First, the necessary disclaimer – there is no way to cover all the applicable rules and regulations regarding investment advisers and the internet in a single blog. While it is hoped that the analysis provided herein is helpful, it is neither intended to serve, nor does serve, as a substitute as for an actual review of the actual materials referenced. The purpose of this post is to alert advisers to some of the issues I am seeing on a regular basis, issues that can have both regulatory and legal liability issues. OK, now that that’s out-of-the-way, on to the good stuff.
For most investment advisers, their web site is an integral part of their marketing plan. Dually registered investment advisers must comply with their broker-dealer’s rules, the rules and the regulations of FINRA, and the entity through which their RIA firm is registered, either the SEC or a state regulatory body. RIAs whose advisory representatives are not FINRA licensed do not technically have to follow FINRA’s rules and regulations. However, they should still monitor FINRA’s releases, as they are often the guidelines used by other regulators and the courts in assessing the conduct of anyone in the financial services industry.
FINRA Regulatory Notice 10-06 offers the primary guidelines for blogs and social networking web sites. In short, FINRA’s rules separate sites with “static” content from sites with “real-time, interactive” content, so-called “interactive electronic forums.” Static content is basically just that, information posted to your web site which is not expected to change. On this blog, it would consist of both my posts and my articles. If you are a dually registered investment adviser, FINRA requires that you get such material approved by your broker-dealer’s compliance department before posting it on your site, as such materials are considered advertising.
Unscripted “real-time, interactive” content, on the other hand, is not considered to be advertising and is therefore not required to be pre-approved prior to posting. However, a dually registered investment adviser’s broker-dealer is expected to review and supervise such activity to ensure that such activity is conducted in compliance with FINRA’s rules and regulations. FINRA generally describes such interactive forums as chat rooms and online seminars.
Whether an investment adviser is dually registered or not, they are subject to the prohibition against false or misleading claims and representations. In a recent enforcement action, an adviser was sanctioned based upon the adviser’s pattern of positive investment recommendations.
FINRA’s rules and regulations require that advisor’s conduct their business in a manner consistent with the principles of fair dealing and good faith. Most states require similar conduct under some form of unfair business practices legislation, as well as common law principles such as fraud and breach of fiduciary duty.
While there is no general prohibition against putting links on an adviser’s web to third-party sites or to allowing third-parties to post on an adviser’s web site. I caution my clients not to do so. Linking to such third-party sites can be construed to approving all of the information on such site, including all links on such site to other third-party sites, what I call the “Seven Degrees of Kevin Bacon” dilemma. An adviser is also deemed liable for any third-party posts on their web site which violate any regulatory or legal standards, including offensive or abusive posts.
Recommendations are a touchy subject. Most broker-dealers prohibit their registered representatives from making any sort of investment recommendations online. I make the same recommendation to my clients to reduce any potential liability exposure.
While many advisers like to post investment recommendations on their web sites and/or make investment recommendations online in chat rooms or other social media sites, making such recommendations increases the risk of potential liability exposure unless the recommendation is suitable for every investor to whom it is made. Since advisors rarely have the required personal information to evaluate every online participant in a social media site, if any investment recommendations are made online, they should be generic in nature. Again, my advice would be to avoid online investment recommendation altogether.
Personal endorsement are another commoon problem. I regularly see personal recommendations/endorsements on LinkedIn pages for investment advisory representatives. While registered representatives can market their services by using personal endorsements, investment advisory representatives cannot. Even if an endorsement is based on services provided as a registered representative, the court and the regulators have consistently held that if someone is dually registered, personal endorsements may not be used in any marketing by the representative.
The last topic I want to touch on is online investment analysis tools. Once again, as an attorney I feel I should disclose that I am currently working on a number of cases involving the suitability of the advice provided by such programs.
The NASD released Notice to Members (NTM) 04-86 in 2004. The release provided that broker-dealers, and by implication their representatives, could use computer programs and their output in providing simulations and analyses on potential outcomes in connection with investment advice being provided to their customers. The financial services industry quickly jumped on board to use such investment analysis programs in connection with financial planning and asset allocation planning.
What many advisers have failed to realize is that the NTM is not a safe harbor for the use of such investment analysis tools. A closer analysis of the NTM indicates that the NTM basically deals with the disclosures which must accompany any use of such programs. The NTM clearly states that anyone using such programs must do so in compliance with al applicable federal securities laws and regulatory rules, including suitability and fair dealing rules.
And there’s the rub. Most investment analysis tools contain some sort of risk tolerance analysis. The validity of such programs is a source of legitimate debate, as, at best, such programs can only analyze an investor’s willingness to accept investment risk.
What many advisers are unaware of is that a suitability analysis requires an analysis of both an investor’s willingness and ability to bear a certain level of investment risk. Interestingly, this two-prong approach to assessing suitability is not only the applicable legal standard for both regulatory and legal decision, but was the standard Harry Markowitz cautioned advisers to use when he introduced Modern Portfolio Theory in 1952. Advisers who blindly accept the output from investment analysis tools without recognizing the limitations of such program, including the suitability analysis limitations, may find themselves on the wrong side of a regulatory or court decision.
The investment analysis tools/suitability issue highlights another issue that advisers need to address. While there are numerous companies offering RIA compliance services, and these companies can usually analyze regulatory notices, proper analysis of such notices requires that existing legal decisions be integrated into the analysis process.
Based on my experience, very few compliance personnel, either in-house or independent, are even aware that the suitability assessment is a two-prong process. As a result, the determination of an investor’s ability to bear investment risk is often overlooked and it is easy to make a succesful suitability claim. As noted investment adviser Harold Evensky noted in his new book, like it or not, the law is inextricably intertwined with the investment advisory business and advisors have a duty to understand both their professional and legal obligations.