Social InVESTfluencers – The regulation of investment recommendations on social media

Do you remember the GameStop hype? In the beginning of 2021, GameStop shares attracted the attention on the stock market. At the beginning of 2021, the GameStop shares did not have much value. Hedge funds, such as Melvin Capital, expected that the GameStop share price would drop further and went short on these shares. Normally, you make profits on your shares when the share price goes up. Going short is an investment strategy where you can earn profits when the share price drops. A group of users of online platform Reddit wanted to outsmart the hedge funds. They encouraged other users of the platform to buy shares in GameStop. This caused the price of those shares to skyrocket. The hedge funds suffered big losses as a consequence, while some Reddit users made big profits. Is it allowed to influence the stock market in this way? Or is this regulated by law?

The risks of social media influence for investors

The GameStop hype shows that social media may influence investment behaviour on the capital markets. The American Securities and Exchange Commission (SEC) released in October 2021 a report focussing on the GameStop hype. The SEC concluded that some areas, such as the market dynamics of short selling, should be further studied and considered.

The British Financial Conduct Authority (FCA) published in 2021 a research to better understand investors who engage in high risk investments. The FCA concluded that particularly young investors are influenced by investment tips and news on social media. In addition, the threshold for these young investors to invest is low. You can already make investments with a few clicks on an app. As a result, young investors take greater risks, while these risks may not always be suitable for them. The research of the FCA shows that 59% of the investors indicated that a significant loss on their investments would have a fundamental impact on their current or future lifestyle. How can these investors be protected against these risks?

The rules

The Market Abuse Regulation (MAR) is aimed at improving the integrity of the financial markets and the protection of investors. The MAR regulates investment recommendations. In short, an investment recommendation is a public recommendation of an investment strategy concerning one or more financial instruments (such as shares, derivatives, bonds and commodities), including any opinion on the present or future value or price of such instruments.

If you give investment recommendations, you must comply with certain transparency rules. Investors should know the credibility of the recommendation and any interest of those making the recommendation. This is to prevent investors from being misled and to enable them to make an informed choice.

The transparency rules are summarised in the following slide:

Source: ESMA Press news - “ESMA addresses investment recommendations made on social media platforms” – 28 October 2021.

So, the MAR sets out the rules on European level. How are these rules interpreted in the Netherlands and how are these rules enforced? Do the rules for investment recommendations also apply to recommendations made on social media?

The pitfalls of ‘finfluencing’

The AFM does not only monitor social media to supervise the rules on investment recommendations, the AFM also entered into discussions with about 150 financial influencers, or as the AFM calls them: ‘finfluencers’. On 21 December 2021, the AFM published an explanatory study on these finfluencers. The AFM signalled that it is a good thing that finfluencers make information on investing more accessible. However, the interests of investors should be the main priority of the finfluencers, which is not always the case. The AFM signalled 5 pitfalls of finfluencing:

1. Providing investment advice without being licensed to do so

‘Investment advice’ differs from ‘investment recommendations’. Investment advice is directed at an individual person while investment recommendations are directed at a wider public audience. You need a licence from a relevant authority to give investment advice. A disclaimer stating that you do not provide financial advice does not relieve you from your obligation to have a licence.

2. Not taking adequate care in making investment recommendations

If you make investment recommendations you must comply with the transparency rules as mentioned above under the heading ‘The rules’.

3. Recommending risky products

The AFM advises against recommending risky products such as cryptos, forex, and turbos. These products are complicated and have a high price volatility. Therefore, they are not suitable for (beginning) retail investors, who are generally the target audience of finfluencers.

4. Working together with unlicensed firms

You should not recommend products from financial firms that are not licensed to operate in the Netherlands. Illegal brokers established outside the EU offer in some cases very high fees to finfluencers for bringing in new clients. The AFM considers such references to unlicensed parties highly undesirable. A consumer cannot rely on investor protection if things go wrong with an unlicensed financial firm.

5. Receiving referral fees for bringing in clients

A number of finfluencers receive fees from banks or brokers for every new client they refer. In the Netherlands, a ban on inducements (provisieverbod) apply to investment firms. This ban on inducements is violated if investment firms pay finfluencers for referring clients to the investment firm. Even though the investment firms are the ones that violate the ban on inducements and not the finfluencers, the AFM advises that you should not get paid for bringing in customers.

The financial regulators

The European Securities and Markets Authority (ESMA) is the financial regulator on European level. ESMA monitors consistent application of EU regulations, such as the MAR, at the national levels and may take binding action in the event of incorrect application. On 28 October 2021, ESMA made a statement to warn influencers who make investment recommendations on social media. The warning entailed that the transparency rules of the MAR apply to influencers and that investment recommendations can have undesired consequences for the influencer. Also for 2022, ESMA mentioned it will continue working on the issue of investment recommendations through social media, to monitor whether different forms of guidance to reach new generations of  investors is opportune.

In the Netherlands, the Autoriteit Financiële Markten (AFM), supervises the rules on investment recommendations. Before ESMA made its warning, the AFM already stated in its newsletter (edition 3 June 2021) that the MAR and underlying regulations also apply to investment recommendations made on social media. The AFM actively monitors social media for incorrect or misleading information about financial instruments. For this purpose the AFM also uses data-driven models to analyse messages on social media.

Enforcement

If you would violate the rules regarding investment recommendations in the Netherlands, the AFM may impose measures on you. These measures can vary from a warning to a fine. The fines for violating the rules may amount up to 1 million euros. To avoid any unpleasant consequences of your investment recommendations, be aware of the legal rules and transparency requirements that are applicable.

Do you think you might be giving investment recommendations on social media? And would you like advice on this topic? Please contact us at Legalloyd Advocaten. We have extensive experience in advising on corporate law and financial law. We can advise you or your company on financial law issues and your interaction with financial regulators such as the AFM.