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The Importance of SARs,CTRs, and Other Due Dilligence Measures

Following the ‘paper trail’ is a widely-held mantra in compliance, especially financial crime compliance. Post-9/11, effective compliance means relying increasingly upon monitoring and reporting. The passage of the USA PATRIOT Act in 2002 elevated the importance of compliance reporting, especially suspicious activity reports (SARs). Given that compliance is designed to prevent and detect potential breaches, suspicious activity reporting becomes an important tool in this effort. Filing of SARs provides data to financial institutions and law enforcement that is integral to identifying patterns of potential criminal behavior or facilitating investigations into possible wrongdoing.

To complete a SAR, data must be recorded not only about the transaction but also about the person attempting or completing the transaction. Even incomplete transactions can be reported as suspicious. A simple example would be a person who intends to purchase a monetary instrument at the local bank, such as a money order, but cancels the transaction after learning the denomination requested will require completing a currency transaction report (CTR). A reasonable interpretation of this behavior would be that the purchaser is attempting to avoid the reporting requirement. Thus, this may be viewed as a red flag and a SAR may be filed after further review. By contrast, if this transaction is completed and the purchaser balks at the need to provide documentation, an employee may reasonably conclude the purchaser’s reaction is suspicious. In this case, not only is a CTR required, but a SAR may also be necessary, given the purchaser’s reticence. In both simplistic examples, the key concept is how the transaction is perceived at the point of sale. What is ‘suspicious’ is, at times, a judgment call grounded in one’s experience and knowledge. As such, we may not always get it right.

Nevertheless, effective compliance rests upon ‘good faith efforts’ and ‘due diligence.’ To underscore the importance of employee vigilance during cash transactions, financial institutions and their employees are not legally liable for filing SARs. This federal protection is called safe harbor. Submission of SARS or any other compliance or fraud report is protected under safe harbor, as described in federal law 31 USC 5318 (g) (c). This protection encourages the flow of suspicious transaction data between financial institutions and law enforcement agencies, while protecting the sources of such information.

By: Sheryl Smikle, PhD

 

Sources

https://www.ffiec.gov/bsa_aml_infobase/pages_manual/OLM_015.htm

https://www.fdic.gov/news/news/inactivefinancial/1998/fil9836b.html

https://www.fincen.gov/sites/default/files/advisory/advissu5.pdf

https://www.fincen.gov/sites/default/files/shared/f902256b.pdf

Counterterrorist Financing

Twenty years ago, anti-money laundering (AML) programs primarily focused on tracking the money derived from criminal activities such as gambling, prostitution, and drug trafficking. Profits from these illegal activities were often significant and in cash. These funds were also untaxed. Consequently, U. S. federal, state and municipal governments were deprived of income. The primary function of the Bank Secrecy Act (BSA) was to limit tax evasion, which was a by-product of illegitimate proceeds derived from ‘covered crimes’ as listed in the BSA. The BSA, passed in 1970, was eventually followed up with another law: the U. S. Money Laundering Control Act (MLCA) of 1986. The MLCA and its subsequent amendments were passed to prevent and detect the infusion of illegal proceeds into the national banking system through placement, layering and integration. The cleansing of criminal proceeds would not only legitimize these funds but also hide the criminal activity that generated them. 

 

With the tragic events of September 11, 2001, there was an expansion in the scope of money laundering prevention. In addition to tracking illegal cash proceeds, there was a heightened concern about clean funds being used for nefarious purposes, namely terrorism. The linking of these two activities was important because both money laundering and terrorist financing (the solicitation, collection and provision of funds for the purpose of terrorism) adversely impacted the financial system. Both of these activities, which can be on a national or an international scale, sought to avoid detection by taxing and legal authorities, involved the transmission of cash via the banking system, and were connected to criminal activity. 

 

Regulatory international bodies such as The Financial Action Task Force (FATF) and The Basel Committee on Banking Supervision (BCBS) established voluntary standards for countries and banking systems to adhere to so that each could effectively develop strategies and frameworks to mitigate the risks associated with money laundering and terrorist financing. Understanding these widespread activities and their connection to each other is a critical prerequisite for combatting each. In sum, anti-money laundering and counter-terrorist financing are two sides of the same coin and must be addressed simultaneously.

By: Dr. Sheryl Smikle

Sources

https://www.imf.org/external/np/leg/amlcft/eng/aml1.htm#financing terrorism https://www.treasury.gov/press-center/press-releases/Pages/po3711.aspx

http://www.fatf-gafi.org/media/fatf/documents/reports/Financing-of-the-terrorist-organisation-ISIL .pdf

De-risking

The global fight against money laundering and counter-terrorist financing, promoted by the Financial Action Task Force (FATF) and the Basel Committee on Banking Supervision (BCBS), has received a recent boost from the U. S. Office of the Comptroller of the Currency (OCC). 

 

Earlier this month, the OCC published guidance for financial institutions concerning how to terminate existing correspondent banking relationships that lack robust Anti-Money Laundering (AML)/Bank Secrecy Act (BSA) compliance controls. Essentially, the OCC expects U. S. global banks to insist that their correspondent banking relationships be contingent upon these banks having rigorous robust AML/BSA standards, processes and frameworks in place. Additionally, the OCC expects continual monitoring of these correspondent banking relationships to ensure a sustainable control environment. Specifically, U. S. banks should examine the respondent bank’s business, markets, products, supervisory regime and inherent and residual risks.

 

Historically, correspondent banks provide emerging markets in the Caribbean, Middle East and parts of Europe with access to the international financial system. These banks also facilitate cross-border payments via money transmitter businesses and international investment opportunities.

 

Currently, some U. S. banks are discontinuing these relationships without the due diligence the OCC guidance recommends. Consequently, the void such actions create may culminate in a lack of transparency, an increase in money laundering and counter-terrorist activities and use of the unregulated shadow banking system.  In sum, fewer correspondent banking risks will yield increased AML/BSA risks. Industry groups in the US and overseas are expressing serious concerns through white papers and advocacy with the OCC, for example the American Bankers Association (ABA) and the Eastern Caribbean Central Bank (ECCB).

 

By: Dr. Sheryl Smikle

Sources


http://antiguaobserver.com/eccb-governor-says-de-risking-is-encouraging-money-laundering/

http://bankingjournal.aba.com/2016/10/occ-issues-guidance-on-amlbsa-risk-management/

https://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf

https://www.imf.org/external/pubs/ft/sdn/2016/sdn1606.pdf

https://www.bakerlaw.com/alerts/the-regulatory-pendulum-when-is-de-risking-by-financial-institutions-too-much

 

Dodd-Frank at a Glance

The Wall Street Reform and Consumer Protection Act​ (WCPA), commonly known as Dodd­Frank, became law on July 21, 2010. Signed into law by President Barack Obama, Dodd­Frank was renamed to honor its co­creators, U. S. Congressman (D­MA), Barney Frank and U. S. Senator (D­CT) and former Chair of the U. S. Banking Committee, Christopher Dodd. The dual goals of this transformative and voluminous series of rules and regulations, as stated in its original name, are to overhaul the financial services and banking industry (symbolized by “Wall Street”, the storied New York City financial district) and enhance federal consumer protections. Both goals attempt to address the lessons gleaned from the unprecedented financial industry meltdown in 2009, which impacted key business sectors such as banking, real estate, and manufacturing, especially automotive manufacturing.

 

There are over 300 Dodd­Frank rules that are documented in more than 5000 pages. Although six years have passed, rules continue to be drafted including rules that address the revamping of the housing finance sector. Interestingly, the authors of these new rules are several federal regulators, including the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), the Federal Housing Authority, and the Commodity and Futures Trading Commission (CFTC), among others. Collectively, these rules focus on (1) preventing another financial crisis, (2) avoiding further taxpayer bailouts, (3) ensuring banks have enough capital liquidity to remain solvent during extreme market volatility, (4) enabling bank bankruptcies to proceed without adverse impact, (5) influencing executive compensation levels, and (6) curtailing derivative risks and excesses. 

 

Dodd­Frank also established a new federal regulator with broad, independent authority, the Consumer Financial Protection Bureau (CFPB). This powerful new agency regulates banks and non­bank financial institutions, authorizes the breakup of large, complex financial companies, bolsters and centralizes the consumer protection regulatory powers of other bank regulators, and wields broad enforcement authorities with very large banks and credit unions, non­bank financial institutions, and mortgage related businesses. 

 

Dodd­Frank is bellwether legislation. It comprises broad and sweeping legislative reforms. Its impact will continue to reverberate throughout the financial services industry as financial service providers adapt and adjust.

 

By: Dr. Sheryl Smikle

Sources

http://www.aba.com/Issues/RegReform/Pages/RR_Introduction.aspx

http://www.doddfrankupdate.com/DFU/DoddFrankSummary.aspx

www.thenation.com/article/how­wall­street­defanged­dodd­frank/

Dodd Frank, Prop Trading and the Volcker Rule

In the wake of the 2008 U. S. financial crisis, new legislation was ushered in to avoid a reoccurrence. Passed in 2010, Dodd­Frank imposes myriad new rules on the financial industry that will irreversibly change the industry’s market behavior and client interactions. In particular, Dodd­Frank has focused on safeguarding consumers. One tool created to do this is the Volcker Rule. Named after the former Federal Reserve Board Chairman, Paul Volcker, this rule is designed to prevent banks from using consumer deposits, on its own behalf, in speculative deals with high gain and loss potential. The final rule was passed in 2013 and also includes compliance program and reporting requirements.

 

Prior to Volcker, commercial banks, brokerages, or other financial institutions could engage in trading with their own financial resources for the sole purpose of making a significant profit. That is, buying and selling stocks, bonds, commodities or other financial instruments for the bank’s own trading book. Such transactions are called proprietary trading, prop trading ​for short.  

 

Prop trading was previously prohibited through the passing of the 1933 Glass­Steagall Act, which was promulgated during the depression era and repealed in 1999 during the Clinton administration. Essentially, Glass­Steagall limited speculative transactions by commercial banks. This act also gave birth to the Federal Deposit Insurance Corporation (FDIC), which guarantees consumer deposits of up to $250,000. As such, the Volcker Rule incorporates many of the prohibitions of the repealed Glass­Steagall Act. It is sometimes referred to “Glass­Steagall­lite”

 

Not only is prop trading curtailed, but also commercial banks cannot own, invest, or partner with either hedge or private equity funds. However, the Volcker rule does allow banks to trade in U.S. securities such as bonds, make trades on behalf of customers, and prevent against bank

losses, or ​hedge. Banks hedge to guard against potential losses using complex data points in order to make educated guesses on the direction of specific market activity, for example interest rates. Permissible hedging relies upon a large collection of data that is used to make educated guesses about the direction of market activity. However, hedging may sometimes be hard to separate from prop trading because of their common techniques. Nevertheless, the Volcker rule attempts to do just that.

By: Dr. Sheryl Smikle

Sources:

http://lexicon.ft.com/Term?term=proprietary­trading

http://blogs.wsj.com/marketbeat/2010/03/15/proprietary­trading­finally­a­definiton/

http://www.iflr.com/pdfs/a­users­guide­to­the­volcker­rule.pdf

 

 

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