23 May 2023

Rethinking the Regulation of Financial Influencers

The growth of social media has led to an unprecedented rise in financial influencers, so-called finfluencers, who share investment ideas and opinions with a global audience. Finfluencers have various business models, from endorsing products to advertising their mutual funds. Retail investors are particularly vulnerable to the risks posed by financial influencers because most lack financial literacy, according to a UK Financial Conduct Authority study from 2021. Additionally, the power dynamic inherent in the influencer-follower relationship can also increase consumers’ susceptibility, particularly through one-sided parasocial relationships. Parasocial relationships are one-sided relationships where one person extends emotional energy and interest towards the financial influencer, who may be completely unaware of the follower’s existence. Such relationships can lead to a higher level of trust, credibility, and reliance on the advice and recommendations of financial influencers, even if they are not qualified or licensed to provide financial advice. This can be particularly dangerous for retail investors with low levels of financial literacy, who may be more vulnerable to the risks posed by finfluencers. Thus, the current regulatory framework may not be adequate to protect consumers from the potential harms of financial influencers.

This Article starts by briefly examining the current regulatory framework for financial influencers (based on Pflücke 2020 and 2022), including how the EU and five platforms govern it. It then proceeds by critically analysing and proposing targeted and actionable policy considerations to increase fairness and transparency on social media platforms. The Article argues that the current approach is neither evidence-based nor tailored to the activities and potential harms of financial influencers, requiring radical reforms to protect consumers and capital markets.

The Current Regulatory Framework

Influencers operate in regulatory grey zones where there may be confusion around what constitutes advertising and what requires disclosure. Financial influencers are additionally regulated because they promote regulated financial products to their audience, including marketing investment funds or giving (general) financial advice, which can significantly impact people’s financial decisions. Financial influencers are thus not only regulated by rules on unfair commercial practices like regular influencers but also by financial advertising law.

The Unfair Commercial Practices Directive encompasses all aspects of finfluencer activities related to so-called ‘hidden marketing’. Under the Directive’s exhaustive ‘black list’ (Annex I), finfluencers are prohibited from falsely representing themselves as consumers (Section 22) and must label sponsored content (Section 11). As seen before the German Federal Court (BGH) or UK Advertising Standards Authority (ASA), the national rules implementing the Directive also dictate how financial influencers must disclose sponsored content to their audience. Failure to correctly disclose commercial activities can result in both civil and administrative sanctions.

Financial influencers’ activities are also subject to several rules from financial law, including the Market Abuse Regulation 596/2014, the Markets in Financial Instruments Directive 2014/65 (MiFID II), and the Commission Delegated Regulation 2016/958. Under the Market Abuse Regulation, producing or disseminating investment recommendations or other investment-related information must be presented objectively and disclose any interests or conflicts of interest (Article 20). Moreover, finfluencers that hold assets and try to manipulate the market in their favour breach the Market Abuse Regulation and commit securities fraud (Article 10(1)(d)). The national rules implementing the MiFID II Directive provide further legal requirements for finfluencers. The Directive sets out criteria for investment advice (Article 24(4)), which is subject to authorisation by national regulators (Article 70(4)). Individual advice to retail investors, such as one-on-one coaching, is exclusively reserved for registered financial advertisers who comply with local laws. Furthermore, the Commission Delegated Regulation requires that ‘facts are clearly distinguished from interpretations, estimates, opinions and other types of non-factual information’ (Article 3(1)(a)). The instrument also specifies formal requirements such as the date and time of the production of the recommendation and provides specific requirements for experts and certain financial products (Article 3(1)(e)). Financial influencers who fail to comply with these regulations may face hefty sanctions. However, as highlighted in my previous paper, the above-outlined rules are unsatisfactory because they distinguish between professionals and non-professionals. Lower standards apply to non-professionals which is, in my view, controversial: consumers cannot draw this distinction unless they conduct a thorough review of the background of a finfluencer.

Content Moderation Rules on Finance Advice on Social Media

Financial influencers are also subject to contractual regulation by social media platforms through their terms of service. These terms of service may include guidelines and restrictions on promoting certain financial products or engaging in deceptive practices, with penalties ranging from account suspension to legal action. Compliance with these contractual obligations is crucial for financial influencers to maintain their social media presence and avoid legal and reputational risks.

All social media platforms have content moderation practices in place because they have a legal responsibility to remove illegal content. The e-Commerce Directive 2000/31 and now the Digital Service Act 2022/2065 generally protect platforms from being held liable for user-generated content, but it is encouraged for them to implement stricter content moderation rules and supervision to prevent the spread of fraudulent or misleading information. These rules can involve the use of algorithms and human moderators to quickly identify and remove inappropriate content.

Under Article 14 of the e-Commerce Directive, service providers are not liable for the information stored and displayed as long as they do not have actual knowledge of illegal activity or information. The Court of Justice set an important precedent in Glawischnig-Piesczek for online content moderation, establishing that while platforms do not have a general obligation to monitor content, they must take down equivalent content globally, even beyond the jurisdiction of the court that issued the order. The Digital Service Act has confirmed and codified these existing rules (Article 8). It further states that platforms do not have to engage in fact finding (Article 8), and they will not lose their legal defences if they undertake further investigations to identify and remove illegal content, known as the ‘Good Samaritan provision’ (Recital 26).

In another paper, I examined the content moderation rules of Facebook, Instagram, YouTube, TikTok, and Twitter. It revealed that platforms actively and significantly regulate financial influencer activities. Some platforms have gone as far as to not only enforce the applicable rules, outlined in the previous section, but also to gold-plate them by banning certain products, services, or practices that are deemed to be particularly risky or misleading. Twitter16 has taken an unconventional approach by imposing a ban on finance-related content in several countries, including Luxembourg, altogether. The reasons behind this decision remain unclear, and it is difficult to ascertain the rationale behind the platform’s actions. Nonetheless, this incident highlights the need for more transparency and accountability in the content moderation practices of social media platforms, particularly with regard to their regulation of financial influencers.

Policy Considerations

In recent years, the rise of financial influencers has created challenges for regulators, as finfluencers often provide advice and recommendations on financial matters to their followers. As depicted above, the current regulatory regime is not tailored to the activities and harms posed by finfluencers. In particular, the influencer-follower dynamic can also increase consumers’ susceptibility and create parasocial relationships, making consumers particularly vulnerable.

One proposal to address this issue is to introduce a positive duty to trade fairly, which could extend to platforms and advertisers. For instance, this proposal was generally suggested in Consumer Theories of Harm by Paolo Siciliani, Christine Riefa, and Harriet Gamper. The current duty not to trade unfairly can lead to ambiguity and confusion for regulators, financial influencers, and consumers. It suggests that anything that is not explicitly forbidden is allowed, which may not adequately protect consumers from harm. A positive duty to trade fairly would place financial influencers under an obligation to respect the legitimate interests of consumers, which could improve the overall quality of financial advice provided by influencers. The idea of introducing a positive duty to trade fairly could lead to more effective regulation of financial influencers and provide better protection for consumers. Therefore, it is worth exploring this proposal further to determine whether it is a viable option for addressing the challenges posed by financial influencers. However, introducing general fair dealing provisions has faced criticism from scholars who argue that it is too vague and could potentially harm businesses. For example, Michael Bridge compared it to ‘letting a bull loose in a China shop’. Critics suggest that defining what constitutes ‘fair’ trading practices may be challenging and result in excessive regulation that stifles innovation. Before proposing such drastic measures, we need further evidence to address these concerns, for example, by conducting impact assessments.

Secondly, transparency should be further increased. Transparency is crucial when it comes to financial influencers. Consumers must be able to distinguish between professionals and non-professionals and understand the risks associated with different financial products. In order to enhance transparency, new disclosure requirements should be established for financial influencers, including specific risk disclosures for new and particularly risky products such as Peer-to-Peer (P2P) lending. Furthermore, platforms should provide country-specific guidance on hidden marketing practices because the rules on how to disclose it differs by jurisdiction, and the commission-based system for advertising financial products should be banned considering the special influencer-following relationship. Regulators should also step up their supervision and enforcement to increase transparency considering the potential harms to consumers. Even qualified financial influencers who offer investment courses or one-on-one coaching should be subject to active supervision by regulators, as this will help to ensure that they are providing accurate and honest information to their followers. It is important that regulators have the resources and expertise to effectively monitor the activities of financial influencers and take action against those who engage in fraudulent or deceptive practices.

Finally, regulators should review the impact of financial influencers on financial stability, particularly in terms of their influence on capital markets and the potential for fraud. This could involve examining the impact of meme stocks and other investment trends promoted by financial influencers and taking action to prevent harmful practices. The US Board of Governors of the Federal Reserve System (FED) and the European Securities and Markets Authority (ESMA) have already warned about the potential harm to capital markets stability in 2021 and 2022. For example, the US Securities and Exchange Commission (SEC) charged eight financial influencers for their roles in promoting a stock manipulation scheme, so-called ‘pump-and-dump’ schemes, on social media platforms. According to the SEC’s allegations, the finfluencers misled their followers by advising their audience to acquire the securities while the finfluencers sold them as soon as the trading volume increased. The eight finfluencers ultimately earned fraudulent profits of approximately USD 100 million from this market manipulation tactic. This shocking incident serves as a stark reminder of the potential dangers posed by unscrupulous financial influencers and the need for greater regulatory oversight.

Rethinking the Regulation of Financial Influencers

The regulation of financial influencers is a complex and multifaceted issue that demands a comprehensive approach. Policymakers and regulators should thus rethink the regulation of financial influencers to effectively address the challenges posed by them. Policymakers and regulators must gather further evidence by conducting impact assessments and tailor the existing or new rules to the harms and risks of finfluencing. They should consider a range of measures and radical reforms, including introducing a positive duty to trade fairly, increasing transparency by implementing new rules and actively supervising financial influencers, and reviewing the impact of financial influencers on financial stability. Additionally, it may be necessary to ban commission-based advertising because financial influencing is distinct from other types of hidden marketing. By taking these steps, we can create a more fair and transparent environment that benefits consumers and protect the global capital markets. Rethinking the regulation of financial influencers is essential to ensure that our social media and financial systems remain robust and trustworthy in the years to come.