodically destroying documents, which does not violate any securities laws or policies. See the Wall Street Journal article from August here.

Regardless of the merit of the accusations against these agencies, individuals subject to SEC or FINRA inquiries can take a lesson from these headlines. Individuals who are the subject of an inquiry by the SEC or FINRA should ensure that they maintain copies of any information provided to the agencies and never alter any documents in an investigation. Providing complete and accurate information to a watchdog can be a difficult task, but an experienced attorney can guide you through the process and help you ensure that you are in compliance with securities laws.

Legal Developments in Securities Law

Federal Judge Critiques SEC’s Proposed Settlement with Citigroup
Could Force SEC to be More Aggressive in the Future
This blog post references Peter Latman’s NY Times article, “Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement,” found here.

Yesterday, the Securities and Exchange Commission (“SEC”) was asked by Judge Rakoff to defend its proposed settlement with Citigroup Global Markets, Inc. (“Citigroup”) based on its structuring and marketing of a largely synthetic collateralized debt obligation. Specifically, the SEC alleged that Citigroup negligently misrepresented key deal terms, such as its own financial interest in the transaction and that Citigroup had exercised significant influence over the selection of assets.

Judge Rakoff questioned the SEC’s decision to accept a settlement of $285 million, while indicating that the SEC estimated that investors lost close to a total of $700 million in the investments. Judge Rakoff was equally inquisitive about the SEC’s injunction, to bar Citigroup from violating securities laws in the future. Notably, the Judge asked, “Why do you ask for an injunction when you never use it?” The SEC can file civil contempt proceedings if an organization or individual under an injunction not to violate securities laws in fact violates securities laws again in the future. Notably, no such charges have been brought in the last ten years. Such injunctive relief has been the subject of ridicule in the past – it is axiomatic that an organization or an individual is prohibited by law from violating securities laws. As is standard with settlements with the SEC, the entity or individual involved does not admit or deny any wrongdoing with regard to the allegations. Judge Rakoff likewise questioned Citigroup’s unwillingness to admit liability in this matter.

Some may remember that Judge Rakoff likewise questioned the SEC’s proposed settlement with Bank of America concerning whether Bank of America misled investors about its acquisition of Merrill Lynch. There, Judge Rakoff initially rejected a $33 million settlement proposal, and later reluctantly accepted a revised settlement for $150 million.

Judge Rakoff’s refusal to “rubber stamp” the SEC’s proposed settlements with large financial institutions could have potential ramifications on the settlements the SEC negotiates in the future. Judge Rakoff’s comment, “I won’t be cute and ask what percentage of Citigroup’s net worth is $95 million because I do not have a microscope with me,” indicates that this type of scrutiny is perhaps reserved for larger financial institutions, rather than their smaller counterparts or even individuals. Seemingly, given the alleged violations involved and the impact on the shareholders involved, the settlement amount was not proportionate to the harm based on Judge Rakoff’s observation. Although the SEC may adjust its disgorgement figures or civil penalties based upon a respondent’s showing of its/his/her financial inability to pay, an entity like Citigroup clearly does not face such a burden. As a result of Judge Rakoff’s refusal to acquiesce to whatever settlement proposal the SEC sets forth, the SEC may play hardball with large financial institutions to avoid future judicial scrutiny. Further, it is conceivable that the SEC may file a civil contempt proceeding the next time that an institution that has been barred from violating securities laws, violates securities laws. Although the SEC has not done so in at least ten years, pressure from the public may mount if an entity like Citigroup or Bank of America is accused of violating securities laws again. It seems unlikely, however, that respondents would be forced to admit liability as a condition of settlements – the practice of neither admitting nor denying liability is not only standard among settlements with the SEC, but in the general practice of law.

So-called smaller actors, such as smaller entities or individuals, may nonetheless find the SEC requesting large settlement amounts, especially given the impact, severity or frequency of their alleged securities law violations. The SEC takes into account a number of factors when determining an appropriate civil penalty, such as the egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations. Think of an individual like Raj Rajaratnam, who was recently ordered to pay a total of $156.6 million in fines and disgorgement, an amount that Judge Rakoff again questioned given Rajaratnam’s net worth and the fact that the civil penalty was designed, in Judge Rakoff’s words, “to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it.”

Further, although the SEC may request injunctive relief that an individual be barred from violating securities laws in the future, that individual may also be barred from serving as a director of a public company, from working in the securities industry, or from participating in the issuance of certain kinds of securities offerings, to name but a few examples. Judge Rakoff’s remarks should serve as a wake-up call for large financial institutions, but others are by no means less vulnerable to the range of consequences the SEC could request.

Legal Developments in Securities Law

Update: SEC Appeals Judge Rakoff’s Ruling Denying Proposed Settlement
One of our earlier blog posts referenced Judge Rakoff’s criticism of the SEC’s proposed settlement with Citigroup – found here. Unsurprisingly, Judge Rakoff rejected the parties’ proposed settlement. The SEC has now filed an appeal, citing legal error and claiming that, “We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits,” as set forth in a statement by Robert Khuzami, the S.E.C.’s director of enforcement (see the New York Times article on this issue here).

The SEC’s appeal is certainly not unprecedented, as the New York Times notes that the agency has indeed appealed such rulings in the past, and in fact won such an appeal in S.E.C. v. Randolph. The SEC’s decision to appeal Judge Rakoff’s decision, which reasoned that the proposed settlement simply was not in the public interest and that more facts were necessary to approve such a settlement, suggests a reluctance to fight Wall Street. One could reason that the SEC may treat larger institutions that are repeat offenders, like Citigroup, less harshly than the “little guys,” or individuals and small companies involved in SEC enforcement actions.

Certainly, the resources involved in litigating against a large institution like Citigroup in federal court are not minimal, but given that investors experienced over $700 million in losses, a settlement amount of $285 million concerning charges of securities law violations pales in comparison to the harm caused. By comparison, the “little guys” cannot afford lengthy litigation against the SEC, and perhaps the SEC can use that as leverage to obtain a settlement that fully disgorges the defendant’s ill-begotten gains. Settlements, however, do involve a case of give and take – the SEC may not get the full amount requested and the defendant agrees to a sum that may be lower than the potential outcome in litigation. With an institution like Citigroup, the SEC may be additionally motivated to settle the matter more expeditiously to avoid a lengthy trial and potential failure in court. With the “little guys,” the SEC holds the upper hand, and it’s hard to imagine a scenario where the SEC would appeal a Judge’s ruling rejecting a settlement with such an individual.

It is no surprise that the reaction among members of the public toward the SEC has been one of outrage concerning the SEC’s decision to appeal Judge Rakoff’s decision. Dennis M. Kelleher, of Better Markets, Inc., wrote in the Huffington Post:

No one should be surprised that the risk-adverse, Wall Street friendly SEC chose not to litigate against Citigroup for pocketing more than $600 million from its $1 billion fraudulent subprime mortgage scheme that cost its customers more than $700 million. Instead, the SEC decided to litigate against the one federal judge who had the audacity to scrutinize their proposed settlements. As the Wall Street Journal headline correctly captured it, “SEC Cops Want to Fight U.S. Judge.”

Ironically, in the eyes of the SEC, Judge Rakoff is a repeat offender (first, Bank of American and now Citigroup!), but Citigroup is literally a repeat offender, having been toothlessly sanctioned by the SEC 5 times in the last 8 years for violations of the securities laws. Judge Rakoff had the nerve to ask the SEC what was the point of slapping their wrist one more time given that the prior five slaps appeared not to make much of an impression. (Such repeated toothless “sanctions” is common for the SEC.)

View Mr. Kelleher’s article here. The Wall Street Journal’s Law Blog featured a piece by Neal Lipschutz that stated:

Here’s a quote from Judge Rakoff’s decision, which I have cited before, that gets to the crux of the matter. “An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous … If its deployment does not rest on facts – cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.”

Khuzami said in part Thursday: “In fact, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.”

But just because something happens a lot doesn’t mean it’s correct. Here’s hoping the power of Rakoff’s apparently singular argument sets a new precedent.

The Wall Street Journal Law Blog post can be found here.

Although it is certainly true that settlements routinely include language in which the defendant neither admits nor denies liability, it appears that perhaps Judge Rakoff took issue with that language in the Citigroup proposed settlement because the institution has been sanctioned multiple times in the last eight years. If the “little guys” commit multiple securities law violations, they would face injunctions and bars from practicing their profession which hit them much harder than a nominal monetary settlement for a large institution. If a large institution can pay only a nominal settlement without admitting or denying liability, what would prevent that institution from carrying on illegal activity that results in a profit? In this situation, Citigroup allegedly made around $600 million from its fraudulent scheme, but tried to settle the matter for $285 million – a $315 million profit. Even if the SEC’s recent actions are not out of the ordinary, appealing Judge Rakoff’s decision has not improved the agency’s image.

Legal Developments in Securities Law

A Look Back at 2011: The Biggest Securities Law News of the Year
2011 was a big year in securities law – from the Galleon Group insider trading convictions to the beginning of the SEC’s whistleblower program under Dodd-Frank. Here, we’ll review the top five securities law stories from 2011.

5. Judge Rakoff Challenges Settlements Made “Without Admitting or Denying Wrongdoing”
In 2010, Judge Rakoff first questioned the SEC’s proposed settlement of $33 million with Bank of America for misleading shareholders concerning its acquisition of Merrill Lynch. In 2011, Judge Rakoff started off the year by expressing his distaste for settlements between the SEC and wrongdoers that were made “without admitting or denying wrongdoing,” a standard practice in the industry. In the SEC’s settlement with Vitesse Semiconductor and three former executives over improper accounting of revenue and backdating of stock options, Judge Rakoff wrote:

The result [of neither admitting nor denying wrongdoing] is a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C. The defendant is free to proclaim that he has never remotely admitted the terrible wrongs alleged by the S.E.C.; but, by gosh, he had better be careful not to deny them either (though, as one would expect, his supporters feel no such compunction). Only one thing is left certain: the public will never know whether the S.E.C.’s charges are true, at least not in a way that they can take as established by these proceedings.

This might be defensible if all that were involved was a private dispute between private parties. But here an agency of the United States is saying, in effect, “Although we claim that these defendants have done terrible things, they refuse to admit it and we do not propose to prove it, but will simply resort to gagging their right to deny it.”

In the Vitesse Semiconductor settlement, however, the Judge found that the amount was fair, reasonable and in the public interest. See article here. Later in 2011, however, Judge Rakoff outwardly rejected the SEC’s proposed settlement of $285 million with Citigroup, which represented only a fraction of the losses involved (the SEC alleged that Citigroup bet against its customers in housing related investments and made profits of $160 million while the customers lost more than $700 million). Judge Rakoff again questioned why Citigroup could get away with neither admitting nor denying liability, and even questioned the SEC’s practice of obtaining injunctions against defendants, prohibiting them from violating securities laws in the future (Judge Rakoff also questioned the factual basis for the charges involved). The SEC has appealed Judge Rakoff’s decision, rather than returning to the Judge with a different settlement, as they did with the Bank of America case in 2010. Judge Rakoff’s actions have instigated a great deal of public debate over the standard language used in SEC settlements, and could have an effect on the SEC’s settlements in the future.

4. Federal Agencies Target Ponzi Schemes in Greater Numbers
In 2011, federal agencies noted that they were attacking Ponzi schemes in greater numbers than ever before. As an example, the CFTC carried out a record 32 enforcement cases involving Ponzi schemes, a 45 percent increase from 2010. See article here. The FBI had over 1,000 inquiries concerning Ponzi schemes, 150% more than in 2008. The SEC notes that it has brought more than 100 enforcement actions against nearly 200 individuals and 250 entities for carrying out Ponzi schemes since the year 2010. Faced with the embarrassment of discovering the Madoff Ponzi scheme 20 years after it started, it seems the agency is striving to prevent another oversight.

Some notable Ponzi scheme allegations this year included James Davis Risher, who was accused of targeting elderly and unsophisticated investors in a $22 million Ponzi scheme and who pleaded guilty in federal court in August 2011, Allen and Wendell Jacobson, a father and son accused of perpetrating a $220 million Ponzi scheme that targeted members of the Mormon Church, and the Fair Finance Company and three executives, accused of orchestrating a $230 million offering fraud involving at least 5,200 investors, many of whom were elderly. Many Ponzi related actions resulted in parallel criminal actions as well.

3. SEC’s Whistleblower Program Launches
In May 2011, the SEC adopted the final rules that would launch the whistleblower program created under the Dodd-Frank Act. The whistleblower program was launched with a very enticing incentive – a percentage ranging from 10-30% of any recovery by the SEC of over $1 million in a successful enforcement action that was spurred by the whistleblower’s tip. In addition to offering legal protection to employees from retaliation for reported potential securities law violations, the monetary incentive is likely to encourage detailed and effective tips from individuals or employees with knowledge of potential violations. In the first seven weeks of the program alone, 337 tips were received by the SEC. The whistleblower program also allows individuals to submit tips anonymously through an attorney. For more information, see our previous blog posts on the subject, here and here.

2. Continued Aggressive Enforcement of FCPA Violations
Although 2008 marked the year of the largest settlement ever for Foreign Corrupt Practices Act (“FCPA”) violations (the Siemens case), 2011 marked a continued effort by the SEC and the US DOJ to aggressively prosecute FCPA violations. For example, the sixth largest FCPA settlement to date took place in 2011 – a massive $218.8 million settlement from the Japanese corporation JGC, for allegedly paying $180 million in bribes to Nigerian officials. Just days before the year’s end, the SEC & DOJ marked the tenth largest FCPA settlement ever when it was announced that Magyar Telekom Plc of Hungary and its majority owner Deutsche Telekom AG of Germany would pay $95 million in criminal penalties, disgorgement and prejudgment interest in connection with sham consultancy contracts with an intermediary that paid €4.875 million to Macedonian officials and falsifying books and records concerning Magyar’s activity in Montenegro.

Deloitte reported that nearly 2/3 of corporate executives, investment bankers, private equity executives and hedge fund managers whom they surveyed stated that they renegotiated or pulled out of planned business relationships, mergers or acquisitions in the last three years due to FCPA concerns. Indeed, even though only 16 corporate cases were pursued this year, compared to 20 in 2010, 18 individuals were charged with FCPA violations, second only the number of individuals charged in the record-breaking year of 2009. See article here. This significant number of individual prosecutions marked an interesting shift toward individual responsibility for FCPA violations, which are viewed as corporate violations. See article here. In fact, the largest individual FCPA forfeiture to date occurred in 2011, when Jeffrey Tesler paid nearly $149 million based on allegedly bribing Nigerian officials in exchange for certain contracts in the state. Mr. Tesler was the former middleman to KBR and its TSKJ partners Snamprogetti, Technip, and JGC. The FCPA Blog has an interesting post on Mr. Tesler’s forfeiture here. This large forfeiture certainly should serve as a warning signal for individuals heading into 2012 – the SEC and DOJ will not hesitate to pursue individuals for FCPA violations, and all signs indicate that enforcement will continue aggressively in the new year.

1. The Year of Insider Trading
The SEC and US Attorney’s Office aggressively pursued insider trading cases in 2011, more so than the year before. In 2011, the SEC and the US Attorney’s Office obtained a record prison sentence and record financial penalty for insider trading, and have showed no signs of slowing down. Judge Rakoff even remarked that decades have passed and insider trading is still rampant, noting that deterrence is an important aspect of handing out penalties and prison sentences. 2011 was monumental in the SEC’s and US Attorney’s Office’s efforts to crack down on insider trading.

The most notable case was that of Raj Rajaratnam, who was convicted of 14 counts of conspiracy and securities fraud in connection with his insider trading in several public companies. Mr. Rajaratnam was arrested along with other former and current traders at Galleon Group, one of the largest hedge fund management firms in the world at the time, which Mr. Rajaratnam founded. Mr. Rajaratnam received an 11 year prison sentence, the largest ever in an insider trading case, and a $92.8 million penalty, the largest ever assessed against an individual for insider trading. A number of his co-conspirators also received prison sentences, with one individual receiving a ten year sentence and the other 13 receiving an average 3 year sentence. The Rajaratnam case certainly underscored the US Attorney’s Office eagerness to pursue record-breaking prison sentences for insider traders, as exemplified by the 19-24 years in prison the prosecution requested in Raj Rajaratnam’s case. Rajat Gupta, who was on the boards at many large public companies, educational institutions and charitable organizations, was also charged this year, and has been accused of providing inside information to Mr. Rajaratnam for him to trade on.

In April 2011, the SEC charged a former Wilson Sonsini Goodrich & Rosati, Cravath Swaine & Moore and Skadden Arps attorney and a Wall Street trader for their involvement in a $32 million insider trading ring. The US Attorney’s office made arrests in a parallel action. The attorney allegedly accessed information on 11 mergers and acquisitions involving the law firm’s clients and then tipped a middleman. This case highlighted how federal agents were able to obtain wiretapped conversations among the attorney, the trader and the middleman, despite the group’s belief that they were acting in an abundance of caution by using disposable cell or pay phones and by using cash from small bank accounts to pay off the scheme.

More recently, James Fleishman, a former hedge fund consultant who worked at Primary Global Research, received 2 and a half years in prison for orchestrating a secret exchange of information between hedge fund traders and employees at companies. Mr. Fleishman had faced 25 years in prison, which is even greater than the sentence requested in Mr. Rajaratnam’s case. This case has had an impact on the financial services industry – expert-network consultants and companies who use such consultants may face regulatory inquiries in light of cases like Mr. Fleishman’s. As a result of the arrests associated with Primary Global and even with Raj Rajaratnam (who claimed his research came from a network of private individuals), many financial firms have stopped or reduced the use of expert-network firms, which connect large investors with outside specialists, simply to avoid the appearance of impropriety. See article here.

This small sample of the insider trading cases that took place in 2011 illustrates the SEC’s and the US Attorney’s Office’s continued effort to aggressively prosecute insider trading violations. The new year will likely continue in the same vein, although it will be hard to top the record breaking year the agencies had in 2011.

Legal Developments in Securities Law

Investors and Investment Advisers Beware: The Use of Social Media in Financial Services
Recently, the SEC charged an investment adviser for violations of the securities laws based on offerings on LinkedIn. Social media has obviously taken on a greater role in everyday life in recent years, with many businesses utilizing outlets like Facebook, Twitter, LinkedIn, YouTube and even blogs (check out our social media guide below for a breakdown of the types of social media, in case you are unfamiliar). The SEC’s enforcement proceeding and the guidelines it released simultaneously are instructive particularly for individuals in the financial services industry and for individuals interested in investing their money in something of which they learned through social media. Here are the salient points to take away from the SEC’s recent guidance.

Investment Advisers: The Securities Laws Apply to the Use of Social Media
It should be obvious that the securities laws do apply to all representations that registered investment advisers (“RIAs” or “firms”) publish to the various social media outlets. Firms should pay careful attention to the antifraud provisions, compliance provisions, and recordkeeping provisions, as specified by the SEC in its January 4, 2012 National Examination Risk Alert. In its Risk Alert, the SEC Staff addressed three areas of review for firms to consider: (A) Compliance Programs Related to the Use of Social Media, (B) Third Party Content, and (C) Recordkeeping Responsibilities.

(A) Compliance Programs Related to the Use of Social Media
Overall, the SEC highlighted that firms’ compliance policies and procedures may not be designed to address social media concerns specifically, causing some confusion about what is permitted and which policies apply to social media use. The SEC provided a number of factors to firms to help evaluate the effectiveness of their compliance programs’ effectiveness vis-à-vis social media, which includes usage guidelines, content standards, monitoring, frequency of monitoring, approval of content, firm resources, criteria for approving participation, training, certification, functionality, personal/professional sites, information security and enterprise wide sites. Particularly, firms may need to consider adopting policies to address investment advisory representatives’ (“IARs”) or solicitors’ business that is conducted on personal or third-party social media sites. As an example, an IAR may have a personal Facebook, but may use his or her network of “friends” as a business opportunity. Although the SEC notes that including business card information may be acceptable, individuals who exceed that very narrow scope may run afoul of the securities laws, and will also implicate their RIAs by doing so. Firms may also have to adopt policies or install firewalls to prevent individuals within the firm’s computer system from uploading sensitive customer information or the firm’s own proprietary information to social media sites. Firms may choose simply to block access to social media sites from within their computer network to avoid such security concerns. To the extent that firms do allow content on social media sites, it should be carefully scrutinized and submitted to such sites only after the compliance department has reviewed the content and approved it. Obviously, consulting an experienced attorney is important for firms to ensure they have built an effective compliance program, but the SEC’s guidance is an important first step for firms or even IARs or solicitors to take to evaluate their use of social media.

(B) Third Party Content
If a firm or IAR operates a Facebook page or similar social media site, third party content is often permitted and indeed encouraged. Individuals can choose to “post” comments, videos, articles, photos, etc. to the firm’s or IAR’s social media site. The SEC noted that clicking “like” on a social media site, such as Facebook, could constitute a “testimonial” under the Advisers Act, and could be the type prohibited under Rule 206(4)-1(a)(1). Per the SEC’s example, clicking “like” concerning an IAR’s biography on a social media site would be considered a prohibited testimonial. Firms or IARs could limit the risks inherent in third party content by:

  1. Not allowing for any third-party postings on their social media sites;
  2. Deleting third-party postings or “likes” if the social media site does not have the option to limit such postings;
  3. Limit third-party postings to approved users;
  4. Posting disclaimers directly on their site stating that they do not approve or endorse any third-party communications posted on their site in an attempt to avoid having a third-party posting attributed to the firm; and/or
  5. Putting in place policies and procedures to address third-party postings.

(C) Recordkeeping Responsibilities
The recordkeeping obligations under the Advisers Act do not distinguish between the various types of social media or other electronic communications (discussion boards, chat rooms, instant messages, texts, e-mails). If a firm or its IARs communicate through social media, the firm must ensure that it can maintain all required records to have them easily available for inspection, for the applicable retention period. The firm must also evaluate all of the social media communications to determine whether they are indeed required records under the Advisers Act. The firm’s compliance department should also ensure that records are being properly maintained. Consulting with an experienced attorney is important to ensure that the required records are being kept for the required amount of time.

Investors: Be Careful What You Believe Via Social Media
In light of the SEC’s recent proceeding against an Illinois-based investment adviser who was allegedly offering to sell fictitious securities on LinkedIn, the SEC likewise issued an alert to investors, entitled Investor Alert: Social Media and Investing – Avoiding Fraud. Individuals often maintain their own Facebook, LinkedIn, and Twitter accounts, and will also use resources such as blogs or YouTube videos to obtain information on potential investments. Even searching one of the popular search engines for more information on a potential investment could lead potential investors to any one of these sites, among many others, such as discussion boards or business review sites. It’s not unusual for an investor to do some investigative research on a company or investment by Googling them – but some of the search results may include fraudulent information on an otherwise legitimate website. The SEC has a number of tips to help investors navigate the stormy waters of social media.

1.“Be Wary of Unsolicited Offers to Invest”
This shouldn’t come as a surprise – people are usually wary of any kind of unsolicited offer, but sometimes these “investment opportunities” can appear particularly enticing in a difficult economic market. If someone whom you don’t know sends you an e-mail inviting you to purchase an haute couture purse for $25, your first reaction will likely be to click the delete button because it’s likely a counterfeit purse (among other reasons). An unsolicited e-mail to invest in a one-of-a-kind opportunity should likewise be treated with suspicion. This kind of message may come up via e-mail, a chat room, a Facebook message, a tweet sent to the investor, or a message directed at the investor on a discussion board. The same message holds true – be incredibly cautious about such offers to invest.

2. “Look Out for Common ‘Red Flags’”
We’ve blogged in the past about how if it sounds good to be true, it probably is. The SEC repeats this warning to potential investors, and notes that investors should beware of phrases like “INCREDIBLE GAINS,” “BREAKOUT STOCK PICK,” and “HUGE UPSIDE AND ALMOST NO RISK!” The SEC notes that investors should take a look at the returns on well known stock indexes – if the promised amount is substantially more, it could be incredibly risky or simply fraudulent. The SEC also mentions that “guaranteed” investments will carry lower returns, and every investment involves some degree of risk. “Risk free” investments are a huge red flag. Finally, the SEC notes that investors should think about each “opportunity,” and not be rushed into an investment.

3. “Look out for Affinity Fraud”
This type of investment scheme is particularly dangerous, as it has a more personal connection than random unsolicited offers. If an individual is a member of an organization or a group, especially online, he or she may be particularly susceptible to investing in an opportunity recommended by a fellow group member. Even if the individual personally knows the person suggesting the investment opportunity, he or she may be the victim of fraud and mistakenly may believe the investment is legitimate. Exercise extreme caution with any offers made through your connection to an organization, religion or group – recently, the SEC has brought enforcement proceedings against individuals who allegedly targeted fellow members of the Church of Jesus Christ of Latter Day Saints through church functions.

4. “Be Thoughtful About Privacy and Security Settings”
Keeping your personal information safe is especially important on the Internet. Do not give away any of your sensitive financial information on social media sites – even if prompted by a supposedly “official” looking account. Hackers can send e-mails or messages from accounts that appear to be from your financial institution, but which are really ploys to obtain your financial information for their own illicit motives. Overall, if you maintain a social media site, consider changing your privacy settings to “friends only” or “private,” to cut back on potential unsolicited investment “opportunities.”

5. “Ask Questions and Check Out Everything”
Many investors who are victims to investment fraud could have avoided the loss of their money by doing some simple research. Check the SEC’s website and its EDGAR system for company filings or your state’s securities regulator’s site (for New York’s Investor Protection Bureau website, click here). You can also check FINRA’s BrokerCheck for more information on registered brokers and the SEC’s Investment Adviser Public Disclosure website for RIAs. Check to see if the company you are investing with has a legitimate address – it could just be a P.O. Box or mailbox. Check the SEC’s website for disciplinary proceedings that may have involved the company or the individual(s) with whom you’ve communicated. Sometimes the Better Business Bureau may have information on complaints lodged against the company. Finally, trust your instincts, and if the research you’ve done doesn’t add up, don’t fall for the hype.

The SEC also posted information on the common types of schemes investors may face and listed a number of resources for victims of investment fraud. Of course, investors who feel they have been defrauded should consider finding an experienced attorney who will be able to assist them with their claims.

Firms and Individuals Should “Like” the SEC’s Recent Alerts
In sum, the SEC’s new guidance on the use of social media is helpful to firms and investors alike, and likely indicates that the SEC will carefully monitor all forms of social media for potential securities fraud violations. If you suspect you have encountered securities fraud through your use of social media, consult with an attorney who may assist you with filing a Whistleblower complaint with the SEC, as we specified in our blog post here. If you are an individual or firm in the financial services industry, pay heed to the warnings from the SEC and ensure that you have an effective compliance system in place, which can be set up with the assistance of a competent attorney.

Social Media Guide

Facebook: Initially started as a social networking site for a select few colleges, Facebook has expanded to over 800 million active users. Used by individuals and businesses alike, Facebook offers the opportunity to create a “Profile,” which can include information on your contact information, interests, photos, and other personal information. Users can also post “status updates” on any topic they may choose. The site also includes a “Wall,” which enables individuals to post comments, photos, videos, articles, etc. to the individual or business’s page. Facebook also includes an instant messaging system, a message system similar to e-mail and a “Like” button under posts by other users which you can click if you “Like” the post. Facebook offers users the opportunity to customize privacy settings, so that only certain parts of a user’s profile can be visible to everyone, while others can be made private, or even available only to certain users.

LinkedIn: LinkedIn is a social networking site used primarily for professional networking, and it has over 135 million registered users. The site helps individuals build a network of connections, which can then be used to find business opportunities, jobs and other people. LinkedIn also features groups, ranging from alumni associations to professional bar associations, which encourage users to post comments or questions. The user’s profile will typically include his or her work experience, similar to a resume, and can include a photograph.

Twitter: Twitter is a social networking site that is essentially microblogging, and it has over 300 million users. Users “tweet” messages of up to 140 characters, and can “tweet” at specific users by using @, or can use a hashtag # to signify a topic or phrase, which could become a “trending topic,” or one of the most popular topics at the moment. Twitter is used by a vast variety of users – the government, individuals, businesses, etc. Twitter is becoming the first source for breaking news for many individuals, with its instantaneous ability to convey information publicly. Even unregistered users can view tweets from its users, unless the user has restricted his or her account.

YouTube: YouTube is a video-sharing website, which enables users to upload, share and comment on videos. Although often thought of as a means to listen to new singers or specific songs, to find clips from television shows or to view funny videos, YouTube is being used more and more by companies to post advertisements or information about themselves.

Blogs: Blogs are similar to journals and often concern a particular subject, and there are over 156 million public blogs currently in existence. Many businesses have started using blogs to provide commentary on subjects pertinent to the fields in which they operate. A blog can be an interesting source of information for different viewpoints or insight into certain topics. Some blogs are more personal, akin to a diary. Some blogs have even developed into important news sources, such as those that have exposed political scandals. Blogs will often allow comments and can spur interesting debates on various subjects.

Bulletin Boards: Much like a community bulletin board, online bulletin boards encourage users to post public messages about any topic imaginable. Sometimes called internet forums, each new discussion starts a thread, and users can comment on the thread until the forum moderator decides to close commenting (if he or she does so at all). Users can post with usernames that will keep their true identities anonymous. Threads may start with questions like “How do I fix a flat tire?” or “What do you think about investing in gold?” Although there are moderators for such forums, that does not guarantee the truth or accuracy of the statements on these forums.

Google+: Google’s answer to Facebook, Google+ is a social networking site that has around 62 million users. Google+ has features like Facebook, such as a profile, a messenger and the ability to post updates, but also includes things like a user’s “Circles” or a collection of contacts, “Hangouts” or places to facilitate group video chat, or sharing links that the user found interesting or useful. Although Google+ has not caught on to the same degree as Facebook, it’s expected that its number of users will grow greatly in 2012.