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1 January 10, 2002 Financial Services Compliance Advisory Proposed Money Laundering Regulations Broaden Foreign Bank Correspondent Accounts Coverage and Reporting Obligations of Broker-Dealers In the final days of 2001, the U S Treasury Department and the Federal Deposit Insurance Corporation issued several proposed regulations implementing the USA PATRIOT Act The Treasury proposals will require a broad range of financial institutions including for the first time all broker-dealers to put in place significantly stronger and more complex compliance programs regarding the potential money laundering activities of a broader range of account holders than ever before required In addition, the FDIC action alerts the banking industry that, effective immediately, money laundering monitoring practices will be an important consideration when federal regulators review merger applications 1 The timetable for commenting on the Treasury Department s proposed regulations ranges from six to ten weeks The regulations will all be finalized before the fall of 2002 Financial institutions of all types will be affected by these coming changes The ambitious regulatory agenda under the USA PATRIOT Act requires that many new requirements be finalized on an accelerated timetable 2 It would be prudent to review in detail the upcoming requirements to ensure the existence of strong compliance programs This Advisory considers in detail each of these new money laundering proposals, as well as other related actions announced by the government in late December In addition, the Advisory provides a 10 Step Compliance Checklist to assist potentially affected U S financial institutions in preparing appropriate responses to the new U S antimoney laundering regulatory regime Proposed Regulations Would Create Wide Coverage Requirements 1 Under the USA PATRIOT Act, all federal financial regulators must now consider money laundering records in approving mergers The OCC advisory letter of December 20, 2001 on USA PATRIOT Act Anti-Money Laundering Provisions (OCC AL ) also includes reference to these requirements for the federal banking agencies 2 See Alston & Bird LLP Advisory, A Detailed Summary of Major Provisions in the International Money Laundering Abatement and Anti- Terrorist Financing Act of 2001 (P L ), dated November 13 and located at alston com/docs/advisories/199709/ A%20Detailed%20Summary pdf The proposal that is likely to have the widest impact on the financial services industry was published on December 28, 2001 by the U S Treasury Department (Treasury) The proposed rule implements new provisions of the Bank Secrecy Act created under the USA PATRIOT Act (Act) that prohibit U S financial institutions from providwww alston com

2 ing correspondent accounts to shell banks The proposed regulation would replace Interim Guidance issued on November 20, Comments are due February 11, 2002 Under the proposed regulation, all correspondent accounts held by a U S financial institution on behalf of any foreign bank must be closed by 90 days after the final regulations are issued, unless the foreign bank has provided the U S financial institution a Certification or other means of verification that the institution is not a shell bank (see below) The proposal defines correspondent accounts broadly to include all transaction accounts, dollar settlement accounts, fiduciary accounts, time deposit and money market accounts, and foreign exchange, securities, derivatives, and repurchase agreements Notably, Treasury proposes to impose identical requirements on broker-dealers as are imposed on depository institutions In both cases, foreign branches of the relevant U S institution are required to obtain Certificates from foreign banks that are bank account holders just as if the foreign branch were located in the U S By contrast, foreign affiliates of U S broker-dealers and depository institutions are treated as if they are foreign banks, and are merely required to provide Certificates in response to requests from their U S affiliates U S -based affiliates of financial institutions headquartered overseas are treated as U S institutions, and are required to obtain Certificates just as if they were headquartered in the U S In deference to the principle of home supervision, the foreign headquarters and foreign affiliates of such financial institutions are not subject to this obligation Broker-dealers would be brought into the money laundering regulatory regime even more directly under a proposed regulation published on December 31, 2001 by the Financial Crimes Enforcement Network of the Treasury Department (FinCEN) The proposed regulation relates to suspicious activity reports (SARs) filed by broker-dealers Among its provisions is the requirement that broker-dealers report any transaction involving funds suspected to be used to violate any federal law or regulation The comment period ends March 1, 2002 Separately, the Federal Deposit Insurance Corporation (FDIC) issued a Financial Institution Letter (FIL) on December 28, 2001 stating that the FDIC will expressly consider the anti-money laundering programs of each depository institution involved in any bank merger when determining whether to grant consent to the proposed transaction This became effective for all applications filed after December 31, 2002 reflecting a policy mandated of all federal financial regulators by the Act Proposed Money Laundering Regulations Cover Foreign Bank Correspondent Accounts Treasury s proposed regulation on foreign bank correspondent accounts was published in the Federal Register on December 28, 2001 and would replace the Interim Guidance, as previously noted 4 The proposed regulation, like the Interim Guidance, directs covered U S financial institutions to require that foreign banks that hold correspondent accounts with them certify certain specified information, including that they have a place of business and are regulated As noted above, the proposed regulation defines correspondent accounts very broadly, and would require compliance from broker-dealers, as well as depository institutions Treasury has requested comments on the breadth of the definition of correspondent account as applied to accounts maintained by both depository institutions and broker-dealers for foreign banks Treasury specifically seeks comments on whether particular types 3 See Alston & Bird LLP Advisory, Treasury Issues Interim Guidance Requiring Certification of Correspondent Bank Accounts, dated November 29, 2001, and located at alston com/docs/advisories/199709/treasury%20issues pdf 4 Department of Treasury; Counter Money Laundering Requirements; Correspondent Accounts for Foreign Shell Banks; Recordkeeping and Termination of Correspondent Accounts for Foreign Banks; proposed rule 66 Fed Reg at (December 28, 2001) 2

3 of accounts pose so little vulnerability to criminal transactions as to merit exclusion from the broad definition of correspondent account Affected financial institutions that hold types of accounts that they believe should not be subject to the certify-or-close requirement, may wish to take advantage of this important opportunity for comment Comments are due by February 11, 2002 Certification Requirements Differ from Interim Guidance The information required for Certification is set forth in a model Certification form published by Treasury as part of the Interim Guidance, and republished with minor modifications as part of the proposed regulation 5 While the proposed regulation is consistent with the Interim Guidance in many respects, it goes beyond it in several key areas: Provides explicit coverage of broker-dealers under the same terms as depository institutions Details specifics as to the inclusiveness of the term correspondent account Treasury s commentary to the proposed regulation states that the term includes not only transaction accounts under the Federal Reserve s Regulation D, but also clearing and settlement accounts, fiduciary accounts, custody accounts, escrow accounts, time deposit accounts, money market deposit accounts and transactions with foreign banks in securities, derivatives, repurchase agreements, foreign exchange, and other instruments to the extent that these transactions involve an account In addition, the Treasury commentary states that the term encompasses a wide array of accounts maintained by broker-dealers, including securities accounts and brokerage accounts (whether individual, omnibus or consolidated), foreign currency trading accounts, over-the-counter derivatives accounts and futures accounts 6 Provides further specification to the term covered financial institution, which includes not only depository institutions, private bankers, and broker-dealers, but also agencies or branches of foreign banks located in the U S The Treasury commentary states that covered financial institutions include the foreign branches of the covered financial institutions, as they are entities that legally are part of covered financial institutions 7 Foreign branches of covered financial institutions would be required to obtain Certificates from foreign respondent banks; foreign affiliates of such institutions would not Provides further specification regarding the term foreign bank, which is described as: (i) any entity organized under the laws of a foreign country; which (ii) engages in the business of banking; (iii) is recognized as a bank by the bank supervisory or monetary authority of the country of its organization; and (iv) receives deposits in the regular course of its business It does not include U S agencies or branches of foreign banks 8 Requires that covered financial institutions close accounts of foreign banks that have failed to provide the required Certification or the equivalent information within 90 days of the issuance of the final regulation For accounts 5 For the model Certification form, see 66 Fed Reg at Fed Reg at 67461; see also the definition at 31 C F R (b) The formal definition remains unchanged from the statute and the Interim Guidance; only the Treasury commentary provides the detailed explanation 7 66 Fed Reg at 67462; see also the definition at 31 C F R (c), which specifies that covered financial institutions include foreign branches of insured banks 8 31 C F R (d) 3

4 of foreign banks that are opened more than 30 days after the final regulation is issued, the period before an account must be closed in the absence of a Certification or its equivalent is reduced In the case of an account established before January 1, 2003, Certification must be provided within 60 calendar days; for accounts established after December 31, 2002, within 30 calendar days 9 Specifies that covered financial institutions must be re-certified every two years by obtaining further verifications that accounts they hold do not pertain to shell banks 10 Notably, Treasury remains silent for now on the question of when and how sanctions will be applied to financial institutions that maintain accounts with shell banks Under the USA PATRIOT Act, civil penalties for international money laundering offenses, including those involving shell banks, shall be levied in at least the amount of twice the value of the funds involved in a transaction, up to a total of $1 million, with penalties assessed for each day a violation of the Bank Secrecy Act takes place The proposed regulations do not provide guidance as to the circumstances under which this sanction would be imposed 11 However, they do specify that failure to close a correspondent account of a foreign bank within 10 days upon request by the Secretary of the Treasury or the Attorney General, following the foreign bank s failure to respond to a subpoena, carries with it a penalty of $10,000 per day 12 In any case, all U S financial institutions will be subject to examination on the new anti-money laundering obligations, enabling regulators to tailor sanctions for violations found by examiners as deemed appropriate But Basic Elements of Certification Remain Unchanged The basic elements of the Certification have changed little from the Interim Guidance As before, the respondent bank must specify whether it: (i) has a fixed place of business in a country in which it is regulated by a banking authority; (ii) is an affiliate of an institution that has a fixed place of business and is so regulated and subject to inspection; or (iii) does not have a physical presence in a country and is not a regulated affiliate Accounts in category (iii) are prohibited by the Act and must be closed In a minor change to the Interim Guidance, a respondent bank must now certify that it does not use any correspondent bank with the Covered Financial Institution to indirectly provide banking services to any foreign bank that does not have a physical presence in any country and that is not a regulated affiliate, with the word indirectly representing the substantive change As before, the respondent bank must: i) identify any owner or group of owners that own 25 percent or more of the institution or control a majority of its directors (including through ownership chains); ii) identify its home country address and regulator; and iii) provide the name and address of an agent designated to accept service of legal process on its behalf in the United States While theoretically there are alternatives to the Certification process, in practice, these alternatives are limited Accordingly, all U S depository institutions, private bankers, and broker-dealers should develop a plan to secure Certificates from the maximum number of foreign banks with whom they have an account relationship Each such foreign bank should be advised that any failure by it to provide a Certificate within 90 days following the issuance of the final regulation (currently anticipated to be on or about March 1, 2002) subjects it to the closure of its U S 931 C F R (d)(2) C F R (c)(1) 11 See USA PATRIOT Act, Section 363, increase in civil and criminal penalties for money laundering; and existing language of 31 U S C 5321(a)(1), which specifies that a money laundering violation occurs for each day the violation continues and at each office, branch, or place of business at which a violation occurs or continues under the Bank Secrecy Act Fed Reg at 67468; 31 C F R

5 accounts Covered U S financial institutions should also develop appropriate procedures to permit the rapid clearance and closure of any such account for which a Certificate or other equivalent verification has not been obtained in compliance with the proposed regulation U S depository institutions, broker-dealers and other entities covered by the proposed regulation should consider how best to comprehensively avoid the twin threats posed by the Treasury s approach On the one hand, they risk losing accounts due to the failure of foreign banks to provide requested Certificates on a timely basis; on the other hand, they risk liability for non-compliance with the Act as a result of maintaining a foreign correspondent bank account in the absence of Certification or equivalent verification Suspicious Activity Reporting Requirements for Broker-Dealers On December 31, 2001, FinCEN issued a proposed regulation to amend the Bank Secrecy Act regulations to require broker-dealers to report suspicious transactions to the Department of Treasury 13 Comments are due by March 1, 2002 Reporting Guidelines Under the proposed regulations broker-dealers would be required to report on all transactions involving or aggregating funds or other assets totaling $5,000 or more when: The broker-dealer detects any known or suspected Federal criminal violation, or pattern of criminal violations, committed or attempted against the broker-dealer, or involving a transaction or transactions conducted through the broker-dealer; or The broker-dealer knows, suspects, or has reason to suspect that the transaction or transactions involve funds derived from illegal activity or are conducted to hide or disguise funds from illegal activity In this category, the transaction must be reported as suspicious merely if the broker-dealer determines that it is not the sort in which the particular customer would normally be expected to engage and after due inquiry, the broker-dealer knows of no reasonable explanation for it 14 Both categories are intended by FinCEN to be interpreted broadly, and to cover not only currency transactions involving the placement of illicit funds, but wire transactions at the placement, layering and integration stages of money laundering as well The first category explicitly includes cases in which the broker-dealer was itself a victim of the crime, as might occur in a case of securities fraud, as well as those in which the transaction was used to facilitate a criminal transaction involving a crime unrelated to the broker-dealer The second category includes all forms of money laundering, including any transaction that is part of a plan to violate or evade any federal law or regulation, without exception SAR Filing Requirements Under the proposed regulation, broker-dealers must file a Suspicious Activity Report Broker or Dealers in Securities (SAR-BD) form with FinCEN within 30 days of the initial detection of facts that may constitute a basis for filing The broker-dealer is granted an additional 30 days to report in cases where it has reason to believe a violation may have occurred, but has yet to identify a suspect 15 Broker-dealers would 13 FinCEN; Requirement of Brokers or Dealers in Securities to Report Suspicious Transactions; proposed rule 66 Fed Reg at (December 31, 2001) C F R (a)(2) C F R (a)(3) 5

6 be required to report immediately any continuing or ongoing money laundering schemes to both law enforcement authorities and the Securities and Exchange Commission Broker-dealers and their officers and employees would not be permitted to disclose any SAR report, except as requested by the government The proposed regulation also limits liability to third parties for filing any SAR by the broker-dealer, and sets forth certain exceptions to the SAR requirement in cases involving specified non-money laundering violations of federal securities and related laws Notably, the proposed regulation extends the SAR obligation to insurance companies and their affiliates that are registered broker-dealers for the purpose of selling variable annuities, and would eliminate the existing exemption for such broker-dealers 16 The rule is expected to become effective sometime this fall (the Act mandates the effective date fall 180 days after the rule is finalized) FinCEN has stated that prior to the effective date it will issue a separate regulation providing the details on what steps broker-dealers must take under the Act to develop and implement programs designed to guard against money laundering 17 FinCEN Proposes Other Money Laundering Guidance and Regulations On December 28, 2001, FinCEN also issued guidance to remind money services businesses (MSBs) of their obligation to report suspicious transactions to Treasury from January 1, 2002 forward 18 On December 31, the agency issued a second proposed regulation making existing currency transaction reports (CTRs) filed by nonfinancial trades or businesses with the IRS available to FinCEN It also issued an identical Interim Rule imposing the CTR obligation until a final regulation is in force 19 Under the new MSB guidance, FinCEN advises money transmitters and issuers, sellers and redeemers of money orders and traveler s checks, of their obligation to report suspicious transactions within 30 calendar days after the date of the initial detection of facts that might constitute a basis for filing an SAR FinCEN s proposed regulation and Interim Rule governing currency reports by non-financial businesses allows the existing currency transaction reporting forms submitted by non-financial trades and businesses to the IRS to be simultaneously shared by FinCEN and the IRS (which uses the information for tax investigations) This change has no impact on existing reporting obligations Rather, it provides FinCEN with the independent ability to use existing information for investigations of financial crimes, including money laundering The FDIC s Financial Institution Letter on Bank Mergers On December 28, 2001, the FDIC issued an FIL specifying that as of January 1, 2002, it would consider the anti-money laundering records of all of the banks involved in a potential merger in determining whether to consent to the proposed merger transaction 20 This merely restates the statutory obligation imposed by Section 327 of the USA PATRIOT Act The identification of anti-money laundering compliance as a separate factor in federal review Fed Reg at This requirement is set forth in 31 U S C 531(8(h), which requires financial institutions to take reasonable steps to guard against money laundering, including establishing enhanced due diligence procedures 18 FinCEN; Requirement that Money Transmitters and Money Orcder and Traveler s Check Issuers, Sellers and Redeemers Report Suspicious Transactions; Effective Date and Reporting Form 66 Fed Reg (Dec 28, 2001) 31 C F R (b)(3) 19 FinCEN; Requirement that Nonfinancial Trades or Businesses Report Certain Currency Transactions; proposed rule 66 Fed Reg (Dec 31, 2001) Interim rule, final and proposed rules at 66 Fed Reg (Dec 31, 2001) 20 FDIC FIL , Merger Applications (Dec 28, 2001) 6

7 of bank mergers compounds the importance of adherence to the new Treasury rules In the FIL, the FDIC stated that it is currently coordinating with the other federal banking agencies to finalize the application of this new requirement The FDIC stated that its consideration of the anti-money laundering record will initially include an analysis of each participating depository institution s record of compliance with applicable Bank Secrecy Act requirements, including the adequacy of policies and procedures, as well as ongoing compliance with financial recordkeeping regulations It warned that adverse findings in this area may form the basis for a denial of the application The FDIC further stated that it intends to publish proposed interim changes to the FDIC Statement of Policy on Bank Merger Transactions and its merger-related regulations in the near term An Ambitious Agenda for 2002 The new federal regime for money laundering has begun to take shape, and will continue to evolve over the course of 2002 as Treasury and other federal regulators issue further regulations to implement the USA PATRIOT Act In the months to come, due diligence programs, new know your customer standards, and other obligations mandated by Congress will emerge as proposed Treasury regulations As a number of these regulations will have relatively quick implementation and compliance deadlines, U S financial institutions, including broker-dealers, should consider adopting an aggressive approach that anticipates the upcoming compliance obligations and thereby reduces institutional risk Attached is a Ten Step Compliance Checklist for U S Financial Institutions, which is designed to serve as a starting point for developing an institutional approach to risk reduction n 7

8 Ten Step Compliance Checklist for U S Financial Institutions 1 Devise Process and Timetable for Review of Foreign Account Relationships Undertake immediate review of accounts held by foreign banks and obtain Certifications from maximum number of foreign banks, including foreign affiliates of domestic financial institutions Build out review of all accounts to systematically obtain certification information in shortest possible time Develop procedures for closing uncertified or potentially high-risk accounts 2 Review and Revise Existing BSA Policies and Procedures Review and revise manuals section-by-section against new requirements of USA PATRIOT Act Previous policy and procedure manuals and rules, without change, are per se inadequate Focus on especially vulnerable components of institution, such as those with accounts involving transactions from jurisdictions or institutions of heightened concern, to protect against possible reputational risk associated with unwitting links to possible terrorist finance Develop procedures for handling the funds of foreign government officials and related parties, to address new money laundering criminal offense of laundering proceeds of foreign corruption 3 Develop New Due Diligence Check-Off/Checklist Create list of compliance activities undertaken by institution Develop checklist of specific steps to be taken by division and when applicable, by affiliates Supplement internal lists through reviews with existing regulatory guidance 4 Develop Policy Covering Affiliates Develop procedures for handling accounts of foreign banking affiliates and foreign non-banking affiliates Develop appropriate policies and practices to ensure equivalent coverage among different types of domestic affiliates (depository, broker-dealers, investment advisors, money transmitters) Give special consideration to potentially vulnerable affiliates (offshore entities in lesser-regulated jurisdictions) 5 Assess Existing OFAC Screening Procedures and Software Evaluate screening software through challenge tests (efforts to game or evade system) Match assessment of current system against promised capabilities of other systems Check institution across departments (for example, trust departments and charities) to ensure understanding of screening issues 8

9 6 Enhance Scrutiny of Transactions Involving Poorly Regulated Jurisdictions Build mechanisms to recognize and reduce institutional risks created by large volumes of activity through bad jurisdictions Closely scrutinize account activity involving under-regulated jurisdictions, not just shell banks Develop policies that take into account international consensus on identity of problematic jurisdictions through use of non-cooperative lists published by the Financial Action Task Force and the Organization for Economic Cooperation and Development 7 Update Know Your Customer (KYC) Policy Review KYC regulations issued and subsequently withdrawn by the Federal Reserve in 1999 against existing institutional policies and procedures Determine areas of widest variance from previously recommended practices Consult with foreign and U S regulators to determine whether further guidance is available from any relevant source regarding best practices Assess areas of potentially greatest vulnerability (Private banking? Hedge fund activity? Internet gambling? Offshore?) Tailor new KYC practices for most vulnerable sectors 8 Devise and Implement Employee Training Program Create education and training program designed to alert each level and type of employee regarding individual anti-money laundering obligations and procedures Develop implementation timetable Secure adequate resources to carry out employee training in a timely manner Assess training program through spot-tests Review after six months, then annually 9 Establish Internal Audit and Review System to Catch Weaknesses Provide mechanism to assess weaknesses before bank examiners point them out Consider implementing both comprehensive tests and spot tests; each have potential value Ensure that results of money laundering audits are reported to both compliance office and senior management for assessment and action 10 Enlist Support of Senior Management for Comprehensive Compliance Program Obtain support for compliance priorities and program from highest executive and management levels Ensure that senior management emphasizes to entire organization that compliance needs to be consistent across jurisdictions and sectors, limiting exceptions to those mandated by law or explicitly adopted by the institution Secure senior management recognition and institutional recognition of need for compliance through all components of the financial institution This is critical in light of broad definitions of correspondent accounts, covered institution, and suspicious reporting activities established under the new federal regulations 9

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