The lapse came as New York Attorney General Eliot Spitzer began to unearth emails by Wall Street analysts who disparaged as "junk" stocks they publicly recommended. Spitzer's investigation of analysts' conflicts of interest led to an $875 million settlement with ten Wall Street banks, showing that email could be a major tool for cracking down on wrongdoing.

As Spitzer's probe began, the SEC was responding to Wall Street's complaints that its email rules were too broad. Annette Nazareth, then the director of the SEC's market regulation division, called the NYSE in the spring of 2001, according to testimony by Salvatore Pallante, then the NYSE executive vice president for member firm regulation.

Pallante testified earlier this year in a case against a Wall Street firm that Nazareth asked the NYSE to stop reporting email and record retention violations to the NYSE enforcement division. The SEC also asked the NYSE to withdraw reports made while the SEC was in discussions with the industry. The testimony was available through the SEC's public records office.

Lori Richards, the director of the SEC's office of compliance, inspections and examinations, told Pallante that she agreed with Nazareth's approach, Pallante said. He said that the NYSE dropped cases it had developed against about 12 member firms after the conversations. In an interview with Dow Jones Newswires, Ed Kwalwasser, who was the NYSE's vice president of regulation in 2001, confirmed Pallante's account.

Pallante didn't return a phone call, and NYSE spokesman Brendan Intindola declined to comment. A call to Richards' office was referred to the SEC press office. SEC spokesman John Heine declined to comment. Nazareth, now an SEC commissioner, declined to comment.

The SEC hasn't contested Pallante's account. Still, in a brief responding to his testimony, the SEC argued that the commission didn't engage in misconduct and that SEC staff opinions aren't the same as the views of the five-member commission. The SEC also argued that its rule is clear.

The SEC requires brokerage firms to keep email messages for three years, with the two most recent years' worth in an easily accessible place. Wall Street has long complained about the regulation, saying it is too broad, strains the limits of storage technology, and could apply even to personal emails, such as messages between brokers or analysts making dinner plans.

The email requirement was first spelled out in a February 1997 SEC release. By 2000, the SEC was in closed-door discussions with Wall Street firms about narrowing the regulation. The discussions were still going on by 2001, when Nazareth made her phone call, according to Pallante's testimony.

In the meantime, Spitzer had begun an investigation of analyst recommendations in which his office reviewed thousands of emails. The probe, which began in June 2001, turned up email showing star Merrill Lynch & Co. analyst Henry Blodget describing InfoSpace Inc., one of the firm's highest-rated stocks, as "a piece of junk."

Since that case, regulators have become aggressive in fining firms that failed to keep email. In December 2002, the SEC, the NYSE and the NASD fined five firms $8.25 million, or $1.65 million apiece. Penalties are increasing: UBS Securities LLC and J.P. Morgan Securities Inc. were fined this year, agreeing to pay $2.1 million apiece to settle with regulators.

Some securities lawyers defend Nazareth's approach. They say that the SEC was trying to respond to complaints about the 1997 mandate at a time when it seemed Wall Street was negotiating in good faith.

An SEC administrative law judge will weigh in soon. Raymond James Financial Inc. is fighting an SEC charge that it failed to fully preserve email by arguing that the SEC had planned to change its own rules and is using Pallante's testimony to bolster its case. SEC Chief Administrative Law Judge Brenda Murray is set to make a decision in the matter by Sept. 15.

Some investor advocates question why the SEC would have considered accommodating the wishes of the brokerage industry in the first place.

"Who in their right mind decides we're going to lighten up on record retention policies for the new, emerging, primary way people communicate in the market?" said Barbara Roper, director of investor protection for the Consumer Federation of America. "What genius came up with that idea?"