Is this the Beginning of the End for Crypto Influencers?

Written by Tiana Whitehouse, Co-Founder & Managing Director at SWOT Team Consulting

Is the swan song of crypto influencers here at last? A class action lawsuit filed in California (USA) against EthereumMax and its celebrity endorsers provides useful insights about the dangers of promotional activities for cryptoassets.

The Rise of the Crypto Influencer

Because cryptoassets are not considered financial products in many jurisdictions, crypto firms are not subject to the onerous financial disclosure requirements and advertising restrictions that have long plagued banks, fund managers and insurance companies.

Many companies have taken advantage of this regulatory loophole to deploy sophisticated data analytics and marketing tools that directly target Gen Z customers through various social media channels. Celebrity influencers who were already paid incredible sums for product endorsement on their TikTok or Instagram accounts suddenly began urging their followers to invest in high-risk cryptoassets.

Although regulators in multiple jurisdictions began issuing warnings to consumers about the dangers of investing in risky and mostly unregulated products, in many cases they lacked the necessary legal tools to take direct action against the crypto companies or their celebrity promoters.

Along with regulatory warnings, leaders in Big Tech have voiced critical opinions of the cryptoasset market as a whole and point to repeated examples of theft, misappropriation of investor funds and outright fraud. Large social media platforms such as Meta (formerly Facebook) and TikTok completely banned the promotion of cryptoassets.

However, the ban on promotion of cryptoassets in the more mainstream social media platforms merely fuelled the movement of keen investors to other forums such as the encrypted app Telegram, which allows users to retain their anonymity. Crypto companies are free to create ‘fan groups’ in these forums that may look unaffiliated with the business but are masterminded and administered by the company’s sophisticated marketing and communications teams. In this environment, ‘pump and dump’ schemes and other fraudulent activity have flourished.

Regulatory Developments

Regulators have long been monitoring ‘perimeter’ activity and identifying potential harms to consumers and financial markets. Australia and France are two examples of countries where regulators have infiltrated Telegram groups to investigate illegal activity and warn participants about the illegality of certain activities. Users have reported seeing automated messages by regulator ‘bots’ invite participants to make a formal complaint if they are unhappy with the conduct of a crypto company.

There have been numerous instances in which the UK’s Financial Conduct Authority (FCA) banned specific crypto ads or prohibited their distribution in highly trafficked public places. The regulator is now in the process of publicly consulting on strengthening financial promotion rules for high-risk investments (including cryptoassets) and intends to publish a Policy Statement and final Handbook rules by mid-2022. Of particular interest to crypto firms is the FCA’s proposal that the new rules will apply from the date that any qualifying cryptoassets are brought within the financial promotion regime.

Just last week, Spain’s National Securities Market Commission (CNMV) imposed a new requirement on crypto influencers or outlets with more than 100K followers and their sponsors to notify them about crypto promotions in advance of the promotion taking place. The promotion must also include a warning to potential investors about the risks associated with the product. Failure to comply with this rule could result in fines up to €300K.

And in a clear sign of tightening rules for Singapore crypto firms, the Monetary Authority of Singapore (MAS) released new guidelines this week that ban companies from advertising crypto products to the general public.

What next?

Thanks to its broad definition of a financial security, the USA has given us our best view of what regulated advertising and marketing for cryptoassets looks like in practice. State and federal regulators have issued guidance on social media marketing of financial products and taken enforcement actions against specific companies and promoters.

Outside of the regulatory framework exists another avenue for disgruntled investors to seek redress — the civil lawsuit. In the recently filed Ryan Huegerich v. Steve Gentile et al, the plaintiff alleges that EtherumMax conspired with its celebrity influencers (most notably Kim Kardashian and Floyd Mayweather) to run a classic pump and dump scheme for the company’s EMAX tokens.

The defendants are separated into two categories — the company’s ‘Executive’ Defendants and the ‘Influencer’ Defendants. Both sets of defendants are accused of actively taking part in the fraudulent promotion of the ‘worthless’ EMAX token for the sole purpose of driving up the price and selling their own holdings before the value inevitably crashed.

What can we learn from the EthereumMax Lawsuit?

1. The sophistication and awareness of the influencer is now up for dissection and analysis.

While influencers who have made a career out of crypto endorsements would most certainly be deemed as having ample knowledge of how these products work, this would not necessarily apply to other types of influencers. A fraud allegation cannot be successful unless the defendant was (or should have been) aware that the promotional activity was in furtherance of a fraudulent scheme.

Kardashian’s knowledge and prior experience with crypto and other investments will be analysed, as well as her overall understanding of legal prohibitions on certain promotional activities. The complaint refers to a previous intervention by regulators on account of another misleading paid social media endorsement by Kardashian, but that incident was in relation to a pharmaceutical product.

Mayweather finds himself in a tougher position legally given that he was still subject to a prior binding settlement explicitly preventing him from promoting any securities (digital or otherwise) for a three-year period. It remains to be seen what consequences he will face from breaching that agreement and whether he will attempt to shift the blame to professional agent(s) or other third parties who manage his endorsement deals.

2. The legal arrangement(s) with the influencer may have some bearing on apportionment of liability.

Celebrity endorsement deals are subject to extensive legal oversight and planning, with contractual agreements that limit personal liability as much as possible. It seems unlikely that Kardashian or Mayweather would have contracted directly with EthereumMax in their personal capacity, and the plaintiff’s complaint notes that the identity of the ultimate holding company is not publicly available. If this case proceeds, it will be interesting to see how many corporate layers and third-party agencies stand between the Influencer Defendants and the company itself.

Regardless of the legal arrangements in this particular case, FinTech leaders should be on notice that contracting directly with influencers is a dangerous move because the company would be viewed as directly controlling their actions. However, it is unlikely that a third-party agency would provide much protection in cases where the company developed the promotional content and the influencer was restricted to the exact parameters and wording of the approved content.

3. Consultants are not on the ‘safe list’.

It is notable that ‘Executive Defendant’ Justin French is included in the lawsuit as someone who exercised significant control over EthereumMax, even though he worked in the capacity of a ‘consultant, developer and spokesman’ and not as a director or senior executive.

Although the legalities of whether French exercised significant control over the company is for the court to decide, specialist consultants should take care not to end up in a similar position. We would argue that French probably had significant influence over the directors, but legal control over decisions will depend on the company’s governance framework and whether key business decisions were properly discussed and recorded in Board meeting minutes.

Consultants who work with companies in the start-up phase should make it clear that they are not decision makers, particularly where they are helping to formulate the business strategy and when the governance framework is not yet formalised or matured. Remuneration based on tokens and/or shares could later be seen as a conflict of interest or possibly even impute liability to the consultant depending on the legal regime.

Even if French is ultimately excused on account of his status as a consultant, he will still face legal defence fees, reputational damage and the interruption to his work capacity while he is actively defending the suit. Consultants who work closely with crypto companies would do well to carry professional indemnity insurance that covers the scope of their services.

4. Be wary of what you present at crypto conferences.

The lawsuit includes certain ‘promotional’ activities carried out by Mayweather at the Crypto 2021 conference in Miami, Florida. It remains to be seen whether this will be classed as a promotional activity to the general public given that it took place in front of a limited audience composed of individuals who are presumably knowledgeable about cryptoassets. The plaintiff notes that Mayweather neglected to discuss Bitcoin (which was the subject of the conference) and promoted the EMAX token instead.

Crypto firms should carefully consider what they say about their products and services at industry conferences, particularly where the content is recorded and distributed online. It is all too easy for content to be taken out of context and misinterpreted by a potential investor who was not present at the live event. Companies should ensure that legal agreements with third-party distributors explicitly prohibit the removal of crucial disclaimers or disclosures.

5. Watch out for press releases.

Crypto firms often use press releases as part of their marketing strategy to announce new partnerships, a successful funding round, the release of a new product, etc.

In this case, EthereumMax issued several press releases confirming the success of its influencer marketing campaigns and directly linking the exponential increase in trading volume to specific influencer promotional activities.

Given that these press releases are now being used as evidence in the fraud case, companies should carefully consider the potential risks of press releases before they are published. Internal policies and procedures should require that any public communications are reviewed by legal and/or compliance and approved by the oversight body or its delegated authorities to reduce the risk of unintended consequences.

6. Always conduct due diligence on influencers.

The fact that Mayweather was hired to conduct crypto promotions when he was explicitly banned from doing so indicates a serious failure on the part of EthereumMax to conduct any third-party due diligence prior to entering into a business relationship with him.

While this is an extreme example, the success of celebrity endorsement deals is directly correlated to the personal brand of the individual being hired to do the promotion. This leaves the company exposed to reputational harm and other serious risks in the event that the celebrity is embroiled in controversy or public censure due to their personal views or actions.

Need to put together compliant advertorial guidelines for influencer engagement? Get in touch with SWOT Team Consulting for a consultation.