On August 14, 2024, the Securities and Exchange Commission (“SEC”) announced a $392.75 million civil penalty settlement of charges against 26 broker-dealers, investment advisers, and dually-registered broker-dealers and investment advisers for failures to maintain and preserve electronic communications.[1]  Specifically, the enforcement actions related to “off-channel communications”—companies’ failure to maintain and preserve electronic communications on personal devices used by employees.  These settlements are the latest in a series of enforcement actions directed at these types of communications, demonstrating the SEC’s continued focus on failures to preserve business-related communications.[2]

Background

Rule 17a-4 under Section 17(a)(1) of the Securities Exchange Act and Rule 204-2 under Section 204 of the Investment Advisers Act require that broker-dealers and investment advisers maintain copies of certain electronic business communications among staff, and that they be able to produce these communications to the SEC upon request.

As we have written about previously, over the past few years, the SEC has brought enforcement actions for failure to apply these Rules to employee personal devices.  In December 2021, the SEC’s Division of Enforcement brought its first off-channel communications case against a broker-dealer.[3]  Since that time, the SEC has consistently filed off-channel communications cases against broker-dealers and dually registered broker-dealers and investment advisers.[4] However, in April 2024, the SEC announced for the first time charges and a settlement in an off-channel communications case against a stand-alone registered investment adviser.[5]

The SEC was likely slower to bring an enforcement action against a standalone investment adviser due to the differences in the recordkeeping obligations of the Rules under the Exchange Act and Investment Advisers Act.  Specifically, Rule 17a-4 under the Exchange Act applicable to broker-dealers requires all communications relating to the firm’s “business as such” to be preserved.  However, Rule 204-2(a)(7) under the Advisors Act requires investment advisers to maintain only four categories of written 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.

The Latest Settlements

The SEC’s most recent off-channel communication settlements are the second to include an entity operating as a stand-alone registered investment adviser.  The SEC noted that each of the investigations uncovered longstanding use of off-channel communications that were records required to be maintained, and that the failure to maintain such records deprived the SEC of these communications in its investigations.[6]

The firms were charged with violating the recordkeeping rules under the Exchange Act and/or Investment Advisers Act, as well as failure to reasonably supervise their personnel with a view to preventing and detecting those violations.  The penalties ranged from $400,000 to $50 million per firm.  The firms also agreed to implement improvements to their compliance policies and procedures, including by retaining a compliance consultant to address recordkeeping practices, policies and procedures, training and surveillance programs, and other items.[7]

Self-Reporting Benefits

The SEC’s announcement emphasized that three of the firms charged self-reported their violations and, therefore, were required to pay significantly lower civil penalties than they would have otherwise.  Specifically, the penalties for the self-reporting firms ranged from $1.6 million to $5.5 million.  Additionally, the orders for the self-reporting firms noted the proactive remedial efforts that the firms took, including retaining a compliance consultant, implementing enhanced surveillance capabilities and issuing firm-owned devices.[8]

Considerations for Investment Advisers and Broker-Dealers

These latest settlements demonstrate that off-channel communications remain a significant focus for the SEC enforcement division.  In light of the large fines and extensive remedial measures included in the recent settlements, firms should consider and review their existing off-channel communications policies and procedures.  Specific takeaways firms should note in light of this latest action regarding such communications include:

• Consider engaging internal audit departments and independent compliance consultants to provide comprehensive reviews of firm policies concerning electronic communications;
• Stand-alone registered investment advisors such as private equity firms and hedge funds should note the SEC’s continued attention and willingness to charge such entities;
• Entities should consult with counsel regarding the benefits of self-reporting upon the discovery of recordkeeping failures.