[Co-Author: Kathryn Rumsey]
Over the last year, the U.S. Securities and Exchange Commission (“SEC”) has been laser-focused on the use of personal devices by employees of the large Wall Street banks to conduct company business. The SEC’s investigations have focused on whether the banks complied with the “books and records” requirement that they preserve all communications that relate to Company business. The SEC has asserted that certain “off-channel” business communications not captured in company systems run afoul of this basic record keeping requirement. Not surprisingly, during the pandemic and with the increase in remote work, the SEC has determined that violations have been widespread.
The SEC’s focus, to this point, has largely centered on broker-dealers. On December 17, 2021, the SEC announced a settlement with a large broker-dealer for its “widespread and longstanding failures” to preserve employees’ off-channel communications in violation of Section 17(a) of the Securities Exchange Act of 1934 and Rules 17a-4(b)(4) and 17a-4(j). The broker-dealer admitted that it failed to preserve business communications on its employees’ personal devices despite being aware that its employees often communicated about business matters on these devices. The broker-dealer agreed to pay $125 million and “implement robust improvements to its compliance policies” to settle the charges.
Then, on September 27, 2022, the SEC issued a press release announcing a $1.1 billion settlement with fifteen broker-dealers and one affiliated investment adviser for failing to maintain and preserve business-related communications by employees on their personal devices.
Recent news reports have suggested that the SEC may now be targeting investment advisers in its push to police retention of business communications, and SEC Chair Gary Gensler has confirmed that the SEC continues to investigate recordkeeping violations stemming from employees’ use of private communication channels for business. Under Section 240 of the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 204-2, investment advisers are required to maintain and preserve certain business-related communications for at least five years. These preservation requirements apply to all electronic communications, including emails, text messages, and third-party messaging applications. According to the reports, the SEC is seeking information regarding investment advisers’ policies and procedures for retaining business-related communications, including asking investment advisers to identify the specific individuals responsible for overseeing the relevant policies and procedures, and to provide documents sufficient to identify individuals who are responsible for, among other things, communicating with investors or potential investors. Investment advisers should therefore anticipate increased scrutiny of their electronic communication retention policies and procedures, particularly as they relate to off-channel communications. While “books and records” violations have been the subject of enforcement actions, until now, those violations were commonly cited in the context of other securities laws violations. It is now clear that “books and records” violations that result from employee use of personal communication applications to conduct company business can expose advisers to significant penalties.
These inquires not only raise sensitive issues about how investment advisors should respond to the SEC, but also how to navigate these issues with employees who are understandably concerned about personal privacy when their cell phones and personal email accounts become the focus of an enforcement investigation. Advisors should review their policies, procedures and training on these topics and expect that their enforcement of internal requirements will be scrutinized.
The SEC’s actions are having a ripple effect in civil litigation as well. Some of the banks that settled with the SEC in the actions discussed above are now facing questions about potential spoliation of evidence in a lawsuit over alleged interest rate swap market rigging. Plaintiffs in that action assert that the SEC settlements show bank employees used their personal devices to communicate regarding business, including potential discussions of interest rate swap trades that could have been relevant to plaintiffs’ case. As a result of this revelation, plaintiffs asked the judge to reopen discovery in the six-year-old action. Financial institutions can expect similar claims to continue emerging in court.