Joel C. Haims
Corporate, Emerging Companies + Venture Capital, Litigation, Securities Litigation, Securities Enforcement, and Investigations + White Collar Defense
On May 10, 2006, the SEC announced that it had filed a civil injunctive action against Morgan Stanley & Co. for allegedly failing to produce emails and electronic records in a timely manner during the course of two separate SEC investigations, and that Morgan Stanley had agreed to settle the matter. The action arose from Morgan Stanley’s electronic document preservation and production practices during SEC investigations into the company’s practices in allocating IPO shares and into possible conflicts of interest between the company’s research analyst and investment banking divisions. The civil injunctive action represents a significant departure from the SEC’s usual practice of filing an administrative action to address document preservation issues, and signals a more aggressive approach to document preservation and production in matters under investigation.
Federal securities laws, including Section 17(b) of the Securities Exchange Act of 1934 (hereinafter "Exchange Act"), 15 U.S.C § 78(q)(b), and Exchange Act Rule 17a-4(j), 17 C.F.R. § 240.17a-4(j), require a company to make its records available to the SEC in a prompt and timely manner. Under Exchange Act § 17(b), a broker-dealer is required to submit its records to the SEC as part of a routine or special examination. In complying with this provision, Exchange Act Rule 17a-4(j) requires a broker-dealer "to furnish promptly" to the SEC those records that are required to be preserved and those records which are the subject of the SEC’s examination.
The SEC asserted that Morgan Stanley violated Exchange Act § 17(b), 15 U.S.C § 78(q)(b) and Exchange Act Rule 17a-4(j), 17 C.F.R. § 240.17a-4(j) by failing to preserve and promptly produce electronic documents sought by the SEC in the context of its investigations. The SEC’s action focused on Morgan Stanley’s practices for retaining, reviewing, and producing emails in response to subpoenas and document requests issued between December 2000 and October 2004. In its complaint, the SEC alleged that Morgan Stanley repeatedly failed to retain, diligently search for, and produce responsive emails. The company also misrepresented the status of its email preservation and production systems to the Commission on a number of occasions.
According to the SEC’s complaint:
The SEC alleged that Morgan Stanley’s repeated email production failures and misstatements delayed the SEC’s research analyst and IPO investigations and caused the SEC to expend significant resources to complete those cases.
To settle the action, Morgan Stanley consented to a final judgment that permanently enjoined it from violating Exchange Act § 17(b), 15 U.S.C § 78(q)(b) and Exchange Act Rule 17a-4(j), 17 C.F.R. § 240.17a-4(j) and agreed to pay a $15 million fine, $5 million of which was to be distributed to the NASD and the NYSE in separate related proceedings. Morgan Stanley also agreed to implement email document preservation and production policies, procedures, and training, and will hire an independent consultant to review the company’s reforms. Morgan Stanley did not admit or deny the allegations in the SEC’s complaint.
This matter highlights the SEC’s increasingly strong interest in timely and complete document productions. Moreover, the fact that the Commission charged Morgan Stanley with violations of the "examination" provisions of Section 17 of the Exchange Act establishes it has the ability and the willingness to seek stiff sanctions not only in the context of failing to provide required records during the course of an enforcement investigation, but during a routine examination as well. The Commission’s somewhat unusual decision to file a civil injunctive action—rather than an administrative action—against Morgan Stanley indicates that the SEC will vigorously pursue companies which fail to implement timely, efficient, and effective document preservation and production procedures.
1: Section 17(b) of the Exchange Act and Rule 17a-4(j) thereafter by their terms relate to the SEC’s authority to conduct examinations of registered broker-dealers and the obligation of those broker-dealers to produce required records to the SEC’s examination staff. The SEC in its complaint notes that those provisions can also be cited to require the production of records to its investigative or enforcement staff.
2: The SEC previously sanctioned Morgan Stanley for failing to preserve emails relating to a broker-dealer’s business for at least three years under the record retention provisions of Section 17(a) of the Exchange Act and Rule 17a-4(b)(4) thereunder, as explained in Exchange Act Release No. 38245 (Feb. 5, 1997). See In the Matter of Deutsche Bank Securities, Inc., et al., Exchange Act Rel. No. 46987 (Dec. 3, 2002).
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