What is Rule 17 and Rule 17a-4?

BY: Imara Joroff, RBFL Student Editor

In 2022, the Securities and Exchange Commission (SEC) reached a record number of ordered money totaling $6.4 billion. This same year, the SEC reached a $1.8 billion settlement with sixteen firms for repeated violations on Rule 17a-4 – Texting Scandals. Rule 17a-4 details the “manner and length of time [business communication] records. . . must be maintained and produced promptly to [SEC] representatives.” The SEC uses these “preserved records . . . [as] the primary means of monitoring compliance with applicable securities laws.”

Off-Channel Communication

Business communication refers to any employee communication made in furtherance of a fundamental business goal. Off-channel communication is business communication that happens on an unofficial and unmonitored platform. This includes communication through secure electronic messaging apps, personal email accounts, and personal social media accounts. Firms face unique compliance challenges created by the use of apps with end-to-end encryption, such as WhatsApp, Signal, WeChat, and Telegram, on personal devices. How are members supposed to record and store business communication that they themselves cannot access?

More Guidance

Rule 17 was created in 1948, twenty-three years before email was created and forty-four years before the first text message was sent. One major complaint from firms is that the SEC does not provide sufficient guidance for how to comply with Rule 17 in the face of rapidly changing technology. Given that Rule 17a-4 is all encompassing, how much guidance is necessary? Firms either save all written electronic business communications in compliance with Rule 17a-4 or they don’t. Thus, if a messaging system does not allow firms to save their broker-dealers’ business communication then firms must prohibit the use of that messaging system.

JP Morgan, a firm involved in the texting scandals, had an explicit policy banning encrypted platforms like WhatsApp but also fostered an environment where senior managers encouraged junior broker-dealers to use the app and actively delete their business communications. In the face of such flagrant disregard for Rule 17a-4, would more guidance from the SEC have saved JP Morgan? No.

Rule 17a-4 Purpose and Threat of Increased Enforcement

The SEC’s mission is to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.” Rule 17a-4 not only holds members accountable, it is also the bedrock of the SEC’s functionality. Unfettered access to off-channel business communication allows the SEC to determine illegal activity, gather evidence, and enforce corrective action before the activity delivers a bomb to the United States economy.

A seldom enforced rule is a suggestion. At the Securities Enforcement Forum, Chair Gensler stated, “Without examination against and enforcement of our rules and laws, [the SEC] can’t instill the trust necessary for our markets to thrive.” The general understanding surrounding violations of Rule 17 is that most firms know about the issues but do not correct them. Thus, the SEC is strictly enforcing Rule 17a-4 against end-to-end encrypted messaging apps with the hope that members will be deterred from using such services.

Potential Future Impact

Mark Zuckerberg is a zealous proponent of Metaverse – his virtual reality platform. The Metaverse will impact the employee experience by allowing people to join a virtual meeting room while working remotely. Would business conversations in the Metaverse, that would have been in-person and thus exempt from Rule 17a-4, now count as business communication being “received” by one avatar and “sent” by another? Alternatively, if all business transpired through virtual reality, would this eliminate the need for written communication like emails and text and thus render Rule 17 obsolete? As stated, in-person verbal communication is not subject to Rule 17a-4. Is this because such communication does not automatically generate a record for firms to store? If so, if the verbal communication in the Metaverse is recorded, would firms be required to transcribe, store, and furnish the transcripts of all meetings? Are firms required to do this now if they record a meeting via Zoom?

Conclusion

  1. P. Morgan Securities LLC., No. 3-20681 (SEC Dec. 17, 2021) https://www-law360-; com.ezproxy.bu.edu/articles/1449792/attachments/1; Barclays Capital Inc., No. 3-21164 (SEC Sept. 27, 2022); Citigroup Global Markets Inc. No. 3-21165 (SEC Sept. 27, 2022); BofA Securities, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, No. 3-21166 (SEC Sept. 28, 2022); Goldman Sachs & Co. LLC, No. 3-21167 (SEC Sept. 28, 2022); Jefferies LLC, No. 3-21168 (SEC Sept. 28, 2022); Morgan Stanley & Co. LLC and Morgan Stanley Smith Barney LLC, No. 3-21169 (SEC Sept. 27, 2022); Nomura Securities International, Inc., No. 3-21170 (SEC Sept. 27, 2022); Credit Suisse Securities (USA) LLC, No. 3-21171 (SEC Sept. 27, 2022); Cantor Fitzgerald & Co., No. 3-21172 (SEC Sept. 27, 2022); Deutsche Bank Securities Inc., DWS Investment Management Americas, Inc., and DWS Distributors, Inc., No. 3-21173 (SEC Sept. 27, 2022); UBS Financial Services, Inc. and UBS Securities LLC, No. 3-21174 (SEC Sept. 27, 2022)
  2. Commission Guidance to Broker-Dealers on the Use of Electronic Storage Media under the Electronic Signatures in Global and National Commerce Act of 2000 with Respect to Rule 17a-4(f), 17 C.F.R. Part 241, Exchange Act Rel. No. 44238 (May 1, 2001); see also 17 C.F.R. § 240.17a-4 (2021)
  3. Press Release, CFTC No. 8599-22, CFTC Orders 11 Financial Institutions to Pay Over $710 Million for Recordkeeping and Supervision Failures for Widespread Use of Unapproved Communication Methods (Sept. 27, 2022) https://www.cftc.gov/PressRoom/PressReleases/8599-22
  4. Gary Gensler, Chair, Securities and Exchange Commission, Remarks at the Securities Enforcement Forum (Nov. 4, 2021) https://www.sec.gov/news/speech/gensler-securities-enforcement-forum-20211104
  5. Ryan Mac, Sheera Frenkel and Kevin Roose, Skepticism, Confusion, Frustration: Inside Mark Zuckerberg’s Metaverse Struggles, New York Times (Oct. 9, 2020)

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