Monday, September 21, 2015

Are Fake Product Reviews or Facebook "Likes" Securities Fraud?

Haskell Murray had an interesting post on Friday about businesses buying fake reviews, followers, or friends online.  That post led me to think about another issue—if a company did that, could it be liable under Rule 10b-5 for securities fraud?

Consider this scenario: An investor is thinking about investing in a company called Ebusiness, Inc. She carefully reviews the company’s online presence and sees that Ebusiness has more followers and friends than anyone else in the industry. The reviews of its products are overwhelmingly positive. She concludes that Ebusiness is destined for greatness and buys its stock.

Later, the press discloses that most of Ebusiness’s followers and friends, and most of its online product reviews, are fake. Ebusiness paid someone else to produce them. The price of Ebusiness’s stock drops precipitously. Would Ebusiness be liable under Rule 10b-5?

Rule 10b-5 makes it unlawful "to make any untrue statement of a material fact . . . in connecton with the purchase or sale of any security. There’s no question that Ebusiness, through its paid agent, made fraudulent statements. There’s also no question that the investor relied on those fraudulent statements and suffered a loss when the truth became known. The real issue is whether those fraudulent statements were “in connection with the purchase or sale of any security,” as required by Rule 10b-5.

The courts have read the “in connection with” requirement broadly, but its meaning is still far from clear. The Second Circuit has indicated that the false statement must be disseminated “in a manner reasonably calculated to influence the investing public.” SEC v. Texas Gulf Sulphur Co. 401 F.2d 833, 862 (2d Cir. 1968). The false statements do not have to be directed specifically at investors, as long as the statement is of a sort that reasonable investors would rely on. In Re Carter-Wallace, Inc. Securities Litigation, 150 F.3d 153, 156 (2d Cir. 1998). The Carter-Wallace case held that product advertisements in medical journals could be covered by Rule 10b-5, although the primary goal of advertising is to influence consumers, not investors.

The same can be said of false "likes" and product reviews. Their primary goal is to influence consumers, not to convince investors to buy the company's stock. A reasonable investor certainly would not rely on a single "like" or product review. But, given the importance of a company's Internet presence, a reasonable investor might rely on the overall weight of likes and product reviews. Such use by an investor is certainly reasonable foreseeable.

Given the uncertainty of the case law, a definite conclusion is impossible. But it is at least possible that fraudulent product reviews or Facebook “likes” could trigger liability under Rule 10b-5. It’s probably just a matter of time before an ambitious plaintiff’s lawyer tries.

C. Steven Bradford, Securities Regulation | Permalink


I love this idea as food for thought. The consumer promotion versus investor promotion issue was part of the Martha Stewart securities fraud case (about which I have written) over a decade ago, too. See United States v. Stewart, 305 F. Supp. 2d 368, 377 (S.D.N.Y. 2004) (noting with respect to a specific statement in question, e.g., that “there is no evidence that Stewart attempted to refine or change this statement in any way that would tailor it to an audience of investors”). And I am sure it plays in many others. So, your point is salient and in an area that should be of concern to firms.

The sticky wicket in this kind of case often seems to be whether the requisite scienter exists. Certainly, this was the case in the Martha Stewart securities fraud enforcement action, although the court mixes its statement on scienter with the applicable burden of proof. See Stewart, 305 F. Supp. 2d at 377-78 (“[W]hen the nature of the audience is viewed within the overall context of the statement, this is too slight an addition to the total mix of evidence of intent to carry the burden of proving criminal intent beyond a reasonable doubt.”). Don Langevoort has written plainly and convincingly about this aspect of the Stewart litigation. See Donald C. Langevoort, Reflections on Scienter (and the Securities Fraud Case Against Martha Stewart that Never Happened), 10 Lewis & Clark L. Rev. 1-17 (2006), available at Of course, the Supreme Court has not ruled directly and expressly on the nature of the scienter element in civil or criminal securities fraud actions. So, that remains a fertile area for continued decisional law developments.

Posted by: joanheminway | Sep 21, 2015 11:15:28 AM

The two situations are pretty distinct. A fake product review can contain false factual statements about a product that are material (and could even give rise to defamation liability which is relevant to corporate value). In contrast, a "like" is clearly a statement of opinion with no factually content necessarily implied (and is even harder to evaluate as a result of the lack of a "dislike" option on Facebook. So, I don't think that fake "likes" on Facebook would give rise to misrepresentation liability. But, it is entirely possible that a campaign to create many hundreds or thousands of fake "likes" on Facebook could constitute a "fraudulent scheme" intended to manipulate the market in that security, which is an entirely different analysis.

Posted by: ohwilleke | Sep 23, 2015 1:36:33 PM

I agree that there's a difference between a single false "like" and a multitude of them. I also think there's a difference between a single product review and a multitude of them. A single false "like" or a false single product review would, without doubt, not be material. But, collectively, they could be.

Assuming we're talking about a large collection of fake likes or product reviews, I'm not sure that the distinction between opinion and fact would matter. Under securities law, one can be liable for false statements of opinion, and these statements of opinion would clearly be false.

Posted by: Steve Bradford | Sep 23, 2015 1:43:17 PM

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