SEC Charges Underscore Importance of Digital Communication Management

J.P. Morgan Securities has agreed to pay $125 million to resolve what the SEC calls ‘longstanding failures by the firm and its employees’ to maintain and preserve certain digital communications.

Earlier this month, the Securities and Exchange Commission (SEC) announced charges against J.P. Morgan Securities LLC (JPMS), a broker/dealer subsidiary of JPMorgan Chase & Co., alleging “widespread and longstanding failures by the firm and its employees to maintain and preserve written communications.”

According to a statement from the SEC, JPMS admitted the facts set forth in the SEC’s order and acknowledged that its conduct violated federal securities laws. In turn, the company has agreed to pay a $125 million penalty and implement robust improvements to its compliance policies and procedures to settle the matter.

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Commenting on the charges, SEC Chair Gary Gensler notes that recordkeeping and books-and-records obligations have been an essential part of market integrity and a foundational component of the SEC’s ability to be “an effective cop on the beat.”

“As technology changes, it’s even more important that registrants ensure that their communications are appropriately recorded and are not conducted outside of official channels in order to avoid market oversight,” Gensler says. “Unfortunately, in the past, we’ve seen violations in the financial markets that were committed using unofficial communications channels, such as the foreign exchange scandal of 2013. Books-and-records obligations help the SEC conduct its important examinations and enforcement work. They build trust in our system.”

As described in the SEC’s order, JPMS admitted that from at least January 2018 through November 2020, its employees often communicated about securities business matters on their personal devices, using text messages, WhatsApp, and personal email accounts. According to the SEC, none of these records were preserved by the firm as required by the federal securities laws. JPMS further admitted that supervisors, including managing directors and other senior supervisors responsible for implementing and ensuring compliance with JPMS’s stated policies and procedures, also used their personal devices to communicate about the firm’s securities business.

The charges and penalty settlement come some three years after a Risk Alert publication issued by the SEC’s Office of Compliance Inspections and Examinations (OCIE) encouraged advisers to “review their risks, practices, policies and procedures regarding electronic messaging.” That guidance, in turn, followed on the heels of various advisory firms, broker/dealers and other financial services providers rolling out new text-based communication solutions to their reps. In the Risk Alert, regulators reminded financial professionals of their duties under the Advisers Act Rule 204-2, known as the “Books and Records Rule.” The alert further encouraged firms to proactively consider “improvements to their compliance programs that would help them comply with applicable regulatory requirements.”

According to the Risk Alert, OCIE examiners had noticed an increasing use of various types of electronic messaging by adviser personnel for business-related communications. Many of the solutions had been reviewed and approved by FINRA, but the SEC noted that its own Books and Records Rule is distinct from any FINRA regulations and applies to digital as well as print communications. 

In the JPMS matter, the SEC says it sent both subpoenas for documents and voluntary requests across a variety of investigations that its staff undertook during the time period mentioned above. However, in responding to these subpoenas and requests, JPMS frequently did not search for relevant records contained on the personal devices of its employees, the SEC’s order states.

Commenting on the findings and penalty, Gurbir Grewal, director of the SEC’s Division of Enforcement, says recordkeeping requirements are core to the SEC’s enforcement and examination programs—and when firms fail to comply with them, they directly undermine the regulator’s ability to protect investors and preserve market integrity.

“We encourage registrants to not only scrutinize their document preservation processes and self-report failures such as those outlined in today’s action before we identify them, but to also consider the types of policies and procedures [JPMS] implemented to redress its failures in this case,” Grewal adds.

Specifically, JPMS agreed to the entry of an order in which it admitted to the SEC’s factual findings and its conclusion that JPMS’s conduct violated Section 17(a) of the Securities Exchange Act of 1934 and Rules 17a-4(b)(4) and 17a-4(j) thereunder, and that the firm failed to reasonably supervise its employees with a view to preventing or detecting certain of its employees’ aiding and abetting violations. JPMS was ordered to cease and desist from future violations of those provisions, was censured and was ordered to pay the $125 million penalty.

Firms that believe that their record preservation practices do not comply with the securities laws are encouraged to contact the SEC at BDRecordsPreservation@sec.gov.

Cash Balance Plans More Popular With Smaller Plan Sponsors

An analysis from October Three also finds certain industries are more drawn to the plan design that is viewed as less risky than traditional DB plans.

There were 10,609 cash balance plans covering more than 10.5 million participants, with assets of $1.06 trillion in 2019, according to an analysis of Form 5500 filings in September by consulting firm October Three. The analysis looked at plans with more than 25 participants.

October Three found cash balance plans continue to grow in popularity across industries, with 19% of plans in the professional, scientific and technical services industries; 13% in construction; 12% in finance and insurance; 11% in health care and social assistance; and 11% in manufacturing. The biggest growth in number of cash balance plans in the past five years has been in the construction industry, with a 165% growth rate. This is followed by the real estate rental and leasing industry (126% growth in number of plans over the past five years) and educational services (100%).

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Cash balance plans have become more popular since the passage of the Pension Protection Act (PPA) of 2006. Experts say this is in part because they create less risk for plan sponsors and the funding is easier to manage than it is with traditional defined benefit (DB) plans.

The number of cash balance plans that remain active is much greater than the number of traditional DB plans that are active. The analysis found that 85% of cash balance plans were active in 2019, compared with 55% of traditional DB plans.

October Three notes that cash balance plans significantly remove the risk present in traditional DB plans. While cash balance plans still using a fixed rate of return can create investing issues, those that use a market return interest crediting rate are enjoying peace of mind and a virtually risk-free experience, the company notes.

“Among corporate plan sponsors, many employers simply find cash balance plans to be a better fit for their workforces than traditional defined benefit plans,” says John Lowell, an Atlanta-based actuary and partner with October Three.

He notes that arguments in favor of cash balance plans include that they are easier to communicate because they are easier for participants to understand. “Because they are often expressed as account balances, cash balance plans tend to be something that current employees feel that they can get their arms around,” Lowell says. “Having an account balance of, for example, $100,000, feels like something more real than having a monthly benefit of $1,000 many, many years in the future. And they grow annually with a contribution and some level of interest or earnings.”

In addition, Lowell says, the portability of cash balance benefits is a strong recruiting and retention feature. Participants can take their balances as a lump sum when they leave a job, rather than only being able to receive the money once they reach retirement age. “While not always the case, workers have gotten used to knowing that when they change jobs, they can take their benefit with them,” says Lowell.

“Additionally, as compared with a traditional pension in which the large majority of the value of that pension is accrued in later years of working, most cash balance plans are designed for employees to accrue benefits relatively ratably throughout their careers,” he notes.

Cash Balance Plans Particularly Popular With Smaller Employers

The October Three analysis shows cash balance plans grew more among plans with fewer than 100 participants than they did in larger plans. There were 9,342 plans with fewer than 100 participants reflected in the Form 5500 filings. This represents a growth rate of 336% over the past 10 years. For plans with fewer than 100 participants, cash balance plans make up 54% of all DB plans. There were 17,692 new cash balance plans with fewer than 100 participants established over the past five years.

There were 1,267 plans with more than 100 participants, representing a 9.4% increase over the past 10 years. Cash balance plans make up 21% of all DB plans with greater than 100 participants. There were 455 new plans with greater than 100 participants established over the last five years.

Cash balance plans have been a popular choice for smaller plan sponsors for years, as an analysis of 2016 data by Kravitz Inc. found that 92% of cash balance plans are in firms with fewer than 100 employees.

In 2019, the largest number of cash balance plans with fewer than 100 participants were in the professional, scientific and technical services industries. The largest number of plans with greater than 100 participants were in the manufacturing industry.

Eighty-nine percent of cash balance plans with fewer than 100 participants were active in 2019, compared with 65% of small traditional DB plans. Among cash balance plans with greater than 100 participants, 58% were active in 2019, compared with 38% of “large” traditional DB plans.

Lowell says that among small businesses and high-income professional services firms, cash balance plans are often designed as supercharged defined contribution (DC)-like plans. “In those cases, simply layering on an additional deferral arrangement on top of an existing one is both easier to design and to understand than is creating a plan with an entirely different design to function in much the same way,” he says.

He adds that in the corporate space, the prevalence of cash balance plans by industry seems to line up fairly well with the prevalence of traditional DB plans by industry. “In other words, those industries that are more likely to have traditional DB plans are roughly equally more likely for those DB plans to be cash balance plans,” Lowell says. “They tend to be industries where the emphasis on recruitment and retention is at a premium. They often employ highly skilled professionals who are difficult to recruit and difficult to retain. Those organizations often view that sponsoring a cash balance plan that is easy to communicate helps to make them an employer of choice.”

More data from the analysis is available here.

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