The Regulatory Risks Facebook Faces In India Could Shape The Future Of The Social Media Industry

May 25, 2021 10:15 AM ETMeta Platforms, Inc. (META)10 Comments7 Likes

Summary

  • On February 25, the Ministry of Electronics & IT in India announced a new Digital Code of Ethics for social media companies.
  • Facebook was given a timeline of 3 months to comply with the new Code, but the company has so far failed to do this.
  • The company might be headed toward rough seas, but there is a long runway for growth and the company is undervalued.
  • Looking for more investing ideas like this one? Get them exclusively at Leads From Gurus. Learn More »

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Facebook, Inc. (FB) won't let you sleep, and no, I'm not talking about Facebook users but investors. Just when you think regulatory troubles are behind Facebook, the company will somehow find itself at the receiving end of more troubles. I have covered many of these regulatory risks in the past on Seeking Alpha. This time around, the company is facing an existential threat in India due to recent regulatory changes pertaining to social media companies. A quick look at the changing regulatory landscape in the country and Facebook's commitment to complying with the new Code of Ethics for social media companies paint a promising picture for the company in India. More importantly, I believe regulators in other regions might follow India's lead, helping social media companies reach some middle ground with policymakers, which would be a win-win situation for both parties.

How is the regulatory landscape changing?

On February 25, the Ministry of Electronics & IT in India announced a new Digital Media Ethics Code which would be applicable to social media platforms and over-the-top streaming companies. The Ministry published many reasons behind its decision to introduce changes to the existing ethics code, and below are some of these reasons.

  1. Spread of fake news.
  2. Misuse of social media platforms to abuse women.
  3. Misuse of social media for settling corporate rivalries.
  4. Use of abusive language and obscene content.
  5. Disrespectful content toward religious beliefs.
  6. Use of social media platforms by criminals for recruitment of terrorists, circulation of illegal content, financial frauds, and incitement of violence and social unrest.

All the points raised by the Indian government, in fact, are not exclusive to India. To start an international push toward making social media platforms a better place for every stakeholder, Indian policymakers have introduced many reforms from its new Code of Ethics. According to this new legislation, social media companies fall into 2 categories: Social Media Intermediaries and Significant Social Media Intermediaries. The Indian government is yet to confirm which platforms fall into each of these categories, but the decision will be based on the number of active users on social media platforms. With 530 million WhatsApp users, 410 million Facebook users, and 210 million Instagram users in India, Facebook, Inc. is certainly a Significant Social Media Intermediary in the country.

Below are some of the due diligence actions proposed by Indian regulators for Significant Social Media Intermediaries on February 25, and companies were given 3 months to implement these changes (please click the link at the beginning of this section to read the complete Code of Ethics).

  • Appointing a Chief Compliance Officer who shall be responsible for ensuring compliance with the Act and Rules. Such a person should be a resident in India.
  • Appointing a Nodal Contact Person for 24x7 coordination with law enforcement agencies. Such a person shall be a resident in India.
  • Appointing a Resident Grievance Officer who shall perform the functions mentioned under Grievance Redressal Mechanism. Such a person shall be a resident in India.
  • Publishing a monthly compliance report mentioning the details of complaints received and actions taken on the complaints.
  • Significant social media intermediaries providing services primarily in the nature of messaging shall enable the identification of the first originator of the information.
  • Significant social media intermediary shall have a physical contact address in India published on its website or mobile app or both.
  • Voluntary User Verification Mechanism: Users who wish to verify their accounts voluntarily shall be provided an appropriate mechanism to verify their accounts.
  • Giving users an opportunity to be heard: In cases where significant social media intermediaries remove or disable access to any information on their own accord, then a prior intimation for the same shall be communicated to the user who has shared that information with a notice explaining the grounds and reasons for such action.
  • Removal of unlawful information.

Facebook, so far, has not complied with these guidelines, and today (May 25) marks the end of the time period given to social media companies to fully comply with the new Code of Ethics.

What's next for Facebook?

I reached out to some of my colleagues in India (well, I do have many) to check whether they have heard any rumors, and I came up with some funny memes about what would happen to Facebook (and the likes of Twitter (TWTR) too) tomorrow because of its non-compliance with new regulations. Memes aside, some Indian news channels have reported that Facebook might be banned in India from May 26 until the company implements all these changes, or at least until the appointment of a Grievance Officer.

Although I believe such a nasty outcome is a bit of a stretch at the moment (the last thing India would want in the midst of a Covid crisis is an uproar from the millions of social media users who are confined indoors), Facebook is certainly headed toward rough seas. Failure to comply with these guidelines will result in Facebook losing the all-important protection available for social media companies from Section 79 of the Information Technology Act. Under this rule, social media intermediaries are exempted from assuming liability for any information published on their platforms by third-party users. Here's an excerpt from Section 79.

INTERMEDIARIES NOT TO BE LIABLE IN CERTAIN CASES

(1) Notwithstanding anything contained in any law for the time being in force but subject to the provisions of sub-sections (2) and (3), an intermediary shall not be liable for any third party information, data, or communication link made available or hasted by him.

Losing the protection from Section 79 will open the door for a sea of lawsuits against the company in India, which is not exactly what the company would want to get itself involved in, especially considering that India is expected to drive earnings growth in the next decade. This is why I believe the company will comply with the new Code of Ethics although it would mean a substantial increase in operating costs in India and possibly a significant time commitment as well to resolve user complaints.

According to a recent article (published just a short while ago) on Business Today, Facebook officials have confirmed their intentions of complying with the new Code of Ethics as soon as possible. As Business Today reports, a Facebook spokesperson said:

We aim to comply with the provisions of the IT rules and continue to discuss a few of the issues which need more engagement with the government.

I am closely monitoring the situation to see what Facebook would come up with, but in any case, I have no doubt the next few months will be very interesting for us as Facebook investors.

The industry might change permanently in the next few years

For so many years, regulators around the world have tried various measures to limit the power of social media companies, but none of these measures could prevent Facebook from maintaining its dominance in a lucrative, fast-growing industry. Social media companies have tried in vain to find some middle ground with regulators as well. The key issue, in my opinion, was that these two counterparties were at 2 different extremes.

The reforms introduced by the Indian government, as far as I see, will help social media companies and regulators find some middle ground. These changes will negatively impact the likes of Facebook, but at the same time, the benefits to society as a result of these initiatives will far exceed the costs of regulation. In the long run, the government will have an acceptable level of control over how people use social media platforms, whereas all these companies will still be able to make handsome profits despite the expected decline in profit margins in the short run, which would be negligible. If regulators in other regions decide to follow India's lead to implement similar changes, I believe Facebook will initially experience some difficulties in adjusting to the new normal but in the long run, regulatory interference will be minimal, and the trust of users toward the company will increase meaningfully, helping the company onboard many new users from emerging markets in which many women consider social media platforms not safe for them at the moment.

Takeaway

Facebook has been part of my portfolio for many years, and the company is a core holding of our growth portfolio at Leads From Gurus as well. Facebook, in my opinion, is still significantly undervalued, and there is a long runway for growth available for the company in the next few years. The regulatory risks the company faces in India, in my opinion, will pave the way for Facebook to come out stronger in the coming years.

I am a story investor, and in my previous articles over the last couple of years, I have discussed my investment thesis for Facebook in detail, so I invite you to check those articles.

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This article was written by

Dilantha De Silva profile picture
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I am an investment analyst with 7 years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities. Please click the "Follow" button to get timely updates on new articles.

I am the founder of Leads From Gurus, a Marketplace service on Seeking Alpha that focuses on uncovering alpha-generating opportunities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, and GuruFocus.

I'm a CFA level 3 candidate, an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK), and a candidate in the Chartered Wealth Manager program.

During my free time, I enjoy reading.



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Disclosure: I am/we are long FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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