US regulators have been on the warpath about WhatsApp and private messages since they discovered that traders and dealmakers were using these “off-channel communications” but their employers weren’t saving them.
When the enforcers complained that this would hamper future investigations and lawsuits, the big investment banks including JPMorgan Chase, Goldman Sachs and Barclays capitulated. Twelve of them have paid out more than $2bn in penalties so far.
The US Securities and Exchange Commission has now turned its attention to private equity and hedge funds. Apollo, KKR and Carlyle have all disclosed they are under investigation and several hedge funds have also been asked to review their employees’ personal phones for evidence that they talked to clients.
But this time the industry is pushing back. Ten trade associations combined forces last month to write to SEC chair Gary Gensler complaining that the commission is “attempting to exceed its authority . . . and engaging in rulemaking by enforcement”.
The difference lies in the nuts and bolts of US financial regulation. The SEC supervises everyone involved in the buying and selling of securities, but the rules for various parts of the investment universe can be quite different.
Big bank capital markets divisions fall under the rules for broker-dealers, which tend to be quite strict and prescriptive, while investment managers that run hedge funds and private equity operate under a less intrusive regime. Products aimed at retail customers are much more tightly regulated than private funds aimed at wealthy and institutional clients.
In the case of record-keeping, for example, US law says that broker-dealers must keep “all communications . . . relating to business as such”. But investment managers operate under a narrower regime that details the kinds of exchanges that must be preserved.
The lobbyists argue that treating investment managers the same way as broker-dealers is unfair. And they fear that the current sweep will uncover chats that should have been preserved. If so, an individual firm may opt to settle with the SEC and agree to put in place expensive new record-keeping requirements that other industry participants will feel obliged to follow.
“Their approach is purposefully antagonistic to the industry,” says Jennifer Han, chief counsel of the Managed Funds Association, which signed the letter.
But regulation by enforcement isn’t the only thing that the investment management industry objects to about Gensler’s SEC. The industry is also highly exercised by efforts to tighten the rules through the ordinary regulatory process.
Since Gensler took office, the commission has proposed a string of new requirements for investment advisers on a wide variety of topics, from outsourcing and cyber security to fee negotiations with clients. Many of these are quite specific about how the problems should be addressed and disclosed.
To the industry, this specificity marks a big departure from the historic practice of relying on a more general duty of care. They say it will push up costs and penalise responsible managers who already have procedures and systems in place because they would have to overhaul them to match the requirements.
“What has been proven to be deficient?” asks Tamara Salmon, of the Investment Company Institute, the main mutual fund industry group. “If we can document it, then by all means let’s fix it. But rulemaking for the sake of rulemaking is to nobody’s benefit.”
Some industry participants fear the flurry of rule proposals will simply lead to a further erosion of the differences between the way broker dealers and investment managers are treated and encourage the commission staff to crack down even more.
“They’re setting the stage for more enforcement activities by the SEC . . . They are laying out more and more landmines and foot faults,” says Brian Daly, a partner at Akin Gump who advises investment managers.
Consumer groups see it quite differently. “Bad behaviour is covered by a duty of care, but that’s inadequate,” says Dennis Kelleher of Better Markets. “Some firms shouldn’t be able to profit from under-compliance. [Clear rules] level the playing field.”
Taken together, it’s a bit contradictory. The investment managers are arguing the SEC should pass more prescriptive rules if they want instant messages preserved, while claiming that other detailed requirements are intrusive and expensive. But regulators do need to strike a balance: protect investors without sapping their returns.