Yesterday the Financial Industry Regulatory Authority (FINRA)  issued guidance to securities firms and brokers regarding the use of social networking Web sites such as Facebook, Twitter, LinkedIn and blogs to communicate with the public.

The guidance in Regulatory Notice can be found at the following link: http://www.mmsend6.com/ls.cfm?r=171160204&sid=8476005&m=915385&u=finra&s=http://www.finra.org/notices/10-06/, is presented in Q&A format, clarifies the responsibilities of firms to supervise the use of social networking sites to ensure that recommendations are suitable and their customers are not misled. The Notice also addresses the recordkeeping and other responsibilities of firms.

“Social networking sites and blogs raise new regulatory challenges, particularly in the areas of supervision, advertising and books and records requirements,” said FINRA Chairman and CEO Rick Ketchum. “Our goal in issuing this notice is to ensure that firms and brokers use social networking sites in an appropriate manner.”

The notice emphasizes that each firm must develop its own policies and procedures - in the context of its own particular business model and compliance and supervisory programs - designed to ensure that the firm and its personnel are complying with all applicable regulatory requirements when using social networking sites. Some technology providers are developing systems that are intended to enable firms to retain records of communications made through social networking sites. As the Notice states, however, “FINRA does not endorse any particular technology to keep such records, nor are we certain that adequate technology currently exists.”

Regulatory Notice 10-06 is a response to the expressed need for guidance explaining how FINRA rules governing communications with the public, recordkeeping and supervision apply to social networking sites. FINRA has previously issued guidance on the application of communications regulations to Internet communications in its Guide to the Internet for Registered Representatives, as well as in numerous podcasts.

In developing the Regulatory Notice, the FINRA staff was informed by its own experience in applying FINRA rules to electronic communications, by its conversations with experts in social networking technology, and by the work of a Social Networking Task Force composed of compliance and other representatives of 14 firms.

When the U.S. Securities and Exchange Commission starts Twittering, it is time for investment advisers to start to worry. Alas, for those of you who do not understand the meaning of the words “starts Twittering” most likely you are: (a) over 25 years old; (b) oblivious to the way information is now communicated in the social networking age; or (c) still wondering where documents go when you delete them from your computer (my best guess is Utica, New York). Up until a few months ago, I was certainly guilty on all three counts. After dedicating myself to learning the nuances of social networking, not only am I still guilty on all three counts, but I now seem to be in a constant state of nervous excitement (all atwitter, as it were).

For the previously uninitiated (such as myself), Twitter is a free social networking and micro-blogging service that enables its users to send and read other users’ updates known as tweets. It is one of the many social networking web sites that allow users to communicate information to a willing audience.

So why am I all atwitter? Quite simply, the use of social networking web sites by registered investment advisors is rife with potential compliance violations. Whereas compliance is all about control and order, social networking is all about everything but control and order. Indeed, its raison d’être is the complete de-centralization of information. Someone in Des Moines decides to recommend your firm on their social networking web site and you might run afoul of the rules prohibiting the use of testimonials.  An employee tweets about the merits of your advisory firm and voilà, it is considered advertising and should be subject to your compliance policies and procedures. The number of things that can go wrong from a compliance standpoint should make any sane compliance officer contemplate a quick career change – prohibited advertising, unauthorized marketing, improper dissemination of nonpublic personal information, vindictive employees purposely spewing false information, well-intentioned employees inadvertently spewing false information and failure to maintain required records are just a few of the compliance issues implicated by the use of social networking web sites.

As if this were not enough to cause an investment adviser significant angst, the fact that the SEC is now twittering should be of additional concern. Indeed, one of their very first tweets discussed a recent enforcement action against an investment adviser. Whereas before an investment adviser’s transgressions were limited to a select few in the business that knew how to access such information, now there are literally millions of outlets and recipients ready to share in an adviser’s misfortune. Even more disturbing is the SEC’s newfound technological savvy. It stands to reason that if the SEC knows how to Twitter, then they certainly know how to troll the most popular social networking web sites looking for compliance violations. It is now very likely that anything posted to the public portion of an adviser’s social networking web site is being seen by more than just potential clients.

LinkedIn

LinkedIn is a business-oriented social networking site used primarily for professional networking. LinkedIn helps investment advisers connect with other investment advisers, clients and potential clients searching for an investment adviser. LinkedIn provides users with a choice of having their profile publically available (meaning anyone can see the information posted) or they can restrict access to a limited or known group of people.  LinkedIn has a “recommendations” feature that allows users to post recommendations and endorsements on the public profile page of other users. LinkedIn also contains a “request recommendations” feature that allows users to solicit recommendations for posting on their public profile page.

Advisers must realize that any communication on an employee’s publically available social networking web site about your advisory firm is considered an advertisement. Because the Adviser Act’s prohibitions on advertising apply to electronic communications, advisers are ultimately responsible for communications about their advisory firm posted by their employees. Unfortunately, social networking sites such as LinkedIn are notoriously difficult to supervise. As most advisors already have a policy that requires pre-approval of any advertising, employee postings on such sites would create a de facto violation of the firm’s own policies and procedures in addition to any Adviser Act violations.

In addition, Rule 206(4)-1(a) under the Advisers Act states that “it shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business within the meaning of section 206(4) of the Act for any investment adviser registered or required to be registered under section 203 of the Act, directly or indirectly, to publish, circulate, or distribute any advertisement: (1) Which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser . . .” Clearly, testimonials on an advisory firm’s or its employee’s LinkedIn public profile would be a violation of this prohibition.

Recommended Compliance Actions

It is advisable for investment advisers to revise their compliance manual to incorporate policies and procedures regarding the use of social networking web sites by its employees. Investment advisers have three options:

1. Allow employees to post information about the advisory firm, but require pre-approval for all such postings (this is the least desirable option as it is a supervisory nightmare);
2. A limited prohibition against allowing any information to be posted to the public profile portion of any social networking web site; or
3. An absolute prohibition against employees communicating any information about the advisory firm (other than the name of their employer) on a social networking web site.

While some advisers may opt for an absolute ban on employees having any presence on a social networking web site, I am not sure of the constitutionality of that course of action. Even asking employees to disclose all social networking web sites where they maintain a presence might be problematic. Investment Advisers must be sensitive to the fact that employees often have a legitimate concern about disclosing their presence on social networking (or any other) web sites that might be seen as “controversial” by an employer. This would be especially true with web sites dealing with religion, politics or sexual orientation. However, investment advisers should make all employees aware that posting any information about their advisory firm on a social networking web site is advertising and, as such, is subject to SEC prohibitions and firm policies and procedures. An advisory firm should also require that all employees – not just supervised or access persons – attest to the fact that they are in compliance with the firm’s rules regarding advertising and electronic communications. The firm’s chief compliance officer should also periodically visit the more common social networking web sites to ensure that there is no violation of the either Rule 206(4)-1 or the firm’s own policies and procedures.