Sutherland FINRA Focus #1: 2013 Electronic Communications

WASHINGTON--(BUSINESS WIRE)--As reported on February 24, 2014, in Sutherland Asbill & Brennan LLP’s annual analysis of FINRA’s disciplinary actions, electronic communication cases generated the highest amount of fines for the regulator in 2013.¹ This past year, FINRA reported $15.1 million in fines from 66 cases involving alleged electronic communication violations.² This Sutherland FINRA Focus delves into the regulator’s recent enforcement actions and examines a few of the key 2013 electronic communication cases. “Electronic communication” cases include the following types of allegations: failing to retain emails and other electronic communications, such as business text messages; failing to adequately supervise emails and other messages; failing to disclose to regulators information about email retention systems; and producing electronic records to regulators in an improper format.

The chart below shows the total number of electronic communication cases and fines FINRA has reported during each of the past six years.

FINRA’s Electronic Communication Sanctions Statistics, 2008–2013
	Fines Reported	Percentage Change	Percentage of Total FINRA Fines	Cases Reported	Percentage Change
2008	$3.1 million	--	11%	26	--
2009	$1.9 million	(39%)	4%	22	(15%)
2010	$4 million	111%	9%	37	68%
2011	$5.3 million	33%	8%	58	57%
2012	$6.5 million	23%	8%	63	9%
2013	$15.1 million	132%	27%	66	5%

These statistics show that there were significant increases in the number of electronic communication cases and the amount of fines in those cases in 2013. While these types of cases averaged, on a yearly basis, $4.2 million in fines between 2008 and 2012, fines shot up to $15.1 million in 2013, an increase of 260% over the prior five-year average. This exponential increase is especially noteworthy in light of the fact that FINRA’s overall fines declined by 27% in 2013, from $78 million in 2012 to $57 million in 2013.³

This substantial increase in electronic communication fines was largely fueled by a $7.5 million fine, FINRA’s largest in 2013, in a settled case involving allegations that a firm failed to properly store hundreds of millions of emails.⁴ FINRA stated that the firm experienced 35 significant email system failures, which allegedly prevented it from accessing hundreds of millions of emails and reviewing tens of millions of additional emails. FINRA asserted that “the firm failed to devote sufficient resources to update its email systems, which became increasingly complex and unwieldy for LPL to manage and monitor effectively.”⁵ FINRA also asserted that the firm made material misstatements to the regulator about the timing of when some of these problems were discovered and the firm’s prior knowledge about potential red flags. The firm was allegedly aware of these significant email system failures and FINRA asserted that these issues caused the firm to fail to “produce all requested email to certain federal and state regulators, and FINRA, and also likely failed to produce all emails to certain private litigations and customers in arbitration proceedings, as required.”⁶ In light of these concerns, the firm also agreed to pay $1.5 million to a fund to compensate customer claimants who may have been impacted by these email retention and supervision issues. Brad Bennett, FINRA’s Executive Vice President and Chief of Enforcement, emphasized that “as [the firm] grew, it did not expand its compliance and technology infrastructure . . . [t]his case sends a strong message to firms to make sure your business does not outgrow your compliance systems.”⁷

Another significant 2013 electronic communication case involved five affiliated firms that agreed to a combined $1.2 million fine for alleged email retention and review violations.⁸ FINRA asserted that the firms failed to retain or review millions of emails. These alleged problems stemmed from issues concerning the proper configuration of email accounts, including not setting up retention systems to capture emails from alternate email addresses, distribution lists, emails received as blind carbon copies, encrypted emails, and emails sent through third-party systems. Many of these types of emails were not retained, and thus, not subject to supervisory review. Additionally, millions of emails that were retained had been flagged for supervisory review, but due to additional configuration issues, those emails were allegedly never reviewed by principals. Mr. Bennett noted that this case involved “broad systemic failures” and that the firms “failed to take adequate steps to ensure that their principals were fulfilling their responsibilities to review emails.”⁹ Mr. Bennett also highlighted the fact that “[e]mail retention and review continues to be an important regulatory responsibility and an issue of concern for FINRA.”¹⁰

According to Brian Rubin, the head of Sutherland’s Securities Litigation and Enforcement Group, “in light of the exponential increase in fines in electronic communication cases in recent years, firms may want to review more closely their email systems and compliance procedures.” As highlighted in the case that resulted in a $7.5 million fine, firms’ technology should keep pace with their business. The two cases highlighted above help demonstrate that seemingly technical issues regarding data configuration and other IT subjects can have a significant, and costly, impact on a firm. As Mr. Bennett stated, email retention and review is an “issue of concern for FINRA” and firms should respond accordingly.

¹ Brian Rubin and Andrew McCormick, Annual Sutherland Analysis of FINRA Sanctions Shows 27% Decrease in Fines; Number of Cases Nearly Identical, Feb. 24, 2014, available at http://www.sutherland.com/NewsCommentary/Press-Releases/161244/Annual-Sutherland-Analysis-of-FINRA-Sanctions-Shows-27-Decrease-in-Fines-Number-of-Cases-Nearly-Identical. Over the next two days, Sutherland will issue other Sutherland FINRA Focus reports analyzing the other 2013 top enforcement issues: trade reporting and short selling.

² The number of cases reported and the amount of corresponding fines come from the Disciplinary and Other FINRA Actions report that FINRA publishes each month. Many of these cases also involved other allegations, making it impossible to attribute the exact amount of any particular fine to a specific allegation.

³ Brian Rubin and Andrew McCormick, Annual Sutherland Analysis of FINRA Sanctions Shows 27% Decrease in Fines; Number of Cases Nearly Identical; Feb. 24, 2014, available at http://www.sutherland.com/NewsCommentary/Press-Releases/161244/Annual-Sutherland-Analysis-of-FINRA-Sanctions-Shows-27-Decrease-in-Fines-Number-of-Cases-Nearly-Identical.

⁴ FINRA News Release, May 21, 2013, available at http://www.finra.org/Newsroom/NewsReleases/2013/P264524.

⁵ Id.

⁶ Id.

⁷ Id.

⁸ FINRA News Release, Feb. 19, 2013, available at http://www.finra.org/Newsroom/NewsReleases/2013/P207604.

⁹ Id.

¹⁰ Id.