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SEC Charges Broker Dealers & Affiliated Investment Adviser with Widespread Recordkeeping Failures

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On September 27, 2022, the Securities and Exchange Commission (SEC) announced settlements and combined penalties of more than $1.1 billion related to charges against 15 broker-dealers and one affiliated investment adviser (Firms) for widespread failures by the Firms and their employees to maintain and preserve written electronic communications in the context of pervasive use of personal text messages and other text messaging platforms such as WhatsApp on personal devices (off-channel communications).  The SEC charged that the use of off-channel communications by employees of the Firms in connection with their respective broker-dealer and investment advisory businesses, and the failure of the Firms to monitor and record such off-channel communications, constituted violations of (i) with respect to broker-dealer activities, Rule 17a-4 promulgated under the Securities Exchange Act of 1934 (Exchange Act), and (ii) with respect to investment advisory activities, Rule 204-2 promulgated under the Investment Advisers Act of 1940 (Advisers Act).

In relevant part, Rule 17a-4 and Rule 204-2, applicable to broker-dealers and investment advisers respectively, require that broker-dealers and investment advisers preserve in an easily accessible place originals of all communications received and copies of all written communications sent relating to their business activities.  In implementing these recordkeeping requirements, broker-dealers and investment advisers are also required to “reasonably supervise” the compliance of their employees with these requirements under §15(b)(4)(E) of the Exchange Act and §203(e)(6) of the Advisers Act.  As such, broker-dealers and investment advisers will need to take meaningful proactive steps to assure compliance, and cannot simply rely on the existence of firm recordkeeping policies.  

The SEC investigation into the Firms uncovered widespread and pervasive use of unmonitored and unrecorded off-channel communications in violation of the Exchange Act and Advisers Act.  Off-channel communications were used at all levels of seniority across the Firms, both for internal purposes, and for external communications with clients, and were used to discuss core business matters such as investment strategy, investment banking services, market analysis and trading results.  Each Firm had certain policies and procedures designed to ensure the retention of business-related records, including with respect to prohibitions and limited permitted use of off-channel communications, but in each case the Firms’ failed to sufficiently implement training, follow-up and review systems to ensure that their respective recordkeeping and communications policies were being followed by employees.  As a result, the SEC found numerous instances of employees disregarding Firm policies and engaging in non-compliant off-channel communications that were generally not monitored, subject to Firm review, archived, or otherwise retained.  

Given the pervasiveness of text messaging and other chat applications in the modern workplace, we anticipate that the SEC will likely make robust recordkeeping compliance programs a point of emphasis moving forward, and the SEC has repeatedly emphasized that compliance with recordkeeping requirements is essential to investor protection and the functioning of fair and efficient capital markets.  Moreover, the SEC did not indicate in the relevant settlement orders that they perceived any functional distinction between the recordkeeping obligations placed on broker-dealers and those placed on investment advisers, and as such, investment advisers should expect recordkeeping to be a point of emphasis in periodic SEC examinations.

To ensure compliance with recordkeeping obligations and to avoid substantial financial penalties, broker-dealers and investment advisers will need to ensure that (i) their compliance department has in place detailed policies and procedures with respect to the use of off-channel communications, and (ii) their compliance departments are authorized and empowered to take proactive measures in monitoring employee compliance with recordkeeping policies, including through the use of (A) training programs, (B) enhanced surveillance protocols for investigating incidents of off-channel communications, (C) swift employment action, including compensation and promotion impact, and termination, following a breach and (D) technological investments to facilitate compliant communications.

It is important to note that there is nothing inherently non-compliant with the use of text messaging and other text or chat applications, so long as they are subject to the monitoring and record retention procedures generally applicable to workplace communications in compliance with firm policies and applicable law.  The problem arises when those communications occur outside of the scope of a firm’s monitoring and retention capabilities, which typically stems from the use of personal, non-firm issued devices.  Recently, firms have started using applications such as “Movius” and “Global Relay”, which secure and record WhatsApp and other text-based communications, while giving employees communication flexibility.  However, these applications only work to the extent that employees appropriately use them in compliance with firm policies, and ultimately, it is up to compliance departments to effectively train and monitor employee usage as described above to ensure that the usage of these applications is compliant with the recordkeeping requirements of the Exchange Act, Advisers Act, and other applicable laws.

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