The UK Financial Services Authority (FSA) has now published its final rules requiring certain of its authorized firms to record and keep telephone and electronic communications. The Policy Statement setting out these rules (PS 08/1) is titled “Telephone Recording: recording of voice conversations and electronic communications.” These rules come into force in March 2009, giving firms one year to put in place any additional data recording systems they may require. While the FSA has scaled back on its consultation proposals, the new requirements will have a significant effect.1
As discussed below, the applicability of the rules extend well beyond the telephone: to email, faxes and any other method of electronic communications. The first part of this memorandum describes the scope and application of the final rules. The second part of the memorandum takes a trans- Atlantic perspective, discussing what FSA firms may expect to see based on US experience, and some of the implications for US firms.
I. The FSA Taping Rule
At present, there is no European Union-wide requirement to record phone calls or electronic communications – the Markets in Financial Instruments Directive, or MiFID, does require firms to make and retain certain records, but Article 51(4) reserves discretion on phone calls and electronic communications to the individual Member States. This MiFID provision is due to be reviewed by the European Commission in conjunction with the Committee of European Securities Regulators by the end of 2009, but the FSA has elected to go ahead with its record retention rules in advance of the outcome of that review. In electing to proceed, the FSA noted that there was no assurance that the EU would in fact adopt any such rule and that, even if a rule were adopted, it would likely be materially narrower in scope than that adopted by the FSA.
In its policy statements, the FSA said that it views recorded communications as a primary tool when combating and taking enforcement action in relation to market abuse (saying that taped evidence can carry particular weight in disciplinary cases as contemporaneous evidence). Thus, the scope of the taping and recording requirements replicate the scope of the market abuse regime and therefore cover “qualified investments” admitted to trading or for which a request for admission has been made on a “prescribed market” and instruments that are related to qualifying investments.
What Must be Taped
Conversations and communications “carried on with a view to the conclusion”2 of a transaction are now generally the subject of taping and record retention requirements. This means that any FSAregulated firm (i) that carries out certain types of activities (ii) with respect to certain types of investments must tape and record (iii) subject to certain limited exceptions.
- Activities. More specifically, the conversations that must be taped are those that involve the following activities: (i) receiving or executing client orders, or arranging for their execution; or (ii) carrying out, executing or placing orders for the firm or its affiliates, including proprietary orders relating to a client order.
The rules do not apply to the following types of personnel: research analysts; back office; corporate finance; investment managers with no authority to deal; and retail financial advisers.
- Instruments. The instruments that the taping requirement applies to are equities, bonds, financial commodities, and financial derivatives in each case for which the instrument or the underlying or related instrument is traded on the London Stock Exchange, AIM or PLUS markets.3
- Means of Communication. In order not to be outpaced by technological developments, the FSA has not defined all means of communications it requires to be recorded. They will, though, include telephone conversations on land-lines, emails, faxes, Bloombergs, video calls, SMS (text messages) and instant messages. Mobile phone calls are not currently included, but the FSA will review this decision in 18 months.
The FSA had originally proposed a three year retention period, but the final rules only require a sixmonth period during which firms must take “reasonable steps”4 to keep records in a way that makes them easily accessible to the FSA. Firms that are subject to an FSA inquiry, investigation or enforcement action may have to keep their records for longer.
The FSA does not mandate technical specifications to enable prompt and accurate retrieval, but firms will have to focus on appropriate methods both for storage, and for searches in order to be able to respond should the FSA make a request for information.
Application to Investment Managers
The FSA has backed away from its earlier proposals to make all investment managers subject to the rules. The new rules expressly exempt discretionary investment managers when they are communicating with other firms that are subject to the UK requirements to tape and record, e.g., UK sell-side firms. In addition, managers will not be required to record communications with firms not covered by the taping rules, which will include non-UK firms, provided those communications are “infrequent” and “represent a small proportion” of the total sum of their electronic and telephonic communications.5 UK managers that trade on a frequent basis with US counterparties will have to record those communications, because those counterparties are not subject to the UK (FSA) taping rule. If those communications are infrequent, they will be exempt.
II. The Trans-Atlantic Perspective
Existing US Law
Currently, broker-dealers registered with the US Securities and Exchange Commission are required to keep all communications relating to their “business as such” (understood to mean almost anything), including internal communications, for a period of three years, the first two years in a readily accessible place. The rule is now applied to e-mails and other written electronic communications, but not to telephone communications, even if those conversations are taped in order to avoid trade disputes.6
Investment advisers registered with the US Securities and Exchange Commission are required to keep written communications (not telephone calls) relating to matters such as recommendations and the placing of orders. The scope of the retention requirement for US advisers is thus somewhat more specific than it is for broker-dealers. However, investment advisers are subject to a longer retention requirement. Most investment advisers’ records must be kept for the current calendar year plus five more.
The most obvious aspects of the trans-Atlantic comparison are of course that the FSA rules apply to telephone conversations and that the UK record retention requirement is shorter. In addition, the scope of the FSA requirements is narrower and the purpose specified in more detail (see more on these points in the final paragraph). Further, the US rules do not generally apply to swaps and certain other derivatives that may be effected in banks or other entities not regulated by the SEC.
Impact in the United States
US persons talking to firms subject to the FSA rules should now be aware that all of their conversations, including voice conversations, are likely to be subject to taping as of next year. This taping requirement will apply not only when a US adviser talks to a UK sell-side firm, but also when a US sell-side firm talks to its UK affiliate.
A Few Considerations Based on the US Experience
Although the FSA rule is limited in scope, as a practical matter it is very difficult to devise a taping system that conforms to the scope of the requirement, rather than going beyond it. For example, if one records and retains emails, it is almost impossible, and it is in any case expensive, to retain only those emails that are within the scope of the retention rule. Most US firms keep all emails, simply because deciding the ones that are not required to be retained would be overly burdensome.
It can be surprisingly difficult to figure out, on an ongoing basis, all the ways and places in which communications generate, and to be assured that one is capturing them all. US firms have been subject to numerous disciplinary actions for recordkeeping failures. At a minimum, firms will find it necessary to conduct systematic audits of their organizations to determine the areas of the firm that are subject to the rules. Having identified relevant areas of the firms, a second audit of the means of electronic communication will be required. In dynamic organizations, both types of audit must be periodically updated.
The requests for documents that will be made by the regulators will grow exponentially with the number of documents that are retained.