A Long Winter's Nap? SEC Off-Channel Communications Enforcement May Draw to a Close
The SEC's wave of enforcement actions concerning "off-channel" communications did not abate in 2024. In total, the SEC announced more than 70 firms agreed to pay more than a half-billion dollars combined to settle charges for recordkeeping failures, including the first enforcement actions for recordkeeping violations against municipal advisors. In this penultimate installment of Season's Readings, we take a look at what drove these settlements this year and what may happen to the so-called "WhatsApp initiative" once there is a new driver at the SEC Division of Enforcement's helm.
Background
Rule 17a-4(b)(4) of the Securities Exchange Act of 1934 (Exchange Act) generally obligates exchange members and registered broker-dealers to maintain originals of all communications received and copies of all communications sent by them in an easily accessible format. Registered investment advisors are subject to similar, albeit narrower, record retention requirements under Rule 204-2(a)(7) of the Investment Advisors Act of 1940 (Advisors Act).
In 2021, the SEC and U.S. Commodities Future Trading Commission (CFTC) began investigating financial institutions' off-channel communications and, specifically, text and instant messages sent and received by employees on their personal devices. Since then, over 100 entities – including broker-dealers, investment advisors, municipal advisors and credit rating agencies – have been charged with violations of the recordkeeping requirements under the Exchange Act and Advisors Act and paid more than $3 billion in civil penalties.
Civil Penalties Continued to Rack Up in 2024
The SEC did not slow down with its investigations in 2024, announcing that it remains committed to ensuring compliance with the recordkeeping requirements under the federal securities laws, which are "essential to investor protection and well-functioning markets." For the year, the SEC charged over 60 firms with recordkeeping violations and obtained civil penalties totaling more than $560 million combined.
The range of civil penalties assessed in 2024 varied greatly, from $50 million on the high end to less than $50,000 on the low end but in all were generally lower than in prior years, when the largest penalties reached $200 million. In one violation instance this year, no civil penalty was assessed.
The largest penalties were assessed against firms that admitted that their personnel – including supervisors and senior managers – sent and received off-channel communications that were required to be maintained but that were not maintained or preserved, depriving the SEC of its ability to review the communications in its investigations. In some instances, the SEC also charged certain firms with failing to reasonably supervise with a view of preventing and detecting recordkeeping violations. The SEC explained that "widespread and longstanding" noncompliance, especially failures that potentially hindered the SEC's investor protection function by compromising a firm's response to SEC subpoenas, may result in "robust" civil penalties.
On the other hand, firms that self-reported and cooperated with the SEC's investigations generally received significantly reduced penalties. For example, according to the SEC, the firm that received a no-penalty resolution took "substantial steps to comply" with the recordkeeping requirements and self-reported, cooperated and remediated its violations.
In a Nov. 6, 2024, speech, the new acting director of Enforcement, Sanjay Wadhwa, touted the success of what he dubbed the "WhatsApp initiative" and explained some of the factors that Enforcement considers when assessing what penalties to recommend, if any, including: the size of the firm, the scope and scale of the violations, precedent, compliance efforts, self-reporting and other remedial measures. As Wadhwa explained, the initiative from his perspective "shone a light on how widespread noncompliance was" and that "the best measure of success of the initiative is how it has changed industry behavior and spurred proactive compliance by market participants."
What's in Store for 2025?
The expectation is that the SEC will greatly reduce, if not end entirely, its investigations into off-channel communications once the new administration takes over on Jan. 20, 2025. Indeed, two of the five SEC commissioners, Hester Peirce and Mark Uyeda, issued a statement on Sept. 24, 2024, urging their colleagues to "reconsider our current approach to the off-channel communications use" because the use of such communications is prevalent and, thus, "even well-intentioned firms could find themselves in the Commission's queue time and time again." Accordingly, they have called for the SEC to work with the industry and public to develop a "pragmatic and privacy-respecting approach" that allows the SEC and firms to maintain the records that they need "at a reasonable cost in both financial and privacy terms." Additionally, Paul Atkins, the nominee who is expected to replace outgoing Chair Gary Gensler, has generally called for an overhaul of the SEC's enforcement approach and has specifically identified the off-channel communications investigations as an area where the SEC has pushed the envelope.
Given the above, at a minimum, it appears that the SEC's ongoing off-channel communications sweep may be coming to an end, along with the hefty civil penalties relating to recordkeeping violations that came with it. Time will tell.