There's a story the folks at the James Advantage Funds like to tell about the last bull market, when the contrarian lost close to $600 million in assets by largely ignoring the tech boom. Instead of battening down the hatches and letting a few people go, its founder, Dr. Frank James, paid all 19 employees out of his own pocket and rode out the storm.
Chalk it up to old-fashioned, Midwestern ideals, employees say. Whatever the case, that company culture made it difficult last year for company president and CEO Barry James to install an e-mail retention, retrieval and storage system - a sort of big brother to keep track of electronic correspondences at the firm's headquarters in rural Dayton, Ohio.
But as the James funds and other smaller fund shops across the country are discovering, the real drawback to a sound compliance program that includes e-mail retention technology is its staggering costs.
A spate of regulatory cases involving some big-time broker/dealers, however, illustrates just how expensive it can be when a robust system isn't in place.
Last spring, Charlotte, N.C.-based Bank of America was hit with a $1 million fine for not retaining accurate records, while in January, Swiss banking giant UBS was hit with a $49.5 million penalty for trading abuses, a fine that was inched higher because of e-mail record lapses. And just last week, New York broker Morgan Stanley reached a $15 million settlement with regulators for failing to retain e-mails.
Ironically, while the Securities and Exchange Act of 1934 and Investment Advisers Act of 1940 are relatively clear in their guidance on retaining books and records as they pertain to broker/dealers, some experts protest that the SEC hasn't provided money managers with the same sort of roadmap. At least on paper, said Barry James, whose shop manages $1.5 billion in assets.
"Information about e-mails from the SEC was a little a fuzzy, but it became very clear after they cited a few people," said James, who was scheduled to deliver his compliance package to his fund directors last week.
James wouldn't elaborate on what the technology is costing his firm, but suppliers suggest that an asset manager with fewer than $2 billion under management and less than 20 employees is likely forking out $20,000 annually.
"We retain all e-mails now, inbound and outbound," James remarked. "We can also search by date, by person and by phrase. But it's not cheap, especially for a smaller firm like ours."
Tim Johnson, a partner at Reed Smith in Pittsburgh, said money managers have been waiting more than a year for clearer guidance from the SEC on e-mail retention. He said advisory firms are having trouble determining which e-mails should be considered books and records, how those e-mails should be stored and what kind of search-and-retrieval technology they need.
"The SEC has made it the asset manager's responsibility to determine what should be kept and what should be deleted," said Johnson, who recently published a study on e-mail compliance practices. "That is incredibly burdensome."
Although Johnson asserts that nowhere in the '40 Act does it state, "Thou shalt keep e-mails," he said the recent posture by the SEC "smacks of rulemaking without following the administrative proceedings act."
More problematic, he offered, is that until just recently, the SEC was requesting random e-mails "every time they walked into an advisory shop," regardless of whether fraud had been committed in the past. According to his study, 77% of fund firms have had regulators request e-mails as part of everything from a routine examination to more serious sweep exams.
Typically, the SEC sought between 10,000 and 30,000 for each request. More troubling, Johnson said, was that 11% of the firms asked to provide e-mails could not deliver exactly what the SEC wanted.
The task is even costlier when a firm doesn't have its own technology.
Johnson recently assisted a money manager in a search of e-mails written by 18 employees over a 90-day period. The review was conducted in connection with a routine books and records exam. A team of lawyers manually reviewed 53,000 e-mails for problematic behavior. Outside of a couple records lapses, no violations were found, but at the end of the day, it cost the firm $250,000.
"The customer got the value. We delivered what we said we would, but all they were left with was the comfort that that slug of e-mails was clean," Johnson said, adding that some larger firms are paying "millions by the month" for similar reviews.
As such, the industry is beginning to push back, he said. Although the SEC isn't actively soliciting feedback on e-mail retention, Johnson said the regulator is receiving a hailstorm of letters from asset managers expressing disappointment in its guidance to date. Until the SEC delivers more exact standards for e-mail retention, said Janaya Moscony, president of SEC Compliance Consultants in Philadelphia, they're left with little alternative.
"Just save everything," she said. "If [regulators] see an outbound message but no inbound message to match, that's an indication that everything isn't being saved."
Don't use outside e-mail accounts, either, Moscony advised. And in terms of cost, she said more and more vendors are emerging, so the price for a third party to perform e-mail retention and retrieval is becoming more competitive. But if your shop also leverages a compliance consultant, she warned, don't use their vendor.
"A lot of vendors call us and want us to work as resalers, but we don't because it creates a conflict of interest," she said.
The good news, Moscony said, is that the SEC appears to be ratcheting back its e-mail requests during routine exams, and the focus is shifting to items like transaction blotters, although the regulator is asking for more data over longer timeframes. Nonetheless, she said, the standing rule is to retain all documents related to books and records for five years. Two years of that must be stored onsite. And if an asset manager is really struggling to determine what counts as a books and records document, Moscony said section 204-2 of the '40 Act "spells that out pretty clearly."
As second- and third-tier managers continue to build their systems, the trend today among larger asset managers is to beef up systems that date back to the early 1990s, said Ralph Severini, a marketing manager for the e-mail retention systems supplier Hummingbird in New York.
"The big guys have already done what they should, and now they're trying to protect against tampering," Severini said. "Some traders are quite technically astute and good at finding ways around steps that have been taken to protect the business."
Since fraud is rarely written about openly, however, it's important that an e-mail retention system's search function includes what's called a "semantic capability," or the capacity to return "like-minded" phrases in addition the original search term.
But building a robust e-mail retention system - most firms will probably find that the technical foundation is already in place - starts with a clear understanding of your business, said Michele Kersey, an industry manager in Hummingbird's commercial sector in Toronto.
"In approaching the problem, storage and search options are critical items to consider, but doing your policy homework is just as important," she said. "Know what you need to keep and for how long before you begin."
In the current regulatory environment, that might be easier said than done.
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