The SEC vs. Facebook: Securities Fraud, Or Just A Blight On Society?

The recent allegations concerning Facebook… er, “Meta”… sound quite damning. Over the past few weeks, former employees, backed by stacks of internal records, have publicly aired a number of ugly contentions. Algorithms directing Facebook users to hate speech and disinformation. Apps that help facilitate human trafficking. Instagram dynamics that harm teen girls’ self-image.

Sounds like a job for… the Securities and Exchange Commission?

Why The SEC?

At first blush, the allegations don’t necessarily fit into what most people imagine is the SEC’s sweet spot. We’re not talking about insider trading, or cooking the books, or stealing money from investors. Why is it a concern of the SEC that Facebook has helped create a nation of anti-vax wackadoos? In fact, given that Facebook is a publicly-traded company, these allegations may very well support a claim of securities fraud — more on that in a moment. Still, some might wonder why, of all places, the whistleblowers have turned to the SEC for help.

Besides the SEC’s interest in overseeing the conduct of publicly-traded companies, there are excellent (if arguably self-interested) reasons for a whistleblower to file a complaint with the SEC. First, under the Dodd-Frank Act, passed in response to the financial crisis of the late 2000s, the SEC can pay financial bounties to individuals who share information leading to the successful prosecution of an enforcement action. These awards, of up to 30% of whatever the SEC ultimately collects, can be quite lucrative — in the past year, two separate whistleblowers were awarded $110 million apiece for tipping off the SEC, and don’t tell me you wouldn’t rat out your own mother for that kind of money. (All told, the SEC has awarded more than $1 billion to whistleblowers over the past decade.)

Perhaps even more importantly here, Dodd-Frank and its related regulations prohibit companies from retaliating against whistleblowers. This can be quite meaningful to former Facebook employees who left the company with a treasure trove of confidential documents clearly subject to nondisclosure agreements. While there is no guarantee that Facebook won’t sue them for removing internal records, the SEC’s rules offer some protection.

So, Is The SEC Investigating Facebook?

Oh, almost certainly. SEC investigations are confidential, so we have no way of knowing for sure unless and until the SEC actually files an enforcement action (which is always public). But Facebook’s most recent quarterly report disclosed that, “in September 2021, we became subject to government investigations and requests relating to a former employee’s allegations and release of internal company documents” concerning the matters described above. The disclosure doesn’t specifically identify the SEC, but sure sounds like they’re on the move.

And given the high profile nature of the current allegations, the SEC will be under pressure to do its level best to get a case out of this mess. [Full disclosure: From 2008–2013, I was the Regional Director of the SEC’s San Francisco Office, the region where Facebook happens to sit. But I have no personal knowledge of what that office may or may not be doing here.] Alas, the public will, as noted, have little or no visibility into what exactly the SEC is finding until it’s all over, absent some more detailed disclosure from the company (unlikely) or witnesses in the investigation leaking to the press (which is legal; only the SEC itself is legally restricted from discussing the investigation while it’s pending).

But Is It Securities Fraud?

Maybe. Some people think of securities fraud as strictly financial, reporting falsified revenues and so forth. Or maybe egregious lies used to steal money from investors, like claiming your company has developed a cure for Covid-19 when it’s simply a Cayman Islands mail-drop. But the concept is broader than that, extending to misrepresentations about other matters that could be important to investors.

For a good example, one need look no further than a case the SEC brought against Facebook itself, just two years ago. There, the SEC found that Facebook had allowed confidential customer data to be used by Cambridge Analytica in connection with American elections, while falsely telling investors that no such misuse of data had occurred. Facebook paid a $100 million penalty to settle the case. (Another example: A few years back, the SEC sued United Airlines for maintaining a money-losing flight route so that a New Jersey official who just happened to oversee airport construction projects could visit his South Carolina home.)

However, there are some significant challenges the SEC would have to overcome in order to bring a securities fraud case here.

First, the SEC would have to show there was an actual misrepresentation. As a general matter, a mere omission isn’t enough. Even if Facebook was doing all the terrible things the whistleblowers say they were — and this time the whistleblowers appear to have brought the receipts — Facebook didn’t have any legal obligation to disclose the ugly side of its platforms to investors. It only becomes problematic if the company’s failure to make these disclosures made their actual statements misleading. In other words, neglecting to mention that the company was ushering users into a cesspool of bogus election fraud conspiracy theories could only support a securities fraud claim if, at the same time, the company was falsely assuring investors that it had procedures in place preventing this sort of thing from happening.

Second, the SEC would have to prove than any misrepresentation was material — that is, it was important to investors. And here’s where things can get tricky. For example, one whistleblower has argued that Facebook placed profits over public safety. But for some Facebook shareholders, that sounds awesome — when you’re buying the company’s stock, isn’t maximizing profits exactly what you’re looking for? Sure, my crazy high school friends are staging armed insurrections and ingesting horse paste because of something they read on Facebook, but, hey, check out my portfolio value!

But for other investors, including more socially-conscious investment funds, how the company behaves as a corporate citizen is a factor in their investment strategy. These days, there is tremendous debate about companies’ ESG (or environmental, social, and governance) disclosures, and the extent to which public companies should be required to tell shareholders about their carbon footprint and the diversity of their personnel and so forth. The SEC is certainly looking to push the envelope regarding what sort of information is deemed material to investors, but whether they can build such a case is ultimately up to a court of law.

Of course, the SEC can always fall back on claims short of outright fraud. There are more technical regulatory requirements that can support a case (the United Airlines case referenced above found that the company had inadequate internal controls, for instance); but that would be a lot less sexy (and support lesser sanctions) than charging Facebook with securities fraud.

What Can The SEC Do To Facebook?

Facebook’s myriad critics are demanding everything from Mark Zuckerberg’s head on a stake (and not necessarily figuratively) to the break-up of the company. Alas, that’s all a bit outside the SEC’s wheelhouse. As a civil agency, the SEC has no authority to bring criminal charges, so jail is out of the picture. (The SEC can refer matters to the Department of Justice for criminal prosecution, but the DOJ typically sticks to cases where investors lose money — and that’s not really what this is about.)

Most SEC enforcement actions result in financial penalties, which largely give the SEC an opportunity to publicly shame the company and extract a pound of flesh, but aren’t going to make a dent in Facebook’s massive war chest.

One arrow in the SEC’s quiver is the ability to bar an individual from serving as an officer and director of a public company. But this won’t be easy. They’d need to prove the officer had specific knowledge and involvement in the alleged misconduct, meaning a need for some juicy emails and, even better, some witnesses willing to testify that they specifically discussed these matters with Zuckerberg or other executives. Moreover, courts tend to grant such relief only in cases of egregious violations — and, for the reasons noted above, that may be a stretch where investors weren’t necessarily harmed financially. Facebook’s senior executives aren’t going to walk away from the company voluntarily as part of a settlement, so even if the SEC brings a case here, we’d likely be in for a long and bruising courtroom battle against a ridiculously well-funded company.

At the very least, those concerned with Facebook’s failings as a corporate citizen can hope for an enforcement action that results in more detailed revelations which will exert greater pressure for reform from Facebook’s shareholders and users, and ultimately from Congress.