Social Networking Websites: Will the Securities and Exchange Commission Want to be Your Friend?

Social Networking Websites: Will the Securities and Exchange Commission Want to be Your Friend?


With social networking websites becoming more and more used by more and more people, regulation by the Securities and Exchange Commission (the “SEC”) may not be far behind. New forms of electronic communication are affecting many areas of the legal landscape. With the rise of MySpace, Facebook, Twitter, LinkedIn, Xanga and other networking and blogging sites, information is being created and disseminated in many new ways – ways that could (should?) attract the watchful eye of securities law regulators. The question of how the SEC fits into social networking becomes an important concern. Have the federal securities laws and regulations been able to keep up? Or is a system first developed in the 1930s – nearly 30 years before television became common, let alone cell phones, the internet and social networking sites – falling woefully behind?
In fact, the need for increased regulatory scrutiny in some areas may already be past critical. There are potentially dozens of ways that regulation of these social networking sites may be appropriate. And there are considerable arguments that the best regulation is no (or little) regulation. Leaving the bulk of these considerations to the side for this discussion, there are three areas in particular where social networking sites raise regulatory issues that should be considered: (1) scams; (2) unregistered offers and investment advisors; and (3) corporate disclosure.
Scams
When it comes to cheating our fellow man, some simple wisdom from the Bible speaks volumes: “What has been will be again, what has been done will be done again; there is nothing new under the sun” (NIV Ecclesiastes 1:9). The age of boiler rooms running stock scams will shift, or perhaps already has shifted, to Facebook posts, Twitter feeds, MySpace shout outs, and more. Add in identity theft, and you have an exceptionally powerful tool for securities scams, especially the old “pump and dump”.
Imagine that, instead of a nameless, faceless broker hocking penny stocks over the phone or through email, a fantastic stock suggestion comes from a close friend or two? A hacker who gains control of a friend’s social network could send you a message suggesting you purchase a stock. Later you discover that a con artist has dumped that same stock once the price is artificially driven up by duped purchasers, leaving you with a practically worthless investment. A few well placed identity thefts, a good deal of hype from “close friends,” and a story that sounds exciting could add up to old-fashioned stock fraud through new-fashioned media. A Star Tribune headline sums up the problem: “Stock Scam Illustrates Growing Problem: penny-stock schemes … are on the rise, the SEC says” (March 23, 2008). Peter Henning, a former SEC and Justice Department attorney and now law professor said “these are hard cases to prosecute. … The SEC is the first line of defense, but there is more than enough [securities] crime out there already.” Social networking sites may be new and flashy, but they amount to new and flashy ways to run age-old security cons.
Unregistered Offerings and Investment Advisors
Social networking sites may cause problems for legitimate offerings as well. The federal securities laws make important distinctions between what the general public (including reporters) may do during the stock registration process, and what affiliates of the offering company (including underwriters) and license holders may do. Problems are likely to arise because the definitions of “affiliate” and “underwriter” are quite broad, as well as because written communications regarding securities are heavily regulated. In the old days (say before 2001 and the rise of blogging and social networking sites), this was a relatively manageable problem because non-securities professionals had no way of easily communicating with a large number of people. Writings made, or recommendations given, regarding securities were few in number and relatively easy to track down.
Now people thinking that they are just “chatting with friends” may inadvertently make offers of, or recommendations for, securities. The Economist recently published an article where Facebook stated that the average number of Facebook friends for each user was 120, although “some people have networks numbering more than 500” (Primates on Facebook, February 26th 2009). Some examples of the number of “friends” one may accumulate are staggering. For instance, CNN reported that Ashton Kutcher has 896,947 and Britney Spears has 905,640 followers on Twitter (Ashton Kutcher Challenges CNN to Twitter Popularity Contest, April 15, 2009). Although the article reported that no single Twitter account has more than one million followers, it seems clear that this barrier will be broken shortly. And lest you think that only stars have this power, otherwise “ordinary” people are now becoming famous because of their social networks. Tila Tequila was an unknown model/actress who “hit it big” by acquiring over one million friends on MySpace. As reported by Time Magazine, by 2006 she had over 1.5 million MySpace friends and her profile had been viewed over 50 million times (Tila Tequila, December 16, 2006). A large network can itself be a road to fame, rather than fame leading to a large network.
So if someone posts a message to their social network that the company where they work is going public next year, is that a written offer by an affiliate for a security? The SEC’s position in past cases would indicate yes. So what does that mean for regulation? Does Ashton Kutcher become an underwriter when he Tweets (the “proper” verb for sending out a message on Twitter) that he just bought 50,000 shares of an internet start-up that he hopes goes public someday soon? As we see commentators working through problems of e-discovery when information is blasted through these new media, is the SEC addressing how these communications line-up with our traditional definitions for securities law? See MySpace, Your Space or Our Space? New Frontiers in Electronic Evidence (86 ORLR 1201) for a good discussion of how the rise of social networking sites is changing the way evidence is gathered and used. These developments will somehow have to be addressed under securities laws.
Also, does a Tweet about a recent stock purchase to a few hundred (or thousand) of your “closest friends” amount to giving investment advice? The Investment Advisors Act of 1940 and other regulations could easily be implicated as people send these writings through their social networks and, unwittingly engage in activities requiring a securities license.
Corporate Disclosure
All of these social networking sites are corporations (or a similar type of entity) with shareholders and hopes for growth, including the possibility of being a public company. Many of them entice talent by offering stock to employees and other investors while still private companies. Section 12(g) of the Securities Exchange Act of 1934 requires registration (and public reporting) when a company has more than 500 security holders and $10 million in assets.
Social networking sites are now approaching and passing this registration threshold. But in the current, depressed stock environment they do not want to go public. As an example, the SEC recently granted Facebook an exemption from registration. As reported by Business Week, Facebook will soon pass this registration landmark. They argued that “there was no need to meet the SEC disclosure requirements” and the SEC agreed, even though this requirement is generally considered to have pushed Google to go public in 2004 (Facebook Gets SEC Stock Exemption, November 21, 2008). As these private companies get bigger and gain more clout, is it wise to have them remain exempt from public disclosure?
Along these same lines, the growth of radio and television in past generations certainly presented new problems for the SEC. But that growth was measured in decades as opposed to the months and years that mark the growth of these social networking sites. According to Wikepedia, the first regularly scheduled television service in the United States began in 1928. But it was 1950 before there were even 4 million households with a television (The History of Television, last accessed July 8, 2009). By comparison, Facebook was launched in February 2004 from a Harvard University dorm room. By December 2005 there were 5.5 million active users. Two college students who started a social networking site reached more users in two years then television did in 22 years! Facebook now has over 175 million users and is still growing (Timeline at facebook.com, last accessed July 8, 2009).
The potential regulatory issues due to social networking sites are legion – both for the regulator and the regulated. The SEC will undoubtedly need to do something. It will be interesting to see if the users of these social networks and the SEC can remain “friends.”
James L. Carey is an Associate Professor teaching business, securities, will, trust and estate law at the Auburn Hills Campus of the Thomas M. Cooley Law School. Prior to joining the faculty of Cooley Law School, Professor Carey was an attorney representing domestic and international companies in all aspects of their business life, and before that he was a stockbroker with a Wall Street firm. Professor Carey received his bachelors of arts (1991) and juris doctorate (1998) degrees from the University of Michigan. He may be reached at careyj@cooley.edu.