SEC Sues Adviser for Failing to Keep Required E-mails
Is this what the SEC meant when they promised us e-mail guidance?
For the first time, the SEC has sued an adviser under the Advisers Act books and records rule for failing to maintain required e-mails. The SECís June 15 order against Charlotte, North Carolina-based Banc of America Investment Services (BAI), a dually-registered adviser and broker-dealer, is a stand-alone e-mail records case, alleging no additional bad acts. However, the SECís order stated that the alleged e-mail retention deficiencies were discovered during the course of an SEC investigation. "Weíre not commenting on what the underlying investigation is," said Lawrence West, associate director in the SECís Division of Enforcement.
The case against BAI is significant for a number of reasons:
First, the case does not imply that the adviser should have kept all e-mails; instead, the adviser was charged with failing to keep only those e-mails that are communications specified by Rule 204-2(a)(7). The SEC alleged that the adviser "failed to keep in any easily accessible place for a period of five years, and/or to preserve in an appropriate office for a period of two years, true, accurate, and current written communications relating to recommendations made, advice given or proposed to be given; receipt, disbursement or delivery of funds or securities; and the placing or execution of orders to purchase and sell securities as required by Rule 204-2." Specifically, the order references Rule 204-2(a)(7) and 204-2(e)(1). Somewhat troubling, however: the SECís actual finding under the "Advisers Act Violations" section of the order more broadly states that BAI violated Rule 204-2 by failing to keep e-mails "related to its investment advisory business" ó thatís a broader standard than whatís set out in Rule 204-2(a)(7).
Second, the case does not imply that the adviser should have kept internal e-mails.
The SEC charged the firmís affiliated broker-dealer, BACAP Distributors, with related violations of the Exchange Actís recordkeeping provisions. In doing so, the SEC noted that BACAP did not keep internal e-mails. However, the SEC did not reference internal e-mails when discussing allegations against the adviser. The distinction in the SECís order appears to be drawn largely from the differences in the two rules: the Exchange Act recordkeeping rule contains a parenthetical referencing internal e-mails; the Advisers Act rule does not. Hence, in noting the firmsí alleged violations, when discussing the broker-dealer rule the failure to keep internal e-mails was noted; when discussing the adviser rule, it was not.
Apparently, however, we shouldnít read a whole heck of a lot into that particular tea leaf.
"In my opinion, this case does not provide any meaningful insight on the Commissionís expectations surrounding an adviserís obligation to maintain internal communications that relate to recommendations or advice," said Investment Adviser Association associate general counsel Caroline Schaefer.
The SEC folks concurred. "We werenít trying to say one way or the other whether internal e-mails have to be maintained," said Kenneth Lench, an assistant director in the SECís Division of Enforcement. And SEC Division of Investment Management chief counsel Douglas Scheidt told IM Insight that he agreed that the case was not intended to provide guidance to advisers on the internal/external e-mail issue.
Third, the case confirms that relying on back-up tapes that are overwritten will not pass regulatory muster. The SEC alleged that the adviser "lacked adequate systems and procedures for the preservation of electronic mail communications." Prior to June 2001, it said, the firm relied on backup tapes and other media that generally were recycled or overwritten every 90 days.
Fourth, the case sends the message that that buying an e-mail retention solution from a vendor is not enough: you have to know how to use it and make sure it works. According to the SEC, beginning in June 2001 the adviser relied on an unnamed "software system" that was "designed to permit supervision of electronic mail communications, as well as retention of such communications." According to the SEC, the firm did not put adequate systems and procedures in place to ensure that the system was implemented properly. The SEC alleged that the firm failed to ensure that the software was capturing "all" e-mails "for the required employees and associated persons."
That reference to "all" e-mails might give you pause. However, as discussed above, the SEC seemed to be focusing on e-mails required to be maintained under Rule 204-2(a)(7).
Fifth, the case highlights the importance of collecting e-mails from all relevant employees (notwithstanding SEC staff statements that perhaps it is not necessary to collect e-mails from groups of employees unlikely to be sending communications covered under Rule 204-2). The SEC alleged that when the firm hired new employees, or transferred employees to different locations with a different computer server, the firm "often did not take steps to ensure" that the software captured those individualsí e-mails. "Although Respondents knew that the software system had not retained [e-mails] for all required employees and associated persons, Respondents did not adequately address the deficiencies in their administration of the software system to ensure retention of [e-mails]," the SEC alleged.
And what, pray tell, was that unnamed software solution? "No comment," said a Bank of America spokesperson.
To settle the SECís action, BAI agreed to pay a civil penalty of $1 million. BACAP agreed to pay $500,000. Both firms agreed to review their e-mail preservation procedures for compliance with applicable federal, state, and SRO laws.
"We cooperated fully with the regulators on this inquiry and weíre pleased to have this issue behind us," said the spokesperson. "Both BAI and BACAP took steps to address the issue as soon as it was identified, and we continue to strengthen our e-mail retention policies and procedures."
One law firm partner described it as "disturbing" that the SEC would bring a case against an adviser for e-mail retention "based solely on speeches by the senior staff, without anything in writing anywhere by the Commission, its staff, or even a summer intern." The SEC staff has been promising e-mail guidance "for well over a year now," he noted.
And guidance is needed. The case, said the partner, "is ambiguous as the rule."
Schaefer concurred. In her view, the case highlights the need for the SEC to clarify the scope of advisersí obligations to retain information under the books and records rule. She noted that, at one point, the order seemed to blur the distinction between BDs and IAs by suggesting that an adviser is required to keep e-mails related to its "business as such" (an adviser has no such duty). "The order illustrates the confusion that has surrounded issues related to the retention of electronic communications over the last two years and the importance of clarifying the Commissionís expectations with an adviserís current legal requirements," she said.
And where is that long-awaited e-mail guidance? Speaking generally, Scheidt said (via e-mail): "The regime change that we are going through has had an effect on the timing of many projects."