Maintaining and preserving electronic communications has become a hot topic for the US SEC after a number of cases involving reputable firms being cited for widespread recordkeeping failures with electronic communications. Long gone are the days of maintaining hard copies of communications in filing cabinets and conducting manual reviews of compliance tests. Firms need to have a handle on how their employees conduct firm business, especially when it comes to electronic communications.
SEC enforcement actions
Even the largest financial institutions are not immune, as we witnessed in December 2021, with the charges brought against JPMorgan Securities LLC (JPMS) for widespread and longstanding failures to maintain and preserve employee communications on personal devices through messaging applications such as WhatsApp and personal emails.
JPMS acknowledged that its recordkeeping failures hampered the SEC’s ability to investigate potential violations of federal securities laws. The SEC also acknowledged that JPMS had recordkeeping policies and procedures in place; however, the firm failed to adopt and implement the written policies addressing such communications.
Additionally, in September 2022, the SEC announced charges against 15 broker-dealers and one affiliated investment adviser for widespread and longstanding failures by the firms and their employees to maintain and preserve electronic communications. The firms admitted to any wrongdoings and agreed to pay combined penalties of more than $1.1 billion.
Earlier this month, the SEC announced charges against 11 firms for “widespread and longstanding failures by the firms and their employees to maintain and preserve electronic communications.” Collectively, the firms acknowledged their conduct in violation of recordkeeping requirements, agreed to pay combined penalties of $289 million, and enhanced procedures to address the violations.
With average remediation above $48 million, it is clear that the SEC is sending a message. But the SEC has also approached this from the rulemaking side, adopting the October 11, 2022, amendments to the recordkeeping rules applicable to broker-dealers, as well as security-based swap dealers and major participants, modifying requirements regarding the maintenance and preservation of electronic records.
Advice to advisers
Retention and archiving
Pursuant to Rule 204-2(a)(7) advisers are required to retain original forms of all received written communications and copies of all written communications sent by members of the adviser. We have now grown accustomed to identifying written communications to include electronic communications such as emails, instant messages, text messages, and other forms of SMS (short message service) communications. As forms of electronic communications continue to develop, technology solutions to assist with the retention and archiving are also evolving.
Stay up to date with technology
In addition to making sure that all forms of firm-issued communications are being retained and archived, advisers must also stay up to date on the ever-changing landscape of technology and communication. As technology continues to evolve, we witness new forms of communication outside traditional channels such as WhatsApp, WeChat, and Telegram messages. Advisers must make sure that employees are not communicating securities-related business matters on unofficial channels where the records are not being archived.
Conduct reviews
Furthermore, advisers must also conduct reviews in order to identify potential violations of securities laws and firm’s policies and procedures. Those aforementioned technology solutions designed to archive can also assist with the review process. Technology has simplified the review and surveillance process for compliance officers, as most solutions offer random sampling options, keyword policies and searches, automated flagging processes, and system-generated reports.
Gone are the days of manually trudging through the mud of firm issued forms of communications to conduct and document reviews. The use of implementing technology will expedite the review process and simplify documentation. Most technology solutions will also provide automated reporting functions for compliance officers to document required periodic reviews of electronic communications.
Implement solutions to ensure compliance with recordkeeping requirements and federal securities laws
Simply having policies and procedures and prohibiting the use of personal devices and text messaging applications are not enough. Advisers must implement solutions to ensure compliance with recordkeeping requirements and federal securities laws.
As we have witnessed the evolution of communication, technology vendors have been working hard to develop solutions to keep up with rigors of regulatory recordkeeping requirements. Even the most advanced encrypted messaging applications are no match for solutions as they have developed the ability to archive messages, multimedia files, and even deleted messages.
Additionally, they have streamlined the process by developing the ability to upload archived content into firms’ existing electronic communications archives. Alternative communication archiving solutions can eliminate the headache of employees utilizing unconventional forms of communication and prevent potential enforcement actions.
Develop training
As we continue to witness case after case from the SEC, firms need to have a handle on how their employees conduct firm business. While the emphasis in cases has been on broker-dealers, these broker-dealers are routine partners for advisers and funds.
Where your business associates are receiving this level of scrutiny, it makes good sense for you to review your own firm, and employee practices. Ensure that firm policies and procedures regarding electronic communications are clear, periodically prompt for updates or new developments, and offer a channel to adopt new technologies and tools. Training should be designed to ensure that employees are well versed in the requirements, and compliance testing should be conducted to identify these behaviors.
Ji Kim is Director of Operations at SEC3. Throughout his career, he has developed a passion for combining compliance, technology, and operations to identify efficiency and efficacy within the financial services industry.
