The Securities and Exchange Commission has fired off another volley of enforcement actions for employees’ improper use of messaging apps — but this time we have a new twist! The SEC has been quietly granting waivers to the offending firms to keep working on deals when normally their conduct would disqualify them from doing so.
The enforcement actions were announced Friday against 16 firms, which collectively paid a total of $81 million in civil penalties. By now the fundamentals of these cases should sound familiar: employees were conducting company business via unauthorized messaging apps, so their firms were unable to capture and preserve those business records. That violates SEC rules for broker-dealers, which require firms to preserve “all communications and copies of all communications sent … relating to its business as such” for two to six years.
The single biggest penalty issued last week went to three subsidiaries of Northwestern Mutual, which collectively paid $16.5 million. Two subsidiaries of Guggenheim paid $15 million, and Oppenheimer & Co. paid $12 million. Other firms paid anywhere from $10 million down to $1.25 million.
These 16 firms are the latest in what is now a long line of Wall Street broker-dealers sanctioned by the SEC (and sometimes the Commodities Futures Trading Commission) for “off-channel communications.” The enforcement wave started in 2021 when the SEC and CFTC fined JPMorgan Chase $200 million; and reached a high point in September 2022 when the SEC fined 16 large firms a total of $1.1 billion.
The SEC has now sanctioned dozens of firms large and small for messaging app violations. Even the Justice Department got into the act, adding a section about messaging apps in 2023 to its guidelines for effective compliance programs.
What’s news today is that the SEC has provided an additional glimpse into how it is enforcing these cases, and into the leniency it is providing firms as they settle their cases.
‘Certain Broker-Dealer Practices’
That glimpse into SEC enforcement comes from a document the agency posted along with the settlement orders for last week’s 16 firms — a four-page administrative order blandly named “Order for Certain Broker-Dealer Practices.”
Essentially, that order allows the 16 firms to keep bringing securities offering to market under relaxed standards, even though SEC regulations would typically mean the offending firms couldn’t do so.
To understand what’s going on, let’s first review what these SEC rules are.
The rules in question are known as Regulation A, Regulation D, Regulation E, and Regulation Crowdfunding. Each of these regulations allow broker-dealer firms to bring certain securities offerings to market if the offerings meet certain conditions. For example, say you’re a small company working with a broker-dealer to sell shares to a small number of investors. Normally your business would need to file all the usual financial statements. Regulation A exempts you from that obligation so long as your business has fewer than 500 shareholders and less than $10 million in assets.
Regulations D, E, and Crowdfunding work in similar ways, exempting companies from certain reporting requirements if their offerings meet certain criteria.
Now the key point: firms can lose their right to operate under these regulations if they are subject to SEC enforcement. For example, as the order itself says, Regulation A becomes unavailable if the broker-dealer firm is subject to SEC enforcement “that places limitations on that entity’s activities, functions, or operations.” Likewise, an offering can’t be brought to market under the Regulation E exemption “if any investment adviser or any underwriter of the securities to be offered is subject to an order of the Commission.”
You can see where this is going. All 16 firms from last week, as well as the dozens of other firms previously sanctioned by the SEC for messaging offenses, would be disqualified from using the exemptions offered under Regulations A, D, E, and Crowdfunding. That would cut off the firms from potentially lucrative business with clients that are closely held companies looking to make a few discreet securities sales to deep-pocketed investors.
The Order for Certain Broker-Dealer Practices waives that disqualification so the offending firms can continue with business as usual.
Are Waivers News or Not?
Now we get to the interesting part: the SEC has been issuing such disqualification waivers all along, but not noting that fact as part of its settlements.
For example, go back to that $1.1 billion settlement in September 2022 with 16 Wall Street titan firms. That press release included all settlement orders for all 16 offending firms — but it did not disclose a previous “Order for Certain Broker-Dealer Practices” order that was issued the same day. That disqualification waiver was tucked away on a much sleepier part of the SEC website labeled “Other Commission Orders and Notices.”
Likewise, the SEC granted disqualification waivers several times in 2023 as it kept up its off-channel messaging crackdown. At no time did the SEC mention those disqualification waivers with the same vigor and vim as it did the actual enforcement orders themselves.
Moreover, the individual settlement orders make no mention of waivers or Regulations A, D, E, and Crowdfunding either. At least, I couldn’t find any mention of waivers or Regulations A, D, E, and Crowdfunding in the half-dozen settlement orders I checked, from JPMorgan way back in 2021 all the way to Northwest Mutual and Guggenheim today. (Weirdly, I cannot seem to find any disqualification waiver issued for JPMorgan.)
So apparently, this off-channel messaging crackdown would normally lead to painful consequences for the offending firms, because they would be disqualified from all those registration exemptions under Regulations A, D, E, and Crowdfunding. Except, the SEC has been giving waivers to get around this sticky wicket all along, and not publicizing that fact.
Disqualification Waivers Through Time
I found only one previous article about the SEC’s disqualification waivers, from a securities lawyer named Bill Singer who used to run a blog called BrokeAndBroker.Com. He, in turn, pointed to a statement from former SEC commissioner Kara Stein, who way back in 2015 pooped all over the idea of handing out disqualification waivers like they were lollipops you get at the end of a trip to the dentist.
Stein made her statement in relation to waivers handed out repeatedly to several large banks tangled up in a foreign exchange investigation, but her words are worth quoting today:
Allowing these institutions to continue business as usual, after multiple and serious regulatory and criminal violations, poses risks to investors and the American public that are being ignored. It is not sufficient to look at each waiver request in a vacuum.
At least three of the financial firms Stein complained about back in 2015 — Citigroup, Barclays, and UBS — have since been charged for recordkeeping failures, and received disqualification waivers along with their settlements.
Hmmm. One wonders what the SEC will do with disqualification waivers when the first repeat offender for off-channel messaging comes along.