SEC Approves Limited Use of Social Media Testimony

The Securities and Exchange Commission (SEC) released guidance aiming to clarify how the testimonial rule barring certain marketing practices under the Investment Advisers Act applies to social media.

The guidance, presented in question and answer format with a  short preamble, argues the SEC is sensitive to the fact that widening use of social media has dramatically increased consumer demand for independent, third-party commentary and reviews of many different types of service providers—including registered investment advisers (RIAs) and others in the financial services space.

The guidance suggests the SEC largely sees it as a positive that consumers are gaining a stronger ability to conduct additional due diligence on current or prospective service providers by connecting with other clients via social media websites. But as the use of social media increases, the SEC is also hoping to cut off any inappropriate or misleading use of social media commentary or reviews by advisory firms.

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The guidance specifically addresses section 206(4) of the Investment Advisers Act of 1940 (known as the “Advisers Act”) and rule 206(4)-(a)(1) thereunder regarding the use of client testimonials in marketing materials. In basic terms, the SEC says it believes, consistent with previous staff guidance, that in certain circumstances an investment adviser’s publication of all of the testimonials about the investment adviser coming from an independent social media site on the investment adviser’s own social media site or practice website would not implicate the concern underlying the testimonial rule.

In other words, the SEC does not necessarily have a problem with advisers promoting their presence on social media when the adviser has no ability to affect which public commentary is included or how the public commentary is presented on the independent social media site. It is also important in the eyes of the SEC that the independent social media site allows for the viewing of all public commentary, both positive and negative, and updating of new commentary on a real-time basis, with little restriction.

Additionally, the SEC reminds advisers they cannot actively suppress negative reviews or testimonials in favor of positive feedback or otherwise aggressively circulate favorable social media testimony.

The SEC feels this attitude is consistent with the spirit of the testimonial rules, which stipulate that it constitutes a fraudulent or manipulative act “for any investment adviser registered under the Advisers Act to publish or circulate any advertisement which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis or report rendered by such investment adviser.”  

The strict nature of that language led many advisers to feel as if any use or promotion of social media content could constitute fraudulent or manipulative marketing practices under the Advisers Act. But that’s not true in every case, the SEC says. The guidance is clear that the SEC is still wary of the aggressive use of client testimonials, pointing out that “by their very nature [testimonials] emphasize the comments and activities favorable to the investment adviser and ignore those which are unfavorable.” But the rule shouldn’t preclude advisers outright from using social media to connect with clients, the SEC argues, or even to connect clients with one another.

The SEC says it is also still concerned that testimonials tend to give rise to a fraudulent or deceptive implication that the experience of the person giving the testimonial is typical of the experience of the adviser’s clients. So even when an adviser has no control over independent social media content, concerns may still exist.

The guidance provides additional insight about what types of social media content can represent a testimonial. The guidance explains whether public commentary on a social media site is truly a testimonial “depends upon all the facts and circumstances relating to the statement.” The guidance doesn’t provide a precise definition or list of criteria, but instead broadly describes a testimonial as any “statement of a client’s experience with, or endorsement of, an investment adviser.”

Under this definition, the SEC acknowledges that public commentary made directly by a client about his own experience with, or endorsement of, an investment adviser may or may not be a testimonial. What appears to matter most to the SEC is how that commentary is developed and whether it is influenced by the adviser.

The SEC also reaffirms that an investment adviser’s publication of an article by an unbiased third party regarding the adviser’s investment performance is not a testimonial, unless it includes a statement of a client’s experience with or endorsement of the adviser.

The only break from precedent covered in the guidance involves advertisements that contain non-investment related commentary about an advisory business. The SEC says it “no longer takes the position, as it did a number of years ago, that an advertisement that contains non-investment related commentary .. such as regarding religious affiliation or community service, may be deemed a testimonial violation of rule 206(4)-1(a)(1).”

Pension Fund Says Hedge Fund Manager Duped Investors

A lawsuit filed by the Massachusetts Bay Transportation Authority (MBTA) pension fund claims New York investment manager Alphonse Fletcher Jr. defrauded investors of $50 million.

Fletcher is being sued by the MBTA Retirement Fund and some of his own hedge funds on fraud accusations, according to a news report from The Boston Globe. The lawsuit, filed in New York, accuses Fletcher Asset Management and other parties of conducting a “long-running fraud” in which they misused client money for their own benefit, inappropriately took inflated management fees, and overstated the value of assets.

The Boston Globe reports the MBTA pension fund invested $25 million with Fletcher in 2007 on the advice of the pension fund’s former executive director, Karl White. White pitched the investment to the pension fund nine months after he had resigned from the MBTA to work for Fletcher.

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Fletcher has told regulators his firm managed assets of $550 million. But the true figure “was always far less, as can be seen now, when honest and accurate valuations are applied,’’ according to case documents.

Plaintiffs in the case include the MBTA fund, the Fletcher Fixed Income Alpha Fund, and three other Fletcher entities. They are seeking $50 million, as well as management and attorney’s fees and interest. The funds suing Fletcher are considered separate legal entities, so they have the right to sue to recoup money for their investors, the news report says.

The lawsuit is being pursued by the bankruptcy trustee, Richard Davis, the person responsible for managing claims by creditors. The Boston Globe report suggests Davis anticipates further lawsuits to emerge in the coming months.

Most of Fletcher’s hedge funds have been in bankruptcy since 2012, court documents and news reports show. The Boston Globe reports the U.S. Bankruptcy Court for the Southern District of New York recently confirmed a plan to liquidate one of the entities, Fletcher International Ltd. This latest lawsuit followed from that plan, the news report says.

Though the MBTA and three Louisiana pension funds are all pursuing Fletcher to recoup funds, it is unclear how much money he has (see “La. Pension Funds Petition for Liquidation of Hedge Fund”). The troubles of in Fletcher’s business came to light in 2011, when he sued fellow owners at the Dakota building in Manhattan for discrimination when they refused to let him buy a fifth apartment there, The Boston Globe reports.

The Securities and Exchange Commission and the FBI have been investigating Fletcher Asset Management. Massachusetts Attorney General Martha Coakley is investigating the MBTA pension fund over the transaction. She also urged the fund’s board to be more transparent in its dealings.

In a statement, the MBTA pension fund acknowledged the lawsuit but declined to comment further, according to the news report. In January, the pension fund also sued the auditor Grant Thornton in Chicago, Quantal, and another auditor, EisnerAmper of New York, in the Fletcher matter, according to the news report.

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