- These enforcement actions underscore the importance of complying with registered entities’ record-keeping obligations, as the SEC has now settled with 19 investment banks and registered investment advisers for failing to maintain and preserve electronic communications.
- While the SEC touts the benefits of self-disclosure, these enforcement actions create uncertainty about the best approach, as self-reporting and non-self-reporting entities of similar size have faced comparable financial and non-financial penalties.
- Without specific guidance from the SEC on cooperation credit for self-reporting off-channel communications, broker-dealers and asset managers must carefully evaluate the risks and benefits of self-reporting in the current regulatory environment.
The Bottom Line
The Securities and Exchange Commission (SEC) today announced that it has settled charges against two broker-dealers for “widespread and longstanding failures” by both firms and their employees to maintain and preserve electronic communications. These settlements, the latest salvo in the SEC’s off-channel communications sweep, shed light on the crucial question of whether firms facing similar recordkeeping issues should self-report, given the potential benefits and drawbacks associated with this decision.
Enforcement Sweep and Encouraging Self-Reporting
These settlements follow a series of well-publicized enforcement actions by both the SEC and the Commodity Futures Trading Commission (CFTC) against large financial institutions for failing to implement and maintain proper controls for business-related communications. Starting with a December 2021 settlement for $200 million, and carrying through to late September 2022 settlements with 16 major financial institutions, the SEC and CFTC have sent a clear message that regulated entities must address any recordkeeping lapses regarding the use of personal devices and other unpreserved platforms (e.g., WhatsApp, personal email, etc.).
Throughout the sweep, the SEC has encouraged firms to self-report similar failures to the SEC. For example, in announcing the enforcement action in December 2021, Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, said the agency encourages registrants to “scrutinize their document preservation processes and self-report failures such as those outlined in today’s action before we identify them.” In September 2022, the SEC fined 16 banks a combined $1.8 billion for failing to monitor and preserve business-related communications. Describing recordkeeping requirements as “sacrosanct,” the SEC again urged broker-dealers and asset managers subject to the federal securities laws to “self-report and self-remediate any deficiencies.”
Until these recent announcements, the SEC press releases had not reported that any settling financial institution had self-reported.
Latest Cases Indicate Limited Impact of Self-Reporting
The benefit of self-reporting in these most recent settlements is difficult to discern, particularly when compared to the settlements in the SEC’s first wave of settlements. This point is illustrated by comparing the SEC’s recent settlement with one of the self-reporting institutions (Self-Reporting Firm) for $7.5 million, with the settlement by a broker-dealer that apparently did not self-report and settled with the SEC in September 2022 (Non-Self-Reporting Firm) for $10 million. The Non-Self-Reporting Firm’s broker-dealer business (as reported in its 2022 financial statements) is nearly double the size of the Self-Reporting Firm’s broker-dealer business. The SEC found that senior leadership of the Non-Self-Reporting Firm engaged in the use of off-channel communications, including senior supervisors responsible for implementing policies and procedures and for overseeing employees’ compliance with those policies and procedures. The SEC additionally found that from a sampling of more than 20 broker-dealer personnel, the Non-Self-Reporting Firm exchanged “tens of thousands” of off-channel communications. In contrast, a sampling of nearly twice as many broker-dealer personnel of the Self-Reporting Firm indicated that supervisors, but not senior leadership, exchanged off-channel communications. The Self-Reporting Firm also appeared to have exchanged fewer business-related communications, as the settlement refers only to “thousands” of such communications.
While the SEC found that the Non-Self-Reporting Firm likely failed to preserve records that were responsive to prior subpoenas and document requests, and did not make that finding with respect to the Self-Reporting Firm, the Self-Reporting Firm was charged nonetheless with the same violations of the federal securities laws. Finally, both the Self-Reporting Firm and Non-Self Reporting Firm were required to retain a two-year compliance consultant to review and assess the entity’s remedial steps relating to its recordkeeping practices, policies and procedures, related supervisory practices, and employment actions, notwithstanding the Self-Reporting Firm’s “significant remedial steps” prior to settlement.
That the Non-Self-Reporting Firm’s broker-dealer business is roughly double the size of the Self-Reporting Firm, and exchanged off-channel communications more frequently and at higher levels of authority, was assessed a penalty of only $2.5 million more than the Self-Reporting Firm raises questions about the advantages of self-reporting in this current sweep. The SEC has repeatedly encouraged broker dealers and asset managers to self-report any electronic communication lapses, going so far as to say such entities “would be well-served” in doing so. It is still the case, however, that the SEC does not require self-reporting as a general matter, and it has not indicated whether it will offer any form of cooperation credit—such as forbearance of or reduced fines—for self-reporting off-channel communications, as it has done in prior self-report initiatives. If these most recent settlements are benchmarks for future settlements involving self-reporting institutions, it appears that any benefit from taking such measures is limited, particularly given the penalty imposed on both self-reporting institutions and the costs associated with retaining a compliance consultant for a period of two years.
While the SEC has encouraged self-reporting, the benefits of doing so remain ambiguous, with both self-reporting and non-self-reporting firms facing similar penalties and compliance requirements. Given the lack of clarity, broker-dealers and asset managers are left to weigh the potential risks and benefits of self-reporting in the current enforcement landscape. It is crucial for these institutions to carefully review their recordkeeping practices and assess whether self-reporting is the most strategic choice in light of the ongoing regulatory scrutiny. Ballard Spahr attorneys in the Securities Enforcement and Corporate Governance Litigation Group and White Collar/Internal Investigations Group have experience in assisting entities and individuals in navigating these issues. Please contact us for more information.
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