The Obligations of Broker-Dealers Under Money Laundering Laws

Reprinted with permission, Personal Financial Planning Monthly, Vol. 2, Number 5, May 2002.

2002, Aspen Publishers Inc. All rights reserved.

Money laundering has been a "hot issue" for securities regulators for some time, and after September 11, it got even hotter. On October 26, 2001, President Bush signed into law the USA PATRIOT Act1 (the Act), which contains extensive anti- money laundering provisions that apply to all financial institutions. The term "financial institution" is defined very broadly to include all registered securities broker-dealers, as well as banks, thrifts, insurance companies, mutual funds, money services businesses, jewelry and coin dealers, and others. Since passage of the Act, sweeping new regulations have been proposed at a breakneck pace, with still more to come later this year.

An underlying policy of the new regulations is the prevention of "regulatory arbitrage" by money launderers and terrorists. In other words, in the post-September 11 world, there will be equivalent regulation of similar activity in different sectors of the financial industries. As one congressional staffer put it, "It's not just banks anymore."

What Is Money Laundering?

Money laundering may be defined generally, in layman's terms, as engaging in financial transactions that involve income derived from criminal activity. Money laundering laws apply to laundered income derived not only from narcotics offenses and drug trafficking, but from a wide array of crimes, such as securities fraud, bank fraud, wire fraud, mail fraud, copyright infringement, gambling, terrorism, and even water pollution. The law covers nearly every imaginable type of financial transaction.

Money is laundered in three stages:

"Placement" occurs when cash generated from illegal activities is introduced into the financial system.

In the "layering" stage, these funds are transferred or moved to other accounts to further obscure their origin.

In the final "integration" stage, the funds are reintroduced into the economy in a way that makes them appear legitimate.

Many believe that broker-dealers are most at risk of being used for money laundering during the "layering" and "integration" stages.

How much money is laundered? No one knows for sure, but the International Monetary Fund has estimated that between 2 and 5 percent of global gross domestic product is laundered each year. In the United States, this translates to perhaps as much as $1 billion or more laundered every year.

Money Laundering Laws That Apply to Broker-Dealers

Several statutes include money laundering laws that apply to broker-dealers.2 The criminal statutes prohibit financial transactions involving proceeds of "specified unlawful activities" (that is, certain crimes, including terrorist activities). In addition to primary liability under the criminal statute, a person or entity could be liable for aiding and abetting violations of the money laundering statutes if they know or are willfully blind to the fact that the transaction involved illegal funds. Thus, a showing of "willful blindness" can satisfy the "intent" element of the crime.3 This means that a party to a financial transaction cannot simply ignore indications of irregularity or wrongdoing ("red flags") that could give reason to suspect that the other party isengaging in money laundering activity.

The Bank Secrecy Act (BSA) is the other major law pertaining to money laundering. The BSA is a reporting and recordkeeping law. The USA PATRIOT Act included numerous amendments to the BSA and mandated that the Treasury Department issue a variety of new regulations to implement various provisions of the Act. Existing BSA regulations and the new, soon-to-become- final BSA regulations contain significant requirements applicable to all broker-dealers, including (1) suspicious activity reports, (2) currency transaction reports, (3) currency and monetary instrument transportation reports, (4) regulations prohibiting "correspondent accounts" for foreign "shell banks" and record-keeping requirements for other foreign banks that have accounts, and (5) regulations governing the sharing of information about suspected terrorists and money launderers among financial institutions and law enforcement agencies. In addition, new NASD Rule 3011 encompasses all of these regulations by requiring all broker-dealers to establish anti- money laundering (AML) programs.

Proposed NASD Rule 3011 - AML Compliance Programs

The USA PATRIOT Act mandates that all financial institutions establish anti- money laundering compliance programs. To effectuate this requirement for broker-dealers, NASD Regulation (NASDR) has proposed new Rule 3011 setting minimum standards for anti- money laundering compliance programs for broker-dealers.4 The rule will become effective, and the programs must be in place, by April 24, 2002.

Rule 3011 requires each firm to develop and implement an AML program. The program must be approved in writing by a member of the broker-dealer's senior management, such as a senior compliance officer or a member of the general counsel's office. The minimum requirements set forth in the rule are as follows:

Written policies and procedures designed to detect and cause reporting of suspicious transactions (See the discussion of the new "SAR" rule below.)

?Policies, procedures, and controls designed to ensure compliance with the Bank Secrecy Act

Independent testing, either by the firm or by an outside vendor, to ensure that the firm is complying with its AML program

?Designation of one or more persons responsible for the AML program

Ongoing training of appropriate personnel

NASD Regulation has stated that each broker-dealer should have the flexibility to tailor its AML program to fit its business, taking into account such factors as size, location, the nature of the firm's business, risks, and vulnerabilities. The NASD issued Notice to Members 02-21 in April 2002 to provide guidelines to broker-dealers concerning AML programs.5

As can be seen from the broad terms of the rule, in order to achieve compliance, a broker-dealer must have an understanding of the Bank Secrecy Act and other anti- money laundering laws, rules, and regulations, as well as anti- money laundering techniques, in order to develop and implement an effective program.

Suspicious Activity Reports (SARs)

Consistent with the requirements of the USA PATRIOT Act, the Treasury Department has proposed regulations, to go into effect July 1, 2002, which would require all broker-dealers to report suspicious transactions to the...