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On Friday, February 9, 16 firms, including five broker-dealers, and seven dually registered broker-dealers and investment advisers, were fined a combined $81m by the SEC to settle charges that they failed to maintain and preserve electronic communications.
Northwestern Mutual, Guggenheim Securities and Cambridge Investment research are some of the firms that have failed to comply with recordkeeping requirements. These firms follow on the heels of major banks such as Wells Fargo and UBS that were fined in 2023 for record amounts.
Nikki Brinkerhoff, Chief Compliance Officer at TradeStation Securities, said: “Unfortunately for most of these firms, even if they had taken steps to remediate, the regulators were already on the path of examinations.”
Starting with the JP Morgan matter from 2021, the SEC openly telegraphed to firms that they were expected to evaluate their controls and self-report their findings, she said.
“Although JP’s matter stated from 2018 forward, most of the current matters use the statement “From at least (fill in the year)” and many start in 2019,” she added.
According to Brinkerhoff, for these types of communications, it becomes very expensive and time consuming to keep up with the rapid change in platforms.
“Registered entities in the US have to adjust their controls and evaluate their policies including their Bring Your Own Device(BYOD) policies consistently,” she told Traders Magazine.
For example, she said, in 2011, Whatsapp was one of the top 20 apps in the U.S. Apple Store, however, by 2013 it had grown to 200 million active users.
“In the Apple App store today there are almost 200 apps. That rapid growth in multiple ways to communicate through electronic methods is very difficult to keep up with,” she stressed.
Brinkerhoff said that if companies have invested in a tool to capture electronic communications, then it’s not hard to monitor the identified communications.
“However, the challenge is the users ability to use many different communication platforms and the continued growth of these types of platforms,” she said.
According to Chip Jones, EVP of compliance at Global Relay, broker-dealers have been using off-channel (primarily texting) communications for years.
“Texting has surpassed email as the primary choice for electronic communications,” he said.
Jones said that the use of text communications expanded dramatically during the pandemic when workers were forced to work remotely.
“The problem is that the vast majority of broker-dealers had policies prohibiting text messages because the firms did not have systems to capture and supervise the communication,” he stressed.
“It was the policies prohibiting business texts that led to the enormous fines by the SEC – broker-dealers were blatantly violating their own supervisory policies,” he added.
“Once the SEC uncovered this practice at JP Morgan, it was easy to establish a sweep to continue to find other broker-dealers doing the same thing,” Jones said.
It is not hard to monitor, he added, giving an example of their Global Relay App that allows users to communicate via text and have those texts captured in the firm’s archive for supervision purposes.
Meanwhile, Audrey Costabile, Senior Analyst in the Market Structure and Technology team at Coalition Greenwich, has a different view, saying that it’s “exceptionally difficult to monitor”.
“According to our recent study Federated Business Communications: The Only Path Forward, findings reveal adoption is low, particularly in some areas of capital markets,” she said.
Costabile added that while the study focused on a specific sub-set of firms, themes are consistent throughout the industry: (1) more and different types of communications channels are being used (e.g., chat, instant message, email, voice, and so on) – while most firms in our study use up to five channels, some respondents had over 20, (2) at least some of these channels are decentralized and non-standard which means each one needs to be monitored for compliance and record-keeping in channel-specific ways, (3) security concerns have grown in recent years with various types of working arrangements (e.g., work from home, hybrid) and differing data types, (4) centralization is happening – the majority of participants in our study are using centralized business communications platforms, however, communication tied to some products and asset classes are being incrementally centralized over time rather than all at once, opening the firm to risk.
Costabile further said that their study findings reveal SEC fines have had an impact on a broader range of firms – particularly asset managers.
“Fines resulting from record-keeping lapses in the surveillance of unauthorized channels, for instance, have caught the industry’s attention,” she said.
According to Costabile, roughly half of participants intend to invest in a single communications interface at some point, with the UK- based firms pushing the hardest to achieve definitive timelines for implementation.
These record setting fines by the SEC have sent shockwaves through the financial services industry, Jones added.
Broker-dealers, investment advisers and others regulated by the SEC, CFTC and FINRA have all been put on notice at this point, that regardless of their regulated entity, they should consider their text communications strategy, he noted.
“Every regulated firm at this point has seen and read about these enormous fines and is reviewing and discussing how to handle them moving forward,” he said.
Staying Compliant
Jones believes that most broker-dealers have come to the realization that prohibiting text communications is not a sustainable policy.
The vast majority of broker-dealers at this point have either adopted or are evaluating compliant services that capture and allow for the supervision of text messages, he said.
“Broker-dealers now understand that they have to step up and fund a compliant solution to capture and supervise text messaging,” he added.
Costabile said that to remain compliant going forward, firms should adopt compliant record-keeping of business communications channels. “Investment in a flexible, built-for-purpose system is a clear goal and is viewed as a competitive differentiator amongst participant firms,” she commented.
Brinkerhoff agreed, saying that without individual accountability of the Registered Representative (RR), any firm will have difficulty maintaining the controls for the rapid evolution in electronic communications.
She added that there was a time, where employees and RRs were expected to have two separate phones – one for personal use and one for work.
According to Brinkerhoff, the rapid development in this space will continue to be a challenge for many firms.
“The SEC is still conducting these risk based exams. I would expect we will see more of these fines that will be for the same time period and be across the BD and Investment Advisor space,” she said.
“You may also want to note that the same type of fines are being issued by the CFCT for the same type of conduct. Most of these firms will pay for both the BD activities and the Futures even though they are dual registrants,” she concluded.
