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Compliance Tips for Navigating Increased Regulatory Scrutiny

By April 29, 2022No Comments

Navigating Increased Regulatory Scrutiny: Compliance Tips for Investment Advisers

By Fizza Khan and Nicholas Nunez

The recent moves made by the U.S. Securities and Exchange Commission (“SEC”) indicate that enforcement actions will likely be on the rise in 2022 when it comes to recording and retaining electronic communications. This type of increased regulatory scrutiny could be especially problematic in today’s Covid-19 “new normal,” which has caused more advisers to work remotely and shifted the ways in which they communicate with clients and other third parties from traditional in-person meetings and phone conversations to electronic messages.

While there is no doubt that the watchful eye of the SEC will impact all types of investment advisers, those specializing in cryptocurrency could find themselves at greater risk due to their reliance on non-traditional forms of electronic communication to conduct business. However, regardless of their type or size, one thing remains very clear: firms that are unprepared could face steep penalties and continued inspection by regulators if their record keeping practices cannot withstand regulatory scrutiny.

Below is an overview of the new regulatory environment that all registered investment advisers are now facing, as well as some record keeping best practices that can help firms stay out of the crosshairs of the regulators.

What Does Increased Regulatory Oversight Mean for Investment Advisers?

In December of 2021, news broke that JP Morgan Securities LLC (JPMS), a broker-dealer subsidiary of JPMorgan Chase & Co., agreed to pay the SEC a $125 million penalty for “widespread and longstanding failures by the firm and its employees to maintain and preserve written communications” on mobile devices, messaging apps and personal emails, coupled with a $75 million fine to the Commodity Futures Trading Commission (“CFTC”). JPMS also agreed to implement “robust improvements to its compliance policies and procedures to settle the matter.”

The SEC released a press release about the matter, explicitly stating that recordkeeping remains a top priority for the Commission and that this will not be the last investigation that the SEC undertakes during its crackdown of Wall Street firms under the Biden administration.

While all investment advisers need to be paying closer attention to their books and records policies and practices, those specializing in cryptocurrencies need to stay particularly vigilant because of the way they trade and communicate with clients, service providers and counterparties. Whether it’s with respect to communications with foreign clients or investors, or with investment and trading platforms, firms operating in the crypto market are increasingly faced with the reality that such third parties prefer, or even require, the use of non-traditional communication channels such as WhatsApp and Telegram to conduct business rather than email and instant messaging (IM). Messages over these types of channels are often not captured on traditional archiving solutions because they simply lack the functionality to record these new communications platforms.

Making things even more challenging is the fact that the crypto market is already operating under a microscope in today’s regulatory climate. Once referred to as the “wild wild West” by Chair Gensler, actions like the recent $100 million fine BlockFi, a crypto start-up, signal that the SEC’s criticism of crypto continues to sharpen through 2022 and beyond, and firms operating in this space should take heed, specifically with regard to record keeping.

Books and Records Tips for Staying Compliant

Given the SEC’s razor-like focus on proper record keeping practices, it is readily apparent that any misstep could be detrimental to investment advisers that do not exercise caution. Firms of all types and sizes – and particularly those specializing in crypto – should be taking a hard look at their electronic record preservation systems, reporting abilities and related policies and procedures across the entire organization to ensure that they are compliant.

To help firms prepare and mitigate potential risks, below are some best practices to consider implementing when it comes to building an effective and successful electronic communications record and retention compliance policy:

  1. Make sure there is an inventory of all forms of electronic communications the firm is using. The firm’s compliance department should be aware of any and all forms of electronic communications the firm’s personnel is using; eliminate those platforms that cannot be archived or only used by a select few
  2. Capture all electronic communications, no matter what platform you are using. Utilize the traditional electronic communications archiving solutions (e.g., Global Relay, Smarsh) to its fullest extent to capture not only the firm’s email, but also WhatsApp, Telegram and other non-traditional communications apps
  3. Consider upgrading your archiving solutions. Supplement the above traditional archiving solutions with new archiving solutions to capture platforms they are missing, like TeleMessage to archive Telegram messages
  4. Take the guess work out of recording communications. To ensure all electronic communications are recorded appropriately, initiate the use of firm-issued devices and firm-specific accounts on the non-traditional communication apps (e.g., firm-issued cell phone with firm-issued WhatsApp account)
  5. Establish firm wide communication protocols and circulate to employees. Require all substantive business communication to be limited to firm-issued email and IMs

The regulatory landscape will continue to evolve and tighten under Chair Gensler, particularly when it comes to cryptocurrency. Investment advisers need to be buttoned up when it comes to compliance policies and protocols, especially with regard to electronic communications record keeping. Implementing the above best practices will help position investment advisers for success in the event of an investigation and mitigate the likelihood of an enforcement action.

 

Fizza Khan is CEO and Nicholas Nunez is Managing Director and Head of Regulatory & Compliance of Silver Regulatory Associates, a firm that provides Compliance & Risk, ESG and Due Diligence services for the investment industry.