- Last week, the SEC announced settlements with 10 broker-dealers and affiliated investment advisers in connection with their failures to maintain and preserve electronic "off-channel" communications.
- This announcement reflects the latest in a wave of enforcement actions against financial firms throughout the industry for their employees' use of "off-channel" communications to conduct business. However, the settlements did not include actions involving some of the industry's largest investment advisers, which have been reportedly responding to document and information requests from the SEC regarding "off-channel" communication use.
- The SEC heralded three of the settling firms for self-reporting and announced that they received lower civil monetary penalties as a result.
The Latest 'Off-Channel' Communications Settlements
Financial regulators' focus on "off-channel" communications first came into public focus in September 2022 with a series of enforcement actions by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) against large financial institutions for violations of their broker-dealer recordkeeping obligations in failing to retain and review business-related electronic communications transmitted by firm employees away from firm recordkeeping systems.1
On September 29, 2023, the SEC announced that it had entered into settlements with five broker-dealers, two investment adviser affiliates of those broker-dealers and three firms dually registered as broker-dealers and investment advisers in connection with these firms' respective failures to maintain and preserve certain electronic communications. Each of the firms admitted that their employees communicated firm business through personal messaging platforms.
The settling firms admitted that, in failing to properly preserve such communications, their conduct violated recordkeeping provisions of sections 15(B) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") and/or sections 203(e) and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act") and related SEC regulations. Specifically, rule 17a-4 under the Exchange Act and rule 204-2 under the Advisers Act set forth the recordkeeping and document preservation requirements for broker-dealers and investment advisers, respectively. The rules are not coextensive, however. Whereas rule 17a-4 requires broker-dealers to retain "all communications. . . (including inter-office memoranda and communications) relating to its business as such," rule 204-2 requires registered investment advisers to maintain four specific categories of written communications.2 In January 2023, 10 financial industry trade associations released an open letter to SEC Chair Gary Gensler, criticizing the Commission for expanding the recordkeeping provisions of the Advisers Act beyond their intended scope. None of the signatories to the letter were among the settling firms.
The SEC found that certain of the settling firms, as result of their failures to capture the "off-channel" communications, likely deprived the Commission of relevant and responsive documents in various SEC investigations. The failures involved employees at multiple levels of authority, including supervisors and senior managers. The firms agreed to pay combined penalties of $79 million and to implement improvements to their compliance policies and procedures to address these deficiencies. These firms also agreed to retain independent compliance consultants to conduct comprehensive reviews of their policies and procedures relating to the retention of electronic communications found on personal devices and the firms' respective frameworks for addressing non-compliance by their employees with those policies and procedures.
In the press release announcing the settlement orders, Gurbir S. Grewal, Director of the SEC's Division of Enforcement, singled out three firms for self-reporting, noting "[t]here are real benefits to self-reporting, remediating and cooperating." Notably, the three self-reporting firms paid a combined $2.5 million in penalties, whereas one of the other firms and its affiliate, which had not self-reported, agreed to pay a $35 million penalty.3 Director Grewal's comment aligns with similar recent comments from senior Department of Justice officials about the benefits of self-reporting.4
This latest round of settlements is further evidence that the SEC continues to take seriously off-channel communications and recordkeeping. The latest announcement is also notable for what it did not include: settlements involving some of the industry's largest investment advisers, which reportedly received requests from the SEC's Division of Enforcement in November 2022 regarding their practices associated with employee off-channel communications for business-related activities.5 With some firms reportedly preparing to challenge the applicability of the Advisers Act to "off-channel" communications unrelated to "books and records" enumerated by rule 204-2, it remains uncertain whether other, investment adviser-only settlements will follow in the future.
1. Past SEC enforcement actions in this space are available here (December 2021 charges against JP Morgan), here (September 2022 charges against 16 Wall Street firms), here (May 2023 charges against HSBC and Scotia Capital) and here (August 2023 charges against 11 Wall Street firms).
2. Rule 204-2 requires investment advisers to preserve communications "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." 17 C.F.R. § 275.204-2(a)(7).
3. That firm and its affiliate entered into a separate cease-and-desist order with the CFTC on the same day, admitting to similar facts and agreeing to pay a $20 million penalty. That order is available here.
5. See Akin's prior alert on these developments here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.