Navigating the Digital Frontier: Social Media and Securities Law Legal Risks for Startups and Entrepreneurs

In the fast-paced world of startups and entrepreneurship, blending the old with the new can often lead to unexpected challenges, especially in the realm of legal compliance. Take, for instance, the intersection of age-old U.S. securities laws—which governs the raising of capital—and the dynamic domain of social media. Many startups are unaware that social media activity potentially can lead to securities law violations.

The Evolution of Investment Promotion Through Social Media

The heart of the issue lies in understanding how using social media to promote investments can make one liable under Section 12 of the Securities Act of 1933 (“Section 12”). Offering or selling securities through a prospectus or oral communication that either includes a materially false statement or omits a material fact violates Section 12. Plaintiffs who successfully prove their Section 12 claims can either rescind the transaction or, if they no longer own the security, recover rescissory damages. See 15 U.S.C. § 77l(a) (2). In other words, if a successful plaintiff still owns the security, they can tender the security back to the seller for the consideration paid for the security, plus interest, less any amount of any income they previously received from the security. If they don’t own the security, they’re entitled to the purchase price, plus interest, less the sale price and any income received from the security.

A critical question that arises in these types of cases is whether individuals or startups that use social media for investment promotion can be classified as “sellers,” putting them at risk for any inaccuracies or omissions in their communications.

Investment promotion on social media by startups can take various forms, ranging from subtle endorsements to explicit calls to action. The key factor is that these promotions are intended to attract investors or raise capital for the startup’s business ventures. 

For example, consider the facts underlying the litigation in Wildes v. BitConnect Int’l PLC, a case in the U.S. Court of Appeals for the Eleventh Circuit, which involved a securities law class action alleging violations of Section 12 against online promoters of a new cryptocurrency coin. The company used social media and videos to make their sales pitches for the coin. The videos promised “huge profits,” and the company offered free online cryptocurrency courses, which helped viewers create accounts through which they could purchase coins. While the trial court dismissed the class action on the basis that the videos didn’t constitute a direct solicitation because they were viewed by millions of people, the 11th Circuit Court of Appeals reversed the trial court’s decision, allowing the class action claims to proceed.

The key point here is that while content, advertising, and promotion on social media can be an effective method for broadening a startup’s reach and potential investor base, these actions can also bring scrutiny under Section 12, as they could be seen as offering securities. It’s crucial for startups to ensure that such actions are transparent and compliant with securities law.

Regulatory bodies are paying close attention to actions that implicate securities laws on social media, as highlighted by the SEC’s recent charges against social media influencers for securities fraud in a $100 million “pump and dump” scheme. A number of celebrities and athletes, from Kim Kardashian to Paul Pierce, have also faced enforcement actions brought by the SEC for illegally “touting” a security.

Promotional activities on social media are also leading to litigation between private parties, and court interpretations of what constitutes “selling” securities on social media, such as the recent decision by the U.S. Court of Appeals for the Ninth Circuit in the case of Pino v. Cardone Capital LLC. 

The central issue in this case was whether social media and other mass communications concerning securities could constitute solicitations potentially creating statutory-seller liability under Section 12. Section 12 imposes liability on persons who “offer or sell” securities “by means of a prospectus or oral communication” that contain material misstatements or omissions. A party can be held liable as a “statutory seller” if he or she either (i) passes title to the securities to the plaintiff or (ii) “engages in solicitation.” In this case, “solicitation” was at issue, and the defendant argued that it did not solicit because it engaged in mass communication—in other words it did not have any direct contact with the plaintiffs.

The court ultimately ruled that promoting investments on social media platforms (i.e., solicitation) could indeed be seen as “selling” under the facts of this case, thereby exposing the promoters to potential liability. 

The federal courts are divided on this issue, with the Ninth and Eleventh Circuits recognizing social media promotions can be solicitation, while others, such as the Second and Third Circuits, demand a direct connection between promoter and buyer. This split highlights the challenges startups face in navigating securities law in the digital age.

Implications for Startups

It’s essential for entrepreneurs to stay informed to remain compliant and mitigate risks associated with digital promotions. Just as entrepreneurs walk a fine line between optimism and fraud when pitching investors for venture capital, the same is true of social media promotion that could cross the line drawn by the securities laws. 

Scrappy startups often don’t consider the potential securities laws implications of their actions in their very early stages. And some undoubtedly do slip under the SEC’s radar or evade plaintiffs’ lawyers, even when technically violating laws. However, as a business grows, so does scrutiny. One of the objectives of the SEC in bringing enforcement actions is deterrence, and the bigger a company becomes, the more likely it is that an action against it will generate headlines that could lead to greater awareness and deterrence. Moreover, the more deep-pocketed a company becomes as it scales, the more likely it is to be a target of plaintiffs’ lawyers.

One of the challenges startups—all companies, really—face is that risk mitigation and compliance isn’t always top of mind when it comes to social media and other forms of mass communication. Such communication is often quick and informal. As the old saying goes, “the medium is the message.” While startups are typically savvy enough to seek legal input and include appropriate disclaimers in more formal communications, the informality of the social media medium can lead to less oversight and care. However, as we’ve seen in recent cases such as Pino, and in the SEC’s enforcement actions, just as much diligence is required.

To address these and other challenges related to the securities laws, startups should work closely with legal counsel to grasp the overarching rules of securities law. This partnership is essential not only for understanding the legal landscape but also for ensuring that any content with the potential to be seen as an investment opportunity is thoroughly reviewed for compliance. 

The evolving interpretations of securities law underscore the importance of caution and due diligence in digital communications, ensuring that the innovative spirit driving startups does not inadvertently lead to legal pitfalls.