Summary
The Securities and Exchange Commission (SEC) is reportedly nearing a settlement with a nationally recognized statistical rating organization (NRSRO) over its failure to preserve certain credit-ratings communications sent through unapproved electronic messaging channels. This suggests that all regulated entities with similar recordkeeping requirements should anticipate heightened scrutiny in this area, regardless of the nature of their business.
The Upshot
- The SEC’s enforcement action against the NRSRO signals the expansion of the off-channel communications sweep to regulated entities beyond broker dealers and registered investment advisers.
- This move is in line with the SEC’s promise to continue “its efforts to enforce compliance with the Commission’s essential recordkeeping requirements.” These efforts have already led to the collection of nearly $2 billion in fines through settlements with nearly two dozen registered entities.
The Bottom Line
It is imperative for these entities to proactively evaluate and, where necessary, improve their recordkeeping practices to ensure compliance.
On July 28, an NRSRO disclosed that it had received a Wells notice from the SEC, signaling a preliminary decision to recommend an enforcement action against the company. This notice stems from an ongoing SEC investigation into the NRSRO’s credit rating subsidiary’s recordkeeping practices, namely its “compliance with recordkeeping requirements for certain credit ratings-related communications sent over unapproved electronic messaging channels.”
As discussed in prior alerts (see here), the SEC has long been interested in the use of off-channel communications. On October 6, 2021, Gurbir Grewal highlighted this area as a compliance priority in his first public speech as the Enforcement Director. Grewal outlined two significant concerns regarding registrants engaging in business-related communications outside of their firm’s approved channels, a practice he referred to as “off-channel communications.” First, Grewal suggested that the practice may violate registrants’ recordkeeping obligations, which are essential to market integrity and enforcement. Second, he warned that off-channel communications could potentially hinder SEC investigations. Grewal revealed that the SEC staff had observed, during multiple investigations, instances where entities failed to retain and produce these off-channel communications. This failure was seen to cause unnecessary delays and obstructions in the investigations. After that speech, the SEC initiated a broad sweep which has resulted in the collection of nearly $2 billion in fines from settlements with almost two dozen registered entities.
The NRSRO’s disclosure represents a significant development in the ongoing sweep, as it would be the first settlement with an entity other than a broker-dealer or registered investment adviser (RIA). It signals the expansion of the sweep to other types of regulated entities with broad recordkeeping requirements, akin to those of broker-dealers and RIA's which have been the prior focus of the sweep.
The NRSRO in question faces a potential enforcement action alleging violations of Rule 17g-2, a regulation governing the records to be maintained and retained by NRSROs. This includes all communications, including electronic communications, “received and sent by the nationally recognized statistical rating organization and its employees that relate to initiating, determining, maintaining, monitoring, changing, or withdrawing a credit rating.”
Other entities regulated by SEC recordkeeping rules, including national securities exchanges, national securities associations, registered clearing agencies, and municipal advisors, are also required to preserve all forms of written communications under rules such as 17a-1 and 15Ba1-8. Under Rule 17a-1, national securities exchanges, national securities associations, registered clearing agencies and the Municipal Securities Rulemaking Board must maintain all correspondence “relating to its business as such and in the conduct of its self-regulatory activity.” Under Rule 15Ba1-8, municipal advisors must keep and maintain “all written communications received, and originals or copies of all written communications sent, by such municipal advisor (including inter-office memoranda and communications) relating to municipal advisory activities, regardless of the format of such communications.”
As the SEC expands its regulatory focus beyond broker-dealers and investment advisors, all regulated entities should brace for more rigorous scrutiny on this issue. This trend is underscored in the SEC's 2023 Examination Priorities, which pinpoint business-related communications as a key area of focus. It is therefore crucial for regulated entities to proactively assess, and enhance where necessary, their recordkeeping practices.
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