The Securities and Exchange Commission is expanding its crackdown on finance firms’ use of private messaging apps like
The SEC earlier this month fined Senvest Management LLC, a New York hedge fund, $6.5 million. It was the first time the agency has brought a case as part of its messaging app enforcement against a standalone investment adviser.
The move comes amid similar crackdowns against banks — and even the SEC’s own employees last week, after the agency banned third-party messaging apps from work mobile phones.
It’s a harbinger of increased scrutiny around the records of private equity and hedge funds, which usually register with the SEC as investment advisers, attorneys say.
“This is not going to go away,” K&L Gates LLP partner Lance Dial said. “This is going to be a perennial priority for enforcement.”
Industry groups have told the SEC they’re uneasy about how the agency appears to view their obligations. They argue private funds shouldn’t be subject to the same requirements as banks.
Bloomberg News has reported the hedge fund Citadel is considering a legal challenge, if necessary, over the scope of record-keeping obligations.
“It’s an issue that has been raised to the staff in the context of investment advisers, and I think has been teed up to ask whether the obligations should be the same for both kinds of firms,” said Amy Jane Longo, a Ropes & Gray LLP partner and former SEC attorney.
Different Obligations
Senvest’s settlement resolved SEC charges that employees discussed company business over text messages and other unmonitored communication channels. The SEC alleged Senvest failed to maintain those communications.
The enforcement action is part of regulators’ multiyear crackdown on the financial industry’s use of messaging apps, collecting over $2.5 billion in fines from Wall Street banks.
The SEC, the Commodity Futures Trading Commission, and the Financial Industry Regulatory Authority have fined dozens of firms for use of private apps, which regulators say interferes with their ability to investigate misconduct and violates rules requiring broker-dealers “retain all communications” relating to their business.
But much of the enforcement actions have focused on banks, not investment advisers, which are subject to a different set of rules. The Advisers Act limits record-keeping requirements to certain categories of communications.
Last year, several trade groups for private equity and hedge funds including MFA, formerly known as the Managed Funds Association, and the Securities Industry and Financial Markets Association said they’d gotten wind that the SEC was seeking evidence of any off-channel business communications from various investment advisers.
“The SEC should not hold investment advisers to the broad recordkeeping requirements applicable to broker-dealers because the regulations, as written, do not require investment advisers to preserve all business communications,” the groups wrote to SEC Chair Gary Gensler. MFA and SIFMA declined further comment beyond the letter.
Perhaps cognizant of those concerns, the SEC in its recent case against Senvest referred to the Advisers Act requirements and said that a number of the problematic messages “related to matters within the scope of the Advisers Act.”
Unintended Consequences?
But the SEC also faulted Senvest for failing to implement procedures to monitor whether its employees were following the firm’s policies concerning work-related communications.
“While the settlement is styled as a record-keeping case in the SEC’s press release, the actual settlement order is ultimately principally about compliance violations and supervision breakdowns,” Peter Altman, an Akin Gump Strauss Hauer & Feld LLP partner and former SEC attorney, said.
That perhaps plays into a different critique industry groups have voiced.
The groups argue that many firms have policies that are broader than the legal requirements, and the SEC shouldn’t turn employees’ non-compliance into legal violations. They warn there could be unintended consequences.
“It will penalize advisers’ good faith efforts to promote compliance by adopting a broader internal requirement, and will incentivize firms to adopt policies that narrowly circumscribe recordkeeping obligations consistent with the statutory requirements, which will introduce subjectivity in interpreting enumerated categories under the rule,” the groups said in their letter.
No Legal Test
Meanwhile, the enforcement action doesn’t definitively answer questions about whether the SEC views broker-dealers and investment advisers as having the same record-keeping obligations, even though the laws governing them are different.
“The fact that none of these cases have litigated in the SEC context has limited our ability to really test what that difference ought to mean,” said Ropes & Gray’s Longo.
Such a test could be coming.
Bloomberg News has reported that Citadel is willing to take the agency to court if the regulator moves against the Miami-based hedge fund over allegations of untracked communications.
Other funds, including
In the meantime, observers expect investment advisers to be under the SEC’s microscope, and say that companies should develop clear policies for how people can communicate about work on personal devices.
“It’s clear from the settlement that the SEC isn’t going to let the more narrow scope of the Advisers Act record-keeping rule limit their inquires into whether or not advisers are using off-channel communications and creating records that should be maintained under the Advisers Act record-keeping requirements,” K&L Gates’ Dial said.
