“Very strict enforcement” is a euphemism used by the American Automobile Association to warn motorists of places where even minor traffic violations will likely be caught and punished with heavy fines. The designation “speed trap” is reserved for very strict enforcement places that appear to be using fines to fund local budgets rather than to improve traffic safety.
The Securities and Exchange Commission has always been known for very strict enforcement, as is appropriate given the vast amount of money that flows through US securities markets, their importance both to the financial well-being of individual investors and the economy, and the gigantic rewards that can be harvested via dishonesty that might seem trivial in other contexts. However, the SEC may be crossing the line from very strict enforcement to speed trap with its fines for the use of WhatsApp and other messaging services by financial industry professionals.
In 1948, in Rule 17a-4(b), the SEC decided firms were required to keep “originals of all communications received and copies of all communications sent…relating to his business as such.” At the time this meant letters, written notices, contracts, statements, presentations and other formal documents. No one took it literally as meaning spoken communication (in-person or by telephone), informal notes, employee party announcements and the like.
Over the years, primarily due to technological improvements, the rule was expanded to cover many recorded telephone conversations, emails and texts. But everyone — and not just in finance — understood the difference between formal written communication and use of official firm-monitored systems; and unmonitored communication. The latter was used for things you didn’t want your boss, or human resources, or compliance, or co-workers, or regulators to see. It included discussions of job opportunities outside the firm, gripes about your manager, not-safe-for-work jokes and gossip about co-workers.
The line between “relating to business” and personal is blurred, and most actual communication between two humans contains both. You might call up a customer to quote a price, but also ask about her social life or tell her a funny story about a mutual friend. You might respond to a business text from a co-worker and include a complaint about the latest HR training. Employees naturally use monitored, official firm systems for formal business communications and safe-for-work personal stuff, and some alternative channel for everything else.
The SEC decided a few years ago that messaging from employees’ personal devices relating to business fell under “communications” as understood by the 1948 rule, rather than the informal conversations the employees had intended them to be. Instead of telling firms to either start collecting these messages or forbid employees from any business-related communication on them, it began an investigation that has resulted in about $2.7 billion of fines (including parallel fines from the Commodity Futures Trading Commission) and is expanding beyond the brokers covered by the 1948 rule.
All this for behavior that everyone except the SEC thought was legal, for which no warning had been issued, and from which no evidence of illicit or harmful behavior turned up as far as we know. Moreover, the rule change makes little practical difference. Employees will simply switch their not-safe-for-work conversations to another channel.
It’s possible that finance will become a little less human, more like life in a casino with 24/7 ceiling cameras and microphones. It’s also possible this will speed the adoption of artificial intelligence algorithms that have no personal life. But neither of these are plausible SEC goals.
Why would the SEC do such a thing? Was it to collect more than one year’s budget, like speed trap towns? Was it to get headlines for sticking it to Wall Street? Was it to expand its power over investment managers — especially hedge funds — who are less subject to SEC regulations? Was it out of a genuine belief that illicit communications were being sent over WhatsApp and the criminals would continue to use that service after firms began monitoring it? Was it right for the SEC to examine the personal phones — thought to be private — of thousands of people not suspected of any crime? How is the SEC’s investor protection mandate served by extracting billions of dollars from investors in brokerage firms?
One entirely speculative answer is that the SEC discovered massive violations — insider trading, market manipulation, customer abuse or other crimes — using unmonitored messaging apps, but it has chosen to keep that confidential for the moment. In that case the record-keeping fines are just the opening salvo in a larger prosecution. The number of violators and near-identical fines, however, make that unlikely, and neither the SEC nor market rumors have hinted at such findings.
The problem with speed traps is not the injustice to drivers forced to pay fines because they have out-of-state plates and missed a deliberately obscured speed limit sign on a featureless rural highway. It’s that speed traps divert enforcement resources from a focus on public safety to town revenue. This erodes the moral authority of police and changes “to protect and to serve” to “to collect and to punish.”
The SEC has not gone all the way to a speed trap. It did not deliberately obscure the 1948 rule, nor are staffers assigned quotas for fines. There are no indications of other abusive practices associated with revenue-by-fine jurisdictions. There is some legal justification for its position (although tenuous enough that a warning to avoid future violations would have been more appropriate than massive fines for innocent past violations).
Nevertheless, the accumulation of WhatsApp fines is enough like a speed trap that we can expect pushback on the horizon. Not from brokerage firms that cannot afford SEC displeasure, and not from Congress, as going to bat for Wall Street does not win many votes. It's investment managers and other businesses where the SEC has weaker legal grounds — Citadel, for example, is reported to be considering a lawsuit — and that are less dependent on the agency’s goodwill who may fight this battle.
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