In what feels like a now well-established pattern for the finance industry, the Securities and Exchange Commission (SEC) has announced charges against 26 firms for widespread recordkeeping failures related to off-channel communications, with associated fines totaling more than $390 million.
Failure to comply
The SEC’s charges against “26 broker-dealers, investment advisers, and dually-registered broker-dealers and investment advisers” relate to “widespread and longstanding failures by the firms and their personnel to maintain and preserve electronic communications.” By failing to meet the SEC’s recordkeeping requirements, firms violated “certain recordkeeping provisions of the Securities Exchange Act, the Investment Advisers Act, or both,” and were also found to have failed to “reasonably supervise their personnel with a view to preventing and detecting these violations.”
Investigations uncovered “pervasive and longstanding use of unapproved communication methods, known as off-channel communications” at all 26 firms, with personnel sending and receiving communications “that were records required to be maintained the securities laws.” Failing to maintain or preserve necessary records “deprives the SEC of these communications in its investigations” and, concerningly, the violations included staff “at multiple levels of authority, including supervisors and senior managers.”
Interestingly, as well as facing fines for recordkeeping rule failures, all of the firms were also charged with failure to “supervise their personnel” with a view to preventing or detecting instances of off-channel communications.
The total penalties levied are a combined $392.75 million, with the highest individual fines ranging as high as $50 million and the lowest at $400,000. The fines underscore how the SEC’s focus has shifted away from its original targets of large investment banks to broker-dealers and investment advisers. Each firm has been ordered to cease and desist from future violations of relevant recordkeeping provisions and has been censured, and firms “have begun implementing improvements to their compliance policies and procedures” to prevent repeat violations.
Gurbir Grewal, Director of the SEC’s Division of Enforcement, said in summary:
“As today’s enforcement actions against more than two dozen firms reflect, we remain committed to ensuring compliance with the books and records requirements of the federal securities laws, which are essential to investor protection and well-functioning markets.”
Seen it all before
If the details and scope of the SEC’s action feel all too familiar, it’s because they are. In September 2022, the SEC charged 16 Wall Street Firms for recordkeeping failures relating to off-channel communications, with fines totaling $1.1 billion. In December 2021, the regulator charged JPMorgan $125 million for failing to ensure that communications were being captured and records kept. Again, in August, 2023, the commission levied charges against 11 Wall Street firms for widespread recordkeeping failures related to “pervasive and longstanding” off-channel communications failures.
The ‘off-channel communications crusade’ isn’t solely being enacted by the SEC. In June, 2024, the Financial Industry Regulatory Authority (FINRA) fined a securities firm $500,000 for its failure to “preserve, and reasonably supervise, business-related text messages,” and we have seen regulatory activity from the Commodity Futures and Trading Commission (CFTC, in tandem with SEC fines against the same firms) and U.K. energy regulator Ofgem against firms for recordkeeping violations related to off-channel communications.
The message from regulators is coming in loud and clear – firms need to meet recordkeeping obligations, and control communications effectively, because these requirements are still firmly at the top of regulatory agendas.
Cooperation = mitigation
Grewal’s summary highlighted that “three firms received credit for self-reporting and will pay reduced civil penalties”:
“Among this group of firms, there are several that differentiated themselves by self-reporting prior to the staff’s investigation, demonstrating once again the real benefits of proactive cooperation.”
This has reinforced Grewal’s view that early, proactive, and substantive cooperation with regulators leads to better outcomes for firms. This has been lent further weight by the CFTC’s filings against one of the 26 firms in the SEC’s action. The CFTC’s order finds that this firm:
“Self-reported [and] proactively conducted a review of the use of unapproved communications methods by its employees.”
The order “recognizes [the firm’s] self-report, its substantial cooperation with the Division of Enforcement’s investigation, and remediation in the form of a substantially reduced penalty.” CFTC Director of Enforcement, Ian McGinley, highlighted that:
“In responding to an industry-wide and consequential problem, [the firm] set itself apart from the more than 20 other registrants the CFTC brought actions against for use of unapproved communications methods.”
McGinley also notes that said firm was “the only registrant” to self-report to the CFTC, resulting in it being singled out for a reduced penalty. However, his summary also highlights that compliance beats contrition:
“The CFTC’s message remains clear—recordkeeping and supervision requirements are fundamental, and registrants that fail to comply with these core obligations do so at their own peril.”
The cost of doing business?
Interestingly, there were signs that firms were bracing for the SEC enforcement action before it was announced – something that seems to be happening with increasing regularity across the industry as the pace of recordkeeping enforcement continues.
Reports indicate that some of the 26 firms in the SEC’s action were setting aside sums as large as $50 million as early as February 2024, in anticipation of settling potential enforcement actions, communicating these measures were to “cover potential liability” in legal disclosures. Similar patterns have been noted, with firms including Blackstone, TPG, and Carlyle Group disclosing SEC probes in their respective securities filings, setting aside sums to cover potential liability from regulatory enforcement actions.
What is interesting here is that, by declaring that they are involved in potential SEC investigations and enforcement activity months ahead of any regulatory announcements, firms are making their involvement somewhat of an open secret. Setting aside considerable sums almost as an insurance policy against being found to have violated regulations, and subsequently fined, begs the question – is this now part of the expected ‘cost of doing business’ for firms struggling to get a handle on off-channel communications within their organization?
With both the SEC and CFTC making it abundantly clear that their continuing crackdown on off-channel communications will not let up any time soon, and the broadening scope of investigations now including a wider range of firms, organizations will be reassessing their policies and procedures, and making sure they have the right tools in place to capture and archive their business communications – and stay on the right side of recordkeeping requirements.
—————–
Substantial research for this blog was performed by Aarti Agarwal
