The SEC’s Intensified Scrutiny of Off-Channel Communications at Registered Firms

At a Glance

• The U.S. Securities and Exchange Commission has maintained its focus to monitor and regulate off-channel communications of its registrants as highlighted in recent settlement actions in which the agency charged 11 Wall Street firms with widespread recordkeeping failures.
• The firms admitted to wrongdoing and agreed to pay combined penalties of $289 million and to remedy their compliance processes and procedures to address these recordkeeping weaknesses.

Besides traditional means of communication, financial services companies communicate with their stakeholders through off-channel channels like social media, instant messaging, email, and other digital platforms. The flexibility and speed of off-channel communications have opened new doors to engage with stakeholders, but also present potential risks in terms of information accuracy, data security, and regulatory compliance. The U.S. Securities and Exchange Commission (SEC) has maintained a focus to monitor and regulate off-channel communications of its registrants as highlighted in recent settlement actions in which the agency charged 11 Wall Street firms with widespread recordkeeping failures. As detailed in the SEC orders, the firms disclosed that their employees communicated about their employers’ business through various messaging platforms, such as iMessage, WhatsApp and Signal. But by not keeping or preserving the overwhelming majority of these off-channel communications, the SEC alleged that the firms were in violation of the recordkeeping provisions of the federal securities laws. The firms admitted to wrongdoing and agreed to pay combined penalties of $289 million and to remedy their compliance processes and procedures to address these recordkeeping weaknesses.

Applicable Rules

Broker-dealers are subject to record retention requirements enumerated in Exchange Act Rule 17a-4, and investment advisers are subject to record retention requirements set forth in Advisers Act Rule 204-2 (Advisers Act).

The recordkeeping rule for broker-dealers is much broader than the recordkeeping rules for investment advisers. In particular, broker-dealers are required to retain “all communications. . . (including inter-office memoranda and communications) relating to its business as such.” Investment advisers are required to maintain four narrow enumerated categories of written communications; specifically, communications “received and . . . sent by such investment adviser” relating to (i) recommendations made or proposed to be made and advice given or proposed to be given; (ii) receipt, disbursement or delivery of funds or securities; (iii) placing or execution of orders to purchase or sell securities; and (iv) predecessor performance.

Other Recent SEC Enforcement Actions and Inquiries

In recent years, the industry has seen a sharp rise in recordkeeping-related enforcement actions taken and substantial fines imposed due to such violations. In December 2021, the SEC imposed $125 million in fines on J.P. Morgan Securities LLC for failures by the firm and its employees to maintain and preserve written communications. Further, in September 2022, the SEC charged 16 Wall Street firms with failures by the firms and their employees to maintain and preserve electronic communications and imposed combined fines of more than $1.1 billion. News reports also came out early in the year that the SEC ran a targeted sweep centering on private equity and hedge fund firms' use of personal devices and whether these communications were authorized or stored. After these reports, 10 financial industry trade associations released an open letter to SEC Chairman Gary Gensler in January, criticizing the commission's actions as beyond the recordkeeping provisions of the Advisers Act. Furthermore, the SEC charged HSBC Securities (USA) Inc. and Scotia Capital (USA) Inc. in May 2023 for widespread and longstanding failures to maintain and preserve electronic communications and levied a fine of $15 million and $7.5 million respectively. Similarly, on June 22, 2023, the SEC charged J.P. Morgan Securities LLC for alleged failure to retain millions of electronic communications and fined the company $4 million for these failures.

Key Aspects of SEC’s Continued Vigilance

The SEC has repeatedly emphasized the necessity for firms to abide by regulatory standards across all communication mediums, even off-channel mediums. Some of the main features of the SEC's continuing watchfulness include:

1. All material information distributed through off-channel communications must be exact, impartial and abide by SEC regulations.
2. Maintaining detailed and quickly accessible records of every off-channel communication is vital for regulatory examinations and audits.
3. The SEC's anti-fraud provisions extend to off-channel communications.
4. Firms must ensure the privacy and security of client data to prevent breaches and unauthorized access.
5. Firms are expected to adopt appropriate compliance measures to ensure that these platforms are used responsibly and in compliance with regulations.

Key Takeaways

As technology has improved communication in the financial sector, financial services firms should focus on devising regulatory compliance programs that sustain and preserve electronic communications. Firms must remain diligent in their efforts to ensure that off-channel communications adhere to standards of transparency, fairness and accuracy as traditional channels. Firms should maintain robust policies governing the use of personal devices and have outside counsel review and update existing policies and procedures to adapt to the current regulatory climate. Firms must remain vigilant regarding their adherence to these regulations and policies, as the SEC has highlighted that a personal device policy alone is insufficient. Instead, firms must demonstrate that they are taking proactive steps to ensure compliance. If a firm realizes that its employees are not adhering to off-channel communication policies and regulations, they should immediately consult with external legal counsel on how to fix the issue and follow the three primary directives from Gurbir S. Grewal, Director of the SEC’s Division of Enforcement in the press release for the recent settlement actions: “admit the violation, cooperate and rectify.”

Faegre Drinker attorneys have extensive experience helping clients with regulatory compliance issues through their work on our investment management, broker-dealer and white-collar teams. Please feel free to contact any of our experienced professionals if you have questions about this alert.