SEC Targeting RIAs for Use of “Off-Channel” Communications

Recent reports indicate that the Securities and Exchange Commission (SEC) is increasing its attention on registered investment advisers (RIAs) and their oversight and recordkeeping responsibilities related to employees’ use of “off-channel” communications.[1] Given the significant penalties that 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 scrutinize their communication practices during any examination. We summarize the SEC’s recent enforcement actions below and recommend steps RIAs should take to ensure their practices withstand SEC scrutiny.  

• The Enforcement Actions. In September 2022, the SEC announced settled enforcement actions imposing $1.1 billion in penalties against 15 broker-dealers and one affiliated investment adviser for violating certain recordkeeping provisions of the Securities Exchange Act of 1934 (the “Exchange Act”) relating to their employees’ use of unauthorized communication channels (the “Settled Actions”).[2] In each case, the firms had adopted policies and procedures that prohibited employees from using personal text messaging or other platforms (e.g., WhatsApp) to communicate both internally and externally to conduct broker-dealer business. These policies and procedures addressed how the firms would comply with Rule 17a-4(b)(4) under the Exchange Act, which requires broker-dealers to maintain records of all business-related communications. However, the firms failed to enforce these policies and procedures. The firms’ employees, including executives and compliance personnel, regularly communicated through prohibited channels to conduct firm business. The firms lacked the capability to capture records of the communications that occurred on these prohibited channels and thus could not comply with Rule 17a-4(b)(4).
• RIA Recordkeeping and Related Obligations. Like the broker-dealers in the Settled Actions, RIAs must retain records of certain employee communications, as set forth in Rule 204-2(a)(7) under the Investment Advisers Act of 1940. In relevant part, Rule 204-2(a)(7) requires RIAs to make and keep records of written communications generally relating to: (i) any recommendation or investment advice; (ii) the receipt, disbursement or delivery of funds or securities; and (iii) the execution of any purchase or sale order. Rule 206(4)-7 requires that RIAs adopt and implement policies and procedures that address, among other things, the recordkeeping obligations under Rule 204-2. Consequently, RIAs must prohibit employees from engaging in business-related communications on channels where adequate records cannot be kept, which could include personal text messaging, social media, or other messaging applications (e.g., WhatsApp). 
• Our Recommendations.  The Settled Actions suggest that the SEC will carefully evaluate the use of such off-channel communication applications and may impose significant penalties on RIAs for violations of their recordkeeping obligations. To mitigate the risk of a significant violation, we recommend that RIAs ensure that: (i) their policies and procedures clearly identify authorized and unauthorized channels of communications, including any appropriate exceptions; (ii) they have implemented systems to capture and retain communications on authorized channels that constitute required records; (iii) their CCO and compliance personnel understand these policies and procedures and are sufficiently empowered to enforce them; (iv) they have trained employees on these policies and procedures, and (v) they have enforced these policies and procedures and documented such enforcement. 

If you have any questions about this topic, please contact a member of MoFo’s Investment Management team.

[1] See Private-Equity Giants Are Latest Targets of SEC’s Record-Keeping Probes, The Wall Street Journal (Nov. 8, 2022). A recent quarterly report filed by a reporting company that owns RIAs states that: “[c]ertain of [the Company’s] investment adviser subsidiaries have received a request for information and documents from the SEC in connection with an investigation concerning compliance with record retention requirements relating to business communications sent or received via electronic messaging channels. As has been publicly reported, the SEC is conducting similar investigations of other investment advisers.”

[2] See SEC Charges 16 Wall Street Firms with Widespread Recordkeeping Failures (Sept. 27, 2022).