Fund Firms Wrestle E-Mail Monster: Industry Takes Save Everything' Approach
February 20, 2006
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.