The Securities and Exchange Commission recently tackled some thorny issues involving independent contractors (“ICs”), their use of electronic business communications, and their broker-dealers' responsibility to archive and subsequently produce such communications.
In the Matter of vFinance Investments, Inc. and Richard Campanella, the SEC focused on the activities of independent contractor Nicholas P. Thompson, a registered representative with Florida-based vFinance Investments from June 2002 through August 2006 and the manager of the firm's Flemington, N.J. branch office. The office was a market maker in Lexington Resources Inc., and Thompson represented retail clients trading in the issuer.
Lexington was his most actively traded stock and produced $274,334 in commissions for him, even though Lexington had only $40,000 in revenue during the relevant period that the SEC examined. Thompson was frequently the inside bid and offer; moreover, vFinance logged 69 percent of Lexington's trading for the first four months of 2004.
In January 2008, the SEC charged Thompson with aiding and abetting vFinance's violations of securities law, and he settled without admitting or denying the charges. Thompson was ordered to cease and desist, pay a $30,000 fine and was barred from the industry with a right to reapply after five years.
The trouble didn't end with Thompson. In July 2010, following a hearing and appeal, the SEC found that vFinance failed to preserve and promptly produce electronic communications regarding its trading in the Lexington securities, and that Richard Campanella, the firm's chief compliance officer, chief operating officer, and president, willfully aided and abetted these violations. The SEC censured Campanella, and fined the firm $100,000 and Campanella $30,000.
vFinance reminds the industry that “business correspondence” includes electronic communications such as e-mails and instant messages (IMs) with both outside parties and within the broker-dealer. Further, it is the content of a given communication rather than its format that determines whether any message is personal or business. The SEC is adamant that there can be no compliance policies that simply deem communications as “personal” based solely upon an employee's IC status or in consideration that the transmitted materials utilized a third-party email/IM address. If it's related to a member firm's business, then it's up to the firm to supervise or prohibit the communication. No ifs, and, or buts.
During the SEC's investigation, vFinance largely left it up to Thompson to decide which of his communications were relevant to various SEC requests for documents and whether he should produce any materials. vFinance apparently viewed Thompson's IC status as rendering some of his communications as off base and private. Moreover, vFinance was aware that Thompson was using an outside email account (“blast.net”) and non-archived IMs; the firm knew that such usage was not fully in accord with its compliance policies, and some communications were not being archived by the firm. As you may expect, the SEC took a very, very dim view of those facts.
The delegation of vFinance's document production responsibility to Thompson was described by the SEC as “questionable from the outset” given Campanella's knowledge of red flags concerning Thompson's Lexington trading. Further, Thompson had previously disregarded Campanella's instructions to cease using the blast.net account for business communications - a pattern that the SEC viewed as indicative of Thompson's unwillingness to heed either the recordkeeping requirements or direct instructions from Campanella. Finally, the SEC was troubled by vFinance's tepid efforts to independently search its and Thompson's offices and storage media - much of that search was apparently left to Thompson's good faith.
Make It Your Business
The SEC bluntly dismissed any suggestion that vFinance was legally constrained by Thompson's status as an IC. Veteran compliance and regulatory professionals familiar with these cases will note the harsh rebuke served up by the regulators:
“Respondents' conduct was egregious. Rather than prioritizing compliance, Respondents authorized lapses in recordkeeping, engaged in dilatory tactics stalling production, and disregarded clear red flags demonstrating the impropriety of their reliance on Thompson to preserve and produce records. Respondents' Exchange Act violations ultimately facilitated the destruction of the only version of certain records critical to a Commission fraud investigation.”