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Recent reports indicate that the Securities and Exchange Commission (SEC) is turning its attention to Registered Investment Advisors (RIAs) and their oversight and record-keeping obligations related to employees’ use of “off-channel” communications.1 Given the significant penalties the SEC has already imposed on broker-dealers for similar violations, RIAs should take the time to ensure their policies and procedures are effective and should expect the SEC to review their communications practices with each review . We summarize the SEC’s recent enforcement actions below and recommend steps RIAs should take to ensure their practices stand up to SEC scrutiny.
- The Enforcement Measures. In September 2022, the SEC announced settled enforcement actions that imposed $1.1 billion in penalties on 15 broker-dealers and one affiliated investment advisor for violating certain recordkeeping requirements of the Securities Exchange Act of 1934 (the “Exchange Act”) in relation to their employees’ use of unauthorized communication channels (the “Handled Acts”).2 In each case, the companies had implemented policies and procedures that prohibited employees from using personal text messages or other platforms (e.g. WhatsApp) to communicate both internally and externally to conduct broker-dealer business. These policies and procedures addressed firms’ compliance with Rule 17a-4(b)(4) of the Stock Exchange Act, which requires brokers and dealers to keep records of all business-related communications. However, the companies failed to enforce these policies and procedures. Company employees, including executives and compliance officers, regularly communicated through prohibited channels to conduct company business. The companies were unable to keep records of the communications that took place on these prohibited channels and therefore could not comply with rule 17a-4(b)(4).
- RIA Record-Keeping Obligations and Associated Obligations.Like the broker-dealers in the Settlement Proceedings, RIAs are required to keep records of certain employee communications as required by Rule 204-2(a)(7) of the Investment Advisers Act of 1940. In its relevant part, Rule 204-2(a)(7) requires RIAs to make and keep a record of written communications relating generally to: (i) recommendations or investment advice; (ii) the receipt, payment or delivery of any monies or securities; and (iii) the execution of buy or sell orders. Rule 206(4)-7 requires RIAs to adopt and implement policies and procedures dealing, among other things, with record-keeping requirements under Rule 204-2. As a result, RIAs must prohibit employees from engaging in business-related communications on channels where adequate records cannot be kept, which could include personal text messages, social media, or other messaging applications (e.g., WhatsApp).
- Our recommendations. The settled lawsuits suggest that the SEC will carefully review the use of such off-channel communications applications and impose substantial penalties on RIAs for violating their record-keeping obligations. To mitigate the risk of a material breach, we recommend that RIAs ensure that: (i) their policies and procedures clearly identify authorized and unauthorized communication channels, including any appropriate exceptions; (ii) they have implemented systems to capture and retain communications on authorized channels which constitute required records; (iii) its CCO and compliance staff understand and have reasonable authority to enforce such policies and procedures; (iv) they have trained employees on those policies and procedures; and (v) they have enforced those policies and procedures and documented that enforcement.
1 See Private equity giants are the latest targets in SEC’s record-breaking investigations, The Wall Street Journal(November 8, 2022). A recent quarterly report filed by a reporting company that owns RIAs states: “[c]received from
[the Company’s] Investment Adviser affiliates have received requests for information and documents from the SEC in connection with an investigation regarding compliance with record-keeping requirements relating to business communications sent or received through electronic messaging channels. As has been publicly reported, the SEC is conducting similar investigations into other investment advisers.”
2 See The SEC indicts 16 Wall Street firms over widespread record-breaking failures (September 27, 2022).
Due to the generality of this update, the information provided herein may not be applicable in all situations and should not be relied on in particular situations without specific legal advice.
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