Suggestions for Bush, and the SEC

Meanwhile, the Investment Counsel Association of America (ICAA)–which represents SEC-registered advisors–is prodding the SEC to clarify its expectations of RIAs' retention, production, and surveillance of e-mail. "The SEC has changed this whole [e-mail retention] area without telling us what the rules are," David Tittsworth, ICAA's executive director, told me in a recent interview. After uncovering e-mail at mutual fund companies last year that exposed questionable trading activity, SEC examiners decided to review advisors' e-mails during examinations. The SEC has not only requested that all of an advisory firm's e-mail be made accessible to examiners, but has even asked that advisors monitor their employees' electronic missives.

The problem, says Tittsworth, is that advisors are now incurring huge costs to comply with the SEC's requests, as they're "contemplating major decisions regarding technologies and firm practices regarding electronic communications." But advisors have yet to see "any written guidance" from the SEC, Tittsworth says. He adds that ICAA's discussions with Chairman William Donaldson and senior SEC staffers about e-mail retention stretch back to last summer. It was then that ICAA began hearing complaints from its members about "the unprecedented e-mail requests" they were getting from the SEC.

It's standard practice now for SEC examiners to request all of a firm's e-mail or the e-mail of high-level management over a three-month period in an electronically searchable format. The SEC says that Section 204 of the Advisers Act–the books and records rule–entitles the regulator to review "any record or information maintained by an investment adviser, including records or information that do not fall under rule 204-2 (unless privileged)." But some advisors, Tittsworth told the SEC in a recent comment letter, haven't saved all of the e-mails that do not include required information under Rule 204-2. The SEC staff, Tittsworth says, has opined that firms are not required to retain e-mail that does not include required information. However, SEC staffers have cautioned that firms must have policies and procedures reasonably designed to ensure that required information is maintained. The ICAA has asked the SEC for "confirmation that this can be satisfied in a number of different ways and that firms need not employ a gatekeeper system to review all e-mail before deletion," Tittsworth says.

He points out further that some advisors maintain e-mail on backup disks that aren't easily searchable. "These firms have incurred considerable expense obtaining additional storage capacity and hiring specialists to restore contents and transfer requested material to a searchable format," Tittsworth says. He adds that some SEC staff members have said that advisors must maintain the functionality of an e-mail document. But it's standard practice for small firms in particular to print e-mail documents and delete the electronic version, he says. The SEC, however, may not look kindly on that. An SEC examination notice received recently by one RIA (at www.investmentadvisor.com/pub/1_1/breaking-news/4339-1.html) specifically demanded "all e-mails, including their corresponding attachments" and added that they "should be provided in an electronically searchable format." However, Tittsworth contends that "an existing rule has been understood to require that e-mail containing required records be maintained electronically rather than on paper."

Since sending its most recent comment letter to the SEC in November, the ICAA has resumed talks with SEC staff, Tittsworth says. The SEC is now trying to determine what its e-mail policy should actually be, Tittsworth says, and is taking into account the types of e-mail technology that are being used by smaller firms.

Advisors should also be aware of other issues that have cropped up during and after SEC exams. Nancy Lininger, president of The Consortium, a Camarillo, California, consulting firm that provides consulting services to advisors and broker/dealers on compliance issues, says a client recently received an e-mail from the SEC stating that the advisor failed to name a chief compliance officer on their Form ADV. It turned out that an examiner made an error and that the officer's name was on the form all along. But Lininger says that "this is a sign that the SEC is watching amendments [that advisors] make to their ADV."

The SEC has cut advisors a little slack in one area: They now have until February 1 to comply with the commission's code of ethics rule, Lininger says. The original compliance date was January 5. When the SEC comes knocking early this year, examiners will expect to see a code of ethics in writing, she says. Unlike other codes of ethics for professionals that are generally based on moral standards, the SEC's version asks for "very detailed personal trading procedures," Lininger says. She thinks the regulator's code of ethics overlaps the SEC's written supervisory procedures rule. Lininger says the SEC doesn't care if advisors maintain two documents–one for a code of ethics and another for supervisory procedures. She would normally recommend maintaining only one, "but I don't think you want to hand out your supervisory procedures when your clients ask for your code of ethics. That is an argument for keeping the two documents, even though the requirements overlap."

Washington Bureau Chief Melanie Waddell can be reached at [email protected].