John H. Walsh
Last December the U.S. Department of Justice announced a record-setting anti-money laundering (AML) settlement with U.K. bank HSBC, claiming it allowed hundreds of millions of dollars from Mexican drug traffickers to flow through accounts in the United States. In total, HSBC paid more than $1.9 billion in penalties.
While few broker-dealers or investment advisors have the risk exposure of an entity like HSBC, this case is expected to have a substantial impact on AML compliance requirements going forward. That’s because federal regulators—who have been proposing substantially more proactive AML measures for broker-dealers and investment advisors for more than a decade—are expected to leverage the massive media attention the HSBC case has generated to bolster their AML efforts in 2013. Moreover, perhaps most ominously, Congress criticized HSBC’s regulators for laxness in past oversight.
As a result, new, stricter AML oversight is in the offing—with initiatives that will impact the country’s broker-dealers and investment advisors, including the trillion-dollar-plus hedge fund industry. In fact, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), the Securities and Exchange Commission, and the Financial Industry Regulatory Authority (FINRA) have already announced new AML initiatives.
FinCEN Initiatives
FinCEN announced that it plans to formally introduce new AML proposals for investment advisers this year. FinCEN’s interest in bringing AML compliance measures to investment advisers actually goes back more than 10 years. In 2003, for example, it published a notice of proposed rulemaking that would have required investment advisers—both registered and unregistered—to establish AML compliance programs. In 2002, it had published a similar proposal, but for unregistered investment companies only.
The proposed rules would have required investment advisors to do what banks, brokerages, and mutual funds are already required to do—monitor their transactions and file suspicious activity reports (SARs) when necessary. But both proposals were withdrawn in 2008, in part because of the difficulty in defining a hedge fund and enforcing the requirements.
However, after the Dodd-Frank Act required U.S. hedge fund advisers to register with the SEC, FinCEN indicated in 2011 that it was once again working on a regulatory proposal to require investment advisers to establish an AML compliance program and monitor/self-report suspicious activity.
In January 2013—with the HSBC case serving as a backdrop—the agency announced it is moving forward with the proposal and that the proposed rules should be released for public comment by mid-year.
SEC and FINRA Priorities
In late February, the SEC announced its examination priorities for the coming year—and the agency’s goals for 2013 include a focus on AML. In particular, SEC examiners will focus on weak AML programs, giving particular attention to how broker-dealers assess the risks in their business practices and implement AML programs related to those risks. Given the growing closeness between SEC examinations and enforcement, where examiners focus, the Division of Enforcement is likely to follow.
AML-related initiatives are underway at FINRA as well. Early each year, for instance, FINRA publishes an annual list of the agency’s regulatory and examination priorities. Not surprisingly, AML is on the list for 2013.
Further, while AML had not been identified as a focus area in the prior year, it is worth noting that in 2013 FINRA described AML as an area of continuing interest. ”Examiners,” FINRA said, “continue to focus on AML compliance, particularly at firms with higher-risk business models due to their clients, products and service mix, or location in which they operate.”
That outlook is consistent with regulators’ previous public statements. For example, in 2011 an official of the SEC stated that in 2010 the SEC and FINRA had conducted 1,900 broker-dealer examinations that included an AML review. In these examinations, 46 percent of the broker-dealers were cited for deficiencies. The SEC’s and FINRA’s renewed interest, therefore, is built upon a significant regulatory foundation—with several hundred broker-dealers cited for AML deficiencies in 2010.
FINRA also indicated that its examiners would focus on AML from “the fundamentals to more esoteric issues.” One specific example related to foreign currency conversion transactions where dollar-denominated foreign bonds are purchased with local currency, transferred to a U.S. broker-dealer, sold, and the proceeds transferred offshore. FINRA stated that U.S. intermediaries may receive bonds worth millions of dollars without knowing who is involved. This business, FINRA said, has raised concerns regarding firms’ level of due diligence and the reviews they perform for suspicious activity.
Due diligence and reviewing suspicious activity were key issues in the 2012 HSBC case. The DOJ said that despite HSBC’s extensive global operations “and the substantial resources it had available to manage transnational risk,” the bank “failed to help secure the United States financial borders and left dangerous gaps that international drug dealers and other criminals readily abused.”
As such, the DOJ charged the bank with failing to maintain an effective AML program, failing to conduct due diligence on its foreign correspondent affiliates, and other AML-related problems.
In light of these developments, broker-dealers and investment advisers could well believe that regulators are about to raise the stakes in this area. Indeed, regulators have stated as much. In 2012, the chief counsel of the SEC’s Division of Trading and Markets stated that the regulators’ “expectations have changed, and frankly have increased.” He went on to note that this is typically the case when a rule has been on the books for a while.
Of course, that may be true for broker-dealers, but not investment advisers. In any event, securities firms have certainly been forewarned.
John. H. Walsh is a partner at Sutherland Asbill & Brennan. He previously served for 23 years at the Securities and Exchange Commission, where he was instrumental in creating the Office of Compliance Inspections and Examinations.
