SEC comes for private funds over unauthorized messaging

The private funds industry should brace for a push by regulators against off-channel communications after a recent enforcement against private funds adviser Senvest Management.

The Securities and Exchange Commission’s enforcement against New York-based hedge fund Senvest Management is the first involving a standalone registered investment adviser, meaning one that isn’t tied to a broker-dealer through dual registration or affiliation, a commission spokesperson told Private Funds CFO.

Senvest admitted to the facts in the commission’s order, which said it found thousands of business-related messages made via personal texts and outside messaging platforms among employees, including by a trio of senior officers and a managing director between January 2019 and December 2021.

The SEC even found instances in which high-level employees had devices set up to automatically delete messages 30 days after being sent.

“The firm’s recordkeeping failures could have impacted the commission’s ability to carry out its regulatory functions and investigate violations of the federal securities laws,” the SEC said in its order.

The enforcement calls for Senvest to pay a $6.5 million fine and retain a compliance consultant to review its policies and procedures for off-channel communications. The consultant will then submit an initial report to commission staff, conduct another evaluation a year after the review and submit a follow-up report.

Senvest did not respond to a request for comment.

SEC gets serious about off-channel comms

The action against Senvest is just the latest chapter in the SEC’s years-long fight against outside communications, working its way through various types of financial institutions before touching the private funds sector.

“The SEC has really leaned into investigating off-channel communications among registered entities” in the last few years, H Gregory Baker, a partner at Patterson Belknap, told Private Funds CFO.

Baker says the commission started its effort with broker-dealers, before moving to duly-registered BDs and investment advisers.

Since 2022 it has brought forward a “litany of cases” focused on communications compliance breaches since 2022, added Joshua Broaded, who leads ACA Group’s regulatory advisory practice.

The Senvest investigation took years to come to its conclusion, suggesting to some compliance professionals that more private funds enforcements are likely on the horizon.

“I wouldn’t say it’s a prelude,” said David Tang, a partner at Dorsey & Whitney who represents private funds managers. “I think it’s already happening.”

Disclosures already made by some alternative investment firms appear to confirm that. Adam Aderton, a partner at Willkie Farr & Gallagher, said some alternative investment advisers have revealed that the SEC is looking into their practices for recordkeeping.

“My expectation is that we will see additional cases in this space and sometime in the not-too-distant future,” he added.

And firms facing enforcement can expect the SEC to play hardball on settlement terms. Where in the past many enforcement settlements allowed the accused to deny wrongdoing, Senvest is an example of the commission’s new, more severe tack toward forcing firms to acknowledge their non-compliance under the Biden administration.

In a 2022 speech, Gurbir Grewal, director of the SEC’s division of enforcement, said obtaining admissions of wrongdoing is “an incredibly powerful accountability measure” that can deter others from making the same mistakes.

Not on your watch – under it

Naturally, illicit off-channel communications easily go under the radar, meaning that even if it’s happening frequently, it may appear to managers that all is well.

“Any investment adviser that looks at those cases and says, ‘that conduct was present over there, but I don’t have it in my shop’ – I think they need to look more closely,” said ACA’s Broaded.

He added that advisers facing strong cases against them should co-operate with the SEC and explain how they attempted to prevent offending conduct. He added that they should tell the commission their plans to fight reoccurrences.

And should you find instances of illicit communications at your firm, you should be co-operative with the SEC. The commission’s criteria for setting fines take into consideration the seriousness of the conduct, how common the breaches are at a firm and how co-operative a company is with regulators, said Broaded.

While “under the right circumstances,” some larger firms with significant resources may want to challenge the SEC on these kinds of cases, “most GPs are probably not going to have the stomach to fight the SEC over this,” Patterson Belknap’s Baker said.

Senvest’s failures and remediation

The particulars of Senvest’s case illuminated aspects of what the SEC looks for in these kinds of cases.

The commission claimed (and Senvest acknowledged) that Senvest failed to oversee off-channel communications and to collect copies of the records. It also said employees didn’t send copies to the adviser.

The regulator not only faulted Senvest for the underlying conduct; it said that the adviser failed to live up to its own compliance manual, which largely bars using unauthorized communications for business purposes.

Under its own compliance rules, Senvest employees can only use otherwise unapproved electronic communication for work-related messages during technological disruptions or emergency situations, but they were still obligated “to report such use and copy those communications to their business e-mail accounts so that the communications could be properly archived,” the SEC said.

To mitigate off-channel messaging moving forward, Senvest has given its employees cell phones for communications. The commission said that these phones will automatically upload messages for records retention.

The SEC used Section 204 of the Advisers Act and Rule 204-2 – the latter covers books and records enforcement – in order to enforce against Senvest.