SCOTTSDALE, Ariz. - Despite the lack of a hard-and-fast rule regarding e-mail retention, mutual funds are hard-pressed to get their arms around electronic archiving, a potentially explosive compliance issue that has examiners licking their chops.

The scandals that have pervaded Wall Street in recent years have put e-mail under the microscope, as e-mails have proven to be a window into what goes on behind closed doors at firms entrusted with investor dollars.

"Candid comments are made over e-mail that people would never make over the phone," said Bill Meck, senior assistant district administrator of the Securities and Exchange Commission's Philadelphia office, speaking at a recent compliance conference sponsored by National Regulatory Services. "They let their fingers do the talking."

Indeed, most of the fraud cases brought against mutual fund complexes in the last two years relied heavily on incriminating e-mail correspondence pertaining to market timing and late trading. In one of several condemning e-mails detailed in the complaint against Invesco, a portfolio manager complained that market timing was "killing the legitimate shareholders" of the fund.

In light of the clear and present danger of leaving a smoking gun for regulators to find, many fund chief compliance officers are scrambling to get an e-mail retention policy in place. But without specific guidance from the Commission, they're not exactly sure what examiners expect.

The provision of the Investment Advisers Act that deals with recordkeeping, Rule 204-2, does not make explicit mention of e-mail simply because it is an outdated piece of legislation.

"The landscape is admittedly confusing," Meck told attendees. Still, the law requires that mutual funds keep certain records pertaining to their advisory business, including financial records, advisory agreements, performance data and client-related records such as recommendations, advice and trader orders.

In the eyes of regulators, e-mail is not considered a type of record but, rather, a means of delivery, and therefore should be treated as a traditional business record.

Some CCOs have asked whether e-mails can be printed out and stored as written records while purging the electronic version. There is little formal guidance on this issue, but regulators have hinted that destroying e-mail is not in their best interest. "You delete e-mail at your peril," Meck said, urging funds to be careful not to purge any records that fit the criteria of required records.

Jail Bait

Further, it's imperative to maintain all records, even those not required under the rule, after a lawful request has been made. "Once an exam notice is received, cease all destruction," Meck said. "All e-mails existing at the time of the exam must be produced." Registrants caught deleting e-mails after a lawful request has been made would be in violation of the "spoilage of evidence" laws.

"Destruction of e-mail after lawful request is equivalent to a go-to-jail card," said Steve Stone, a partner at law firm Morgan Lewis.

The bottom line, really, is that fund shops must have e-mail records stored in an organized and easily searchable format so that they can turn around a request from regulators swiftly, which typically means 24 hours. This can be an overwhelming task if there isn't a piece of archiving software sitting on the desktop or a third-party service provider automating the process.

Since the SEC will ask for certain types of e-mails, it's not enough to just keep all your e-mails. "If you keep everything, you still haven't solved the problem of how to sort through it," said Jim Volk, chief compliance officer for SEI Investments' fund accounting and administration business. "You can't just give them all the tapes and say, 'Knock yourself out.'"

Service providers that offer e-mail archiving solutions can come at a hefty price, and many funds are not ready to put up the dough until there are specific rules on the books. "From a cost/benefit standpoint, we'd almost take the chance that we'd have to go through the manual process when needed, as opposed to spending a lot of money on some technology that might not even be necessary a year from now," Volk said.

With that, he was alluding to the fact that the SEC has been known to back off on certain proposals after evaluating its merits, as was the case with the 2% redemption fee rule. While the SEC is not likely to softpedal this issue, many firms are content to wait it out.

Brevity Is Key

Absent a highly sophisticated system, funds have to train their staff to handle e-mail properly. "People tend to use e-mail very unwisely at times," Volk noted. "E-mail is great for keeping track of things, but I'm a huge fan of letting the e-mail be the final summary of what transpired as opposed to a log of the discussions that went back and forth because you can't control it."

Volk also pointed out that people often misconstrue the spirit of what transpired and recommended against making guesses, assumptions or estimates over e-mail because, in the end, you'll have a number of different people making comments without being equipped with having all the facts.

Volk suggested that compliance professionals keep subject lines toned down, so as to not arouse undue suspicion.

For example, instead of putting "big problem" in the header, label it: "Issue to discuss." He also advised that employees be precise and abstain from anything they wouldn't want forwarded to a regulator or end up on the cover of The Wall Street Journal. By keeping that in mind, your e-mails will be smarter, you'll send less of them and you won't wrongfully incriminate yourself by using the wrong word, he said.

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