Fighting Over Off-Channel Communications
In 2021, when the SEC sued J.P. Morgan Securities LLC for its failure to preserve off-channel communications, the administrative order’s language suggested the Commission was pretty mad:
32. In none of the examples above did JPMorgan preserve the security [sic] business communications created by the text message, WhatsApp chat, or email communications in accordance with the requirements under the federal securities laws. This failure compromised and delayed Commission investigations.
33. Some of the text messages at issue were highly relevant to the Commission staff’s investigations. Further, JPMorgan is unable to account for when and which text messages were deleted.
34. By failing to search for, and produce, relevant text messages sent or received through unapproved communications methods and located on the personal devices of its employees, JPMorgan deprived the Commission of potential sources of evidence in various investigations, in addition to the ones described herein. Moreover, in the above matters, the Commission expended significant additional resources to investigate JPMorgan’s production failures which also delayed those investigations.
In 2024 (and in 2023 and 2022), the language is way milder. Here’s what it says in almost every case: “By failing to maintain and preserve required records relating to its business, ____________ likely deprived the Commission of these off-channel communications in various investigations.”
“Likely”?
One of the things we’ve wondered about these cases, most recently in a September 3 wave of cases filed against a bunch of credit rating agencies, was how did they get to “likely”? Did the Commission actually have various investigations that were impeded? Was it literally more likely than not? Did they find previously undiscovered documents on staff phones and run some searches to backtest the likelihood? Did the firms push back on this language? It seemed a little weird to us that the Commission was “likely” deprived of off-channel communications every single time.
But what else could B-Ds and IAs push back on in this area? Matt Levine seems skeptical of the SEC’s off-channel push in general – “You can’t do that, apparently,” he wrote last week – and he noted last year that Citadel might fight a similar effort in court if the SEC ever gets around to them. Advisers are in a somewhat better position than broker-dealers to litigate if they choose to, because their rule is more tightly cabined.
The Rules
SEC Rule 17a-4(b)(4) requires that broker-dealers preserve in an easily accessible place originals of all communications received and copies of all communications sent relating to the broker-dealer’s business as such. It’s broad.
We glossed over it in our last piece, but the rules treat investment advisers a little differently. For them, Rule 204-2(a)(7) requires that investment advisers preserve in an easily accessible place originals of all communications received and copies of all written communications sent relating to, among other things:
(a) any recommendation made or proposed to be made and any advice given or proposed to be given;
(b) any receipt, disbursement, or delivery of funds or securities;
(c) the placing or execution of any order to purchase or sell any security; or
(d) predecessor performance and the performance or rate of return of any or all managed accounts, portfolios, or securities recommendations.
It’s a little more narrow! Advisers don’t have to preserve every last communication relating to their “business as such.” The communications have to relate to one of those four things.
Room to Fight?
We’re less skeptical about the applicability of these general recordkeeping rules to off-channel communications than it sounds like Levine is. It’s a little weird that the rules now capture way more communications than they would have when they were first written so many decades ago. But so what? We wouldn’t feel that confident about litigating against the SEC on the core issue of whether covered communications needed to be retained and kept in an easily accessible place, etc.
But the penalties in these cases are pretty huge. Four firms paid $50 million each last month; Moody’s and S&P Global Ratings just got hit with $20 million each, and a 2022 batch saw $125 million penalties doled out to eight different firms. You might be able to get a better deal in an honest-to-goodness court. Especially if you could demonstrate that it wasn’t actually all that likely that the personal cell phones “likely deprived the Commission of these off-channel communications in various investigations.” Without a specific harm to the SEC’s investigations it seems like one of these firms might have an issue worth litigating. One of them could negotiate to the brink of settlement, and if the final number was too many tens of millions, they could wait to get sued in federal court instead. Does anyone think the penalty imposed there would be a significant multiple of the negotiated number? Of course, you’d have to have some lawyers ready to handle a complex trial. Anyway, it’s easy for us to say, which I guess is why we’re saying it.
In re J.P. Morgan Securities LLC (Dec. 17, 2021)
SEC Charges Six Credit Rating Agencies with Significant Recordkeeping Failures (Sept. 3, 2024)