Electronic messaging creating compliance challenges for investment firms

Broker-dealers and investment advisers must mitigate regulatory risks posed by modern communication channels

In an industry, such as financial services, that is continually impacted by the fast-paced evolution of technology, staying abreast of regulatory requirements related to these changes is an ongoing challenge. One such example is the industry-wide concern tied to the continuous evolution of electronic communications channels.

Broker-dealers and investment advisers are faced with the need to stay up to date on these advancements while also complying with supervisory and recordkeeping requirements. Adding to the challenge is balancing these requirements against the convenience and increasing reliance on mobile devices.

Along with staying up to date, firms should also conduct risk assessments to identify how the use of mobile devices and the increasing availability of various communication channels impact their business; identify potential regulatory gaps; and determine whether there is a need to offer alternatives that align with the regulatory requirements. If not mitigated, this risk may result in regulatory actions that include monetary penalties.

The Securities and Exchange Commission (SEC), in a joint effort with the Commodity Futures Trading Commission (CFTC), levied combined penalties totaling $1.1 billion against 15 major broker-dealers and one investment adviser for failure to maintain and supervise business-related communications. The SEC and CFTC found that both upper and lower-level employees were engaging in business-related communications via text messaging apps that were not maintained in the firm’s record retention protocols and not reviewed pursuant to the firm’s supervisory procedures.

Regulators increasing focus on ‘off-channel’ communications

The requirements for broker-dealers and investment advisers to create, maintain, and supervise business communications are not new.

The SEC’s books and records rules (which is closely mirrored by FINRA rules) essentially require that, for record retention purposes, these institutions must maintain business communications. As such, every firm that intends to communicate, or permit its associated persons to communicate, with regard to its business through a text messaging app or chat service must first confirm that it can retain records of those communications as required by the rules. Further, these institutions must capture and maintain business-related communications in such a way that it can review them for inappropriate business conduct and fulfill the supervisory rule requirements.

What is fairly new, however, is the regulators’ interest in “off-channel” communications and the difficulties it poses in the regulators’ mission to investor protection and ensuring market integrity. These off-channel communications can impede regulators’ ability to conduct examinations and investigations by making it difficult for broker-dealers and investment advisers to capture and provide such communications to regulators when requested.

A powerful, yet simple tool used by the regulators when investigating alleged misconduct is looking at correspondence, including “what was said,” “how it was said,” “when it was said,” and “who said it.” If a broker-dealer or investment adviser cannot produce these required communications, it could adversely impact the regulator’s ability to examine the financial institution’s compliance with its rules and regulations. Therefore, it’s not surprising that regulators appear to be ramping up enforcement actions against firms that fail to comply with the various SEC and CFTC regulations that mandate the supervision and retention requirements of business communications.

During the Hot Topics Lightning Round segment of the SEC’s November 2022 Compliance Outreach Seminar, Zachary Sturges, senior counsel with the SEC’s Enforcement Division, shared a few important takeaways about electronic communications compliance. Sturges said this is a large-scale industry-wide problem and that “a substantial number of broker-dealer and investment adviser personnel have been routinely using off-channel communications to carry out their work functions.”

Sturges also stated that this “pre-dated COVID” and he believes it “reflects how contemporary professionals, both in finance and other businesses, communicate.”  In addition, Sturges reminded the audience that “this type of misconduct is relatively simple to prove.”

Based on recent actions and comments by regulators about electronic business communications, compliance in this area appears to be an ongoing area of focus that will continue into 2023 and beyond.  Another indicator of the regulators’ focus on business communication is the October 2022 SEC approval to adopt rule amendments designed to modernize the recordkeeping requirements given technological changes over the last two decades and to make the rule adaptable to new technologies in electronic recordkeeping. These rule changes allow broker-dealers to use new methods (e.g., cloud computing) to comply with record retention requirements that may reduce compliance costs.

Take steps to mitigate business communications compliance risk

While planning for emerging regulatory risks such as electronic messaging may be more challenging, it is possible – and necessary. Kaufman Rossin’s regulatory compliance team can help your firm conduct a risk assessment, identify gaps, if any, and recommend practical solutions to help mitigate identified issues. Kaufman Rossin can help you evaluate the right approach for your business needs, recommend updates to your policies, procedures and controls, recommend solutions to facilitate compliance with retention and supervision requirements, and train your staff.

Contact us to learn more about SEC and FINRA rules related to electronic business communications and how Kaufman Rossin can help your business stay in compliance.