The following is a guest article by Susan Mathews, Principal & Founder of Madigail Consulting, LLC a securities compliance consultant providing research and ethics compliance, training and external CCO services to investment research providers. Susan was previously an Enforcement Attorney at the SEC and was the Regulator Liaison for the independent research portion of the SEC’s Global Research Analyst Settlement.
Why should you care what your analyst just posted about a report on Twitter? Because the SEC and FINRA care and may sue you if the post was inappropriate. A recent Supreme Court ruling has increased liability further, allowing private lawsuits for seeking damages for misleading information disseminated by social media or emails. This article will briefly cover the main issues you should be on top of, which will be explained in greater detail in a live webinar slated to be held on Wednesday, April 24th and 12:00 pm. Click here to register for this free webinar.
The Supreme Court issued a surprising decision the end of March 2019 in Lorenzo v. SEC,[i] deciding that individuals who forward misleading information through any form of social media can be held liable under Section 10(b) of the Exchange Act. Lorenzo was an investment banker at a small broker dealer, Charles Vista, who sent emails valuing a company at $10 million when he knew the valuation was closer to $400,000. Lorenzo claimed he was forced to send the emails by his boss. The Court held that dissemination of false or misleading statements with intent to defraud was illegal under the antifraud provisions of the Exchange Act, even if the disseminator did not “make” the statements, but merely forwarded them in an email. As a result of this ruling, it will be easier for regulators and private litigants to bring anti-fraud actions involving social media and emails.
A key take-away is that research providers must have effective social media policies in place and have some way to monitor what employees are posting or emailing. Virtually every insider trading and market manipulation case brought by the SEC recently has involved some kind of social media. A few examples of wrongdoing using social media caught by the SEC:
- A Goldman Sachs compliance department employee hired to improve the firm’s electronic surveillance used his access to confidential emails to trade in his and his father’s accounts in China.[ii]
- Professional football player Kendricks received confidential merger tips from former Goldman junior analyst and writer Damilare Sonoiki, thru coded text messages and facetime conversations. In an effort to evade detection, Sonoiki also tipped a family friend in text messages using a Nigerian dialect.[iii]
- Two robo advisers made false statements to clients on their websites and social media. Wealthfront Advisers posted misleading original tweets on its feed and also selectively retweeted posts by other Twitter users. Wealthfront paid bloggers for successfully soliciting new clients to open accounts.[iv]
You may recall back in 2015, the SEC brought action against a Scottish man who created fake Twitter accounts to appear like short ideas providers Muddy Waters and Citron Research. http://www.integrity-research.com/us-regulators-go-after-short-ideas-spoofs/[v] This type of wrong-doing has continued to grow and tippers are using more creative methods in an effort to avoid detection by authorities. The ultimate irony, perhaps, is that the SEC itself was just hacked and the stolen information was used to commit insider trading. [vi]
Twitter is a site that is particularly rampant with potential violations. Increasingly research analysts tweet about upcoming reports, price movements and opinions. The SEC has recently devoted part of its Cyber Security office specifically to detect wrongdoing on social media.
As a former regulator, I would argue that tweeting about an upcoming report is unacceptable and may violate pre-publication FINRA rules. For example, consider the following tweet: “Analyst X publishes takeaways from his meetings with managements of $NEWR and $TDC. Full reports out today @researchfirm.” A regulator might argue this is an advertisement or testimonial in violation of SEC and FINRA rules. Tweets prior to publication also encourage readers to contact the research firm before the broad publication of the report in hopes that analysts will reveal more information before it is widely-known.
Post Lorenzo, it will be easier for regulators and private litigants to allege fraud against secondary actors and to hold such actors primarily liable. While the SEC often brings social media-related cases under investment adviser or broker-dealer related statutes and rules, now it can file against unregulated entities, including independent research providers and analysts, under general anti-fraud statutes. It may be easier for regulators to detect potential wrongdoing based on algorithms that detect “report taunting” on social media. Register now for a free webinar on April 24th at 12:00 pm to learn about policy considerations, rules and regulations that can help you bolster your information controls so that you continue to follow industry best practices.
[i] No. 17-1077 (3/27/19).
[ii] The defendant paid over $460k in fines and is barred from industry; SEC v. Yue Han, et al.,Lit. Rel. No. 23491 (3/16/16).
[iii] Kendricks and the family friend pled guilty and are cooperating with prosecutors and the SEC; SEC v. Kendricks, Lit Rel. No. 24252 (8/29/18).
[iv] Wealthfront Advisers, IA Rel. No. 5086, 12/21/18; see also, Hedgeable, Inc. ,IA Rel. No. 5087, 12/21/18, (roboadvisor similarly charged for allowing its clients to post on its web site and social media performance comparisons).
[v] SEC v. James Alan Craig, Civil Action No. 3:15-cv-05076 (N.D. Cal.); Lit. Rel. No. 23401 (11/6/15).
[vi] SEC v. Ieremenko, US Dist Ct, DNJ, No. 19-00505, 1/17/19: A Ukranian hacked into the SEC’s Edgar and newswire systems. The hacker extracted data from files containing nonpublic earnings results and then tipped seven traders.