Hiring Social Media Influencers? How You Influence Matters

FINRA, as part of its targeted exam of member firms’ social media practices for gaining new customers, recently announced an $850,000 fine against M1 Finance LLC (“M1 Finance”) stemming from promotional social media posts made by influencers the firm hired to expand its customer base. Unfortunately for M1 Finance, FINRA determined that prior to hiring these influencers, it failed to implement effective supervisory procedures that complied with FINRA Rules and securities law to oversee the communications its influencers were posting online. Therefore, FINRA found this resulted in social media posts that violated multiple FINRA Rules for communicating fair and balanced investment information to retail customers. Firms should consider the lessons to be learned from M1 Finance’s experience.

Background

M1 Finance provides self-directed trading to retail investors through a mobile app on its website. For more than three years between January 2020 and April 2023, M1 Finance paid approximately 1,700 social media influencers more than $2.75 million to promote the firm by posting promotional information online to potential retail customers on various platforms resulting in more than 39,400 new accounts with the firm. M1 Finance paid the influencers a set fee for each new account opened with no limit on the total any influencer could earn from generating new accounts. In furtherance of this arrangement, M1 Finance directed the influencers to include in their social media posts a hyperlink to the firm’s website through which potential retail customers could open and fund a brokerage account with the firm. M1 Finance also provided graphics to include in posts and a “Welcome Guide” for influencers highlighting specific services the firm offered, like its margin lending program, and touting the lack of commissions or management fees associated with the firm’s products. The Welcome Guide even invited influencers to contact M1 Finance with their own promotional ideas.

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Proposed Changes to PTE 2020-02 that Impact Broker-Dealers

The DOL has proposed amendments to its regulation defining fiduciary advice so that, in most cases, a single recommendation to a retirement investor will be a fiduciary act.  In addition, the DOL has proposed amendments to  Prohibited Transaction Exemption (PTE) 2020-02, which provides relief for prohibited conflicts of interest (e.g., commissions and fees). Both the amended regulation and the PTE could be finalized soon.  This post focuses on the proposed amendments that will impact broker-dealers and their registered representatives (investment professionals).

Background

The current and proposed PTE 2020-02 allow broker-dealers and investment professionals to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to private sector tax-qualified and ERISA-governed retirement plans, participants in those plans, and IRA owners (collectively, “retirement investors.”).  The current version of the PTE is not available for investment advice generated solely by an interactive website based on personal information supplied by the investor on the website (i.e., robo-advice) where there is no personal interaction or advice with an investment professional.

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Compensation Requirements under Proposed Amendments to PTE 2020-02

Broker-dealers and their registered representatives (advisors) providing services to private sector tax-qualified and ERISA-governed retirement plans, participants in those plans and IRA owners (collectively, Retirement Investors) are subject to a number of compensation rules.

ERISA’s fiduciary responsibility rules mandate that ERISA plans pay no more than reasonable compensation to service providers (including advisors).

In addition, the prohibited transaction rules that apply to Retirement Investors set limitations on compensation. For example, if a service provider receives compensation in excess of a reasonable amount, the excess is a prohibited transaction for both the plan fiduciary and the service provider. It is also a prohibited transaction if an advisor receives compensation that varies based upon the recommendation made (i.e., variable compensation) or third-party compensation as a result of the recommendation, unless a prohibited transaction exemption applies. Lastly, some prohibited transaction exemptions – like Prohibited Transaction Exemption (PTE) 2020-02 – have other limitations on compensation. This post focuses on the compensation limitations in the DOL’s proposed amendments to PTE 2020-02.

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Crypto is Here to Stay in 2024, So Be Careful How You Talk About It

More than ever before, financial services regulators must increasingly adapt to technological advances. Perhaps no other technological advancement is more important right now than crypto currency. Crypto currency is defined as digital assets issued or transferred using blockchain technology. Earlier this month, the SEC, despite SEC chairman Gary Gensler’s well-known skepticism of crypto, granted Bitcoin, the world’s largest crypto currency, approval to be the first crypto asset listed as an exchange traded fund (ETF). This defining moment for crypto currency further cements the relatively new technology into the financial services and securities landscape.

Anticipating the changing tides, FINRA recently declared in its 2024 Annual Regulatory Oversight Report that it would add a brand-new Crypto Asset Development section – dedicated to providing guidance for member firms engaging in (or expecting to engage in) the crypto economy. This new section includes reports from FINRA’s November 2022 targeted exam reviewing the practices of certain member firms that communicate with retail customers concerning crypto assets and crypto asset-related services. The relevant time period of the exam was from July 1 through September 30, 2022. On January 24, 2024, FINRA published an update to the targeted exam, claiming that approximately 70 percent of the more than 500 retail customer communications it reviewed contained potential FINRA Rule 2210 violations (communication with the public), including the following:

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The Proposed DOL Fiduciary Rule: Significant Changes for Advisers

Benefits and executive compensation partner Fred Reish and counsel Joan Neri coauthored an article for IAA Today on the proposed fiduciary rule issued by the Department of Labor (DOL).

The authors highlight key provisions of the proposal and the amendments to prohibited transaction exemption (PTE) 2020-02 that will potentially impact investment advisers. They also note that the next step is for the DOL to receive comments on the proposed changes and develop a final regulation, and they reasonably expect final rules in mid-year 2024.

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In Case You Missed It: Broker Dealer Law Blog – Summer 2023

The Broker-Dealer Regulation & Litigation Digest is a periodic compilation of the most read blog posts published on the Broker-Dealer Law Blog during the last few months. Catch up on the latest insights on litigation, regulatory, compliance and fiduciary issues impacting broker-dealers and other financial services companies.

A New Opportunity for 529 Account Beneficiaries – Tax Free Rollovers to Roth IRAs

By Fred Reish and Joan M. Neri
Beneficiaries of qualified tuition programs under Section 529 of the Internal Revenue Code (529 accounts) will have a new opportunity starting January 1, 2024. Under SECURE Act 2.0 (the Act), 529 account beneficiaries will be able to rollover funds from the 529 account into a Roth IRA without incurring tax or penalties providing certain requirements are met.

The Best Interest Standard for Recommending Account Types

By Fred Reish and Joan M. Neri
Under Regulation Best Interest, the Securities and Exchange Commission (SEC) imposes a best interest standard on account recommendations by broker-dealers. This is because recommending an account type is viewed by the SEC as recommending an investment strategy involving securities. The SEC imposes a similar best interest standard on registered investment advisers under the SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers.

Investors Versus Machines: The SEC Cracks Down on AI, Robo-Advisors and Potential Conflicts of Interest

By Sandra D. Grannum, Jamie L. Helman and Justin M. Ginter
Artificial intelligence (AI) tools are divisively integrating into all aspects of society — from the classroom to the courtroom. Many broker-dealers have also implemented AI-assisted analytics and technology. No one is questioning the “pros” of AI. But many are still concerned about the risks. The SEC is no different, nor are they any less divided. Here, the SEC has honed in on conflicts of interest that may arise through the use of AI.

The SEC’s Intensified Scrutiny of Off-Channel Communications at Registered Firms

The U.S. Securities and Exchange Commission has maintained its focus to monitor and regulate off-channel communications of its registrants as highlighted in recent settlement actions in which the agency charged 11 Wall Street firms with widespread recordkeeping failures.

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Investors Versus Machines: The SEC Cracks Down on AI, Robo-Advisors and Potential Conflicts of Interest

We are probably still years away from Wall Street being overrun by actual robots. Nonetheless, artificial intelligence (AI) tools are divisively integrating into all aspects of society—from the classroom to the courtroom. Many broker-dealers have also implemented AI-assisted analytics and technology. Indeed, over the last several years, many firms have made investing more easily accessible and user-friendly through “robo-advisors.” No one is questioning the “pros” of AI. But many are still concerned about the risks. The SEC is no different, nor are they any less divided. Here, the SEC has honed in on conflicts of interest that may arise through the use of AI.

On July 26, the Securities and Exchange Commission (SEC) proposed a regulation under the Securities Exchange Act of 1934 and Investment Advisors Act of 1940 to combat what it sees as conflicts of interest arising from using predictive data analytics by broker-dealers and investment advisors. In strong language, the proposed rule seeks to “to eliminate, or neutralize the effect of, certain conflicts of interest associated with broker-dealers’ or investment advisers’ interactions with investors through these firms’ use of technologies that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes.” The proposed regulation would require broker-dealers and investment advisors to take steps to address potential conflicts of interest from predictive analysis and similar technologies that interact with investors to prevent firms from placing their own interests ahead of the investors’ interests.

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The Best Interest Standard for Recommending Account Types

Under Regulation Best Interest (Reg BI), the SEC imposes a best interest standard on account recommendations by broker-dealers.  This is because recommending an account type is viewed by the SEC as recommending an investment strategy involving securities.  The SEC imposes a similar best interest standard on registered investment advisers under the SEC’s Interpretation Regarding Standard of Conduct for Investment Advisers (the RIA Interpretation).

The DOL also imposes a best interest standard under its prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees) (the PTE), which allows broker-dealers and their registered representatives to receive conflicted compensation resulting from non-discretionary fiduciary investment advice about a change of account types for a retirement plan or an IRA.

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