The WhatsApp showdown between SEC and wealth managers

US regulators have been on the warpath over WhatsApp and private messaging ever since they discovered traders and dealmakers were using these “off-channel communications” but their employers are not bailing them out.

When enforcers complained that doing so would hamper future investigations and trials, the big investment banks, including JPMorgan Chase, Goldman Sachs and Barclays, capitulated. Twelve of them have so far paid more than $2 billion in penalties.

The US Securities and Exchange Commission has now turned its attention to private equity and hedge funds. Apollo, KKR and Carlyle have all announced they are under investigation, and several hedge funds have also been asked to check their employees’ personal phones for evidence of speaking to clients.

But this time, the industry is striking back. Ten trade associations came together last month to write to SEC Chairman Gary Gensler to complain that the commission is “trying to exceed its powers. . . and engage in rule-making through enforcement”.

The difference lies in the fundamentals of US financial regulation. The SEC oversees everyone involved in buying and selling securities, but the rules for different parts of the investment universe can be very different.

The capital markets departments of large banks are subject to broker-dealer rules, which are usually quite strict and prescriptive, while investment managers operating hedge funds and private equity are subject to a less intrusive regime. Products targeting retail clients are much more tightly regulated than private funds targeting high net worth and institutional clients.

For example, in the case of records, US law states that broker-dealers “all notices . . . in relation to the business as such”. But investment managers operate under a narrower regime that describes the types of exchanges that must be preserved.

Lobbyists argue that treating investment managers like broker-dealers is unfair. And they fear the current sweep will uncover chats that should have been kept. If this is the case, an individual company may choose to settle with the SEC and agree to introduce expensive new record-keeping requirements that other industry participants will be bound to.

“Your approach is intentionally antagonistic to the industry,” said Jennifer Han, chief counsel of the Managed Funds Association, which signed the letter.

But regulation through enforcement isn’t the only thing the investment management industry opposes about Gensler’s SEC. The industry is also very busy with efforts to tighten the rules through the normal regulatory process.

Since Gensler took office, the commission has proposed a set of new requirements for investment advisers on everything from outsourcing to cyber security to client fee negotiations. Many of these are very specific about how the issues should be addressed and disclosed.

For the industry, this specificity represents a major departure from the historical practice of relying on a more general duty of care. They say it will drive up costs and penalize responsible managers who already have procedures and systems in place because they will have to revise them to meet requirements.

“What has been found to be lacking?” asks Tamara Salmon of the Investment Company Institute, the mutual fund industry’s premier group. “If we can document it, then by all means let’s fix it. But rule-making for the sake of rule-making is of no use to anyone.”

Some industry participants fear that the barrage of proposed rulemakings will simply further erode the disparity between the treatment of brokers and investment managers and encourage commission officials to become even more aggressive.

“They are setting the stage for further enforcement action by the SEC. . . They’re laying more and more land mines and foot bugs,” says Brian Daly, a partner at Akin Gump, who advises investment managers.

Consumer associations see things very differently. “Bad behavior is covered by a duty of care, but that’s insufficient,” says Dennis Kelleher of Better Markets. “Some companies shouldn’t be able to take advantage of a non-compliance. [Clear rules] level the playing field.”

Taken together, it’s a bit contradictory. Investment managers argue that the SEC should issue stricter rules if they want instant messages to be preserved, while claiming that other detailed requirements are intrusive and expensive. But regulators need to strike a balance: protect investors without sacrificing their returns.

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Adam Bradshaw

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