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The Senate Banking Committee’s Jan. 29 hearing on implementation of the USA Patriot Act offers banks scant comfort that their compliance burdens under �� 313 and 319(b) of the act will be lightened any time soon. Indeed, there were strong indications at the hearing that Congress will be especially rigorous in its oversight of these provisions and steadfast in ensuring that they are implemented promptly, effectively and strictly in accordance with congressional intent. Of particular significance, Chairman Paul D. Sarbanes, D-Md., questioned whether the proposed regulations recently issued by the Treasury Department under these provisions satisfy this standard. By way of background, � 313 prohibits U.S. “covered financial institutions” (this term includes FDIC-insured depository institutions, uninsured U.S. branches and agencies of foreign banks and SEC-registered securities broker-dealers) from directly dealing with foreign banks that do not have a physical presence anywhere in the world and are not supervised by any jurisdiction (foreign shell banks). Section 319(b) requires covered financial institutions to obtain information identifying the owners of each foreign bank for which they maintain a “correspondent account” and the person designated by such bank as its agent for service of process in the United States. SAFE HARBOR The regulations proposed by Treasury would provide a “safe harbor” under �� 313 and 319(b) for covered financial institutions that obtain from their foreign bank customers a signed statement certifying to (i) whether or not the foreign bank is a shell bank; (ii) the nature of the foreign bank’s dealings, if any, with shell banks outside the United States; (iii) the identity of its owners; and (iv) the name and address of its designated agent in the United States. Specifically, the proposed regulations would codify, with certain modifications, the form of certification developed last November by Treasury in consultation with the Justice Department and federal financial regulatory agencies and with input from representatives of the banking industry. This model certificate seeks to establish a uniform, agreed upon approach to complying with the statutory requirements and in fact already has been widely distributed by banks to their foreign bank customers. The availability of a regulatory safe harbor under �� 313 and 319(b) has obvious attractions to covered financial institutions, and efforts to ensure their eligibility for the safe harbor through a certification process should be encouraged. However, the experience of banks to date indicates the need to streamline this process to reduce its burdens and costs. In addition, it has exposed several aspects of the model certificate that should be modified before its enshrinement as a regulatory standard. SIMPLER PROCESS In developing a more effective and less burdensome process, particularly close attention should be devoted to the following considerations: There is a critical need to delineate appropriate boundaries for what constitutes a correspondent account. The Patriot Act contains an extremely broad definition of the term “correspondent account,” sweeping within its coverage transactions and relationships between covered financial institutions and foreign banks that traditionally have not been associated with the conduct of a correspondent banking business. Indicative of Congress’ understanding that such an all-encompassing definition may not be entirely suitable to all circumstances in which it might apply, the act authorizes Treasury to “further define” the term as it deems appropriate. The proposed regulations would adopt the broad statutory definition and apply it for purposes of implementing not only �� 313 and 319(b), but also � 312, which calls for enhanced due diligence with respect to correspondent accounts maintained by certain types of foreign banks (implementation of these requirements will be addressed by Treasury in a future rulemaking). This extension of the definition beyond the subject matter of the proposed regulations to other requirements whose contours have yet to be delineated underscores the importance of reaching an appropriate consensus on what constitutes a correspondent account in connection with the pending proposal. The industry is likely to have only one bite at this apple. In its proposal, Treasury has indicated a willingness to consider modifications to the definition, but has placed the burden squarely on the industry to justify any such revision. In this regard, a fundamental distinction should be drawn between the prohibition and the regulation of covered financial institutions’ dealings with foreign banks. A broad definition of correspondent account may be justified where the statutory purpose is to prohibit the establishment or maintenance of account relationships, as is the case under � 313 with respect to direct dealings with foreign shell banks. A more refined definition is called for where the statute seeks instead to regulate an account relationship, as is the case under � 319(b) and � 312. For example, literal application of the statutory definition would include securities, derivatives, repo and foreign exchange transactions entered into by a foreign bank, acting as principal, with a U.S. bank. Likewise, the definition, literally applied, would cover a foreign bank’s overnight deposit of excess funds in a U.S. bank. Such transactions may be among those that should be prohibited under � 313 if they involve direct dealings with a foreign shell bank, but none are reasonably characterized as undertaken in furtherance of any money laundering or terrorist financing scheme. Accordingly, no purpose under the Patriot Act would be served by subjecting them to the additional requirements of � 319(b) or � 312. Such treatment would only unnecessarily increase the burden on U.S. and foreign banks alike and consume scarce bank resources that should be focused instead on accounts that are more susceptible to use for a prohibited purpose. FOREIGN SHELL BANKS A more flexible approach also is called for with regard to the provisions of � 313 relating to indirect dealings with foreign shell banks. In addition to prohibiting covered financial institutions’ direct dealings with foreign shell banks through correspondent accounts, the Patriot Act requires them to take “reasonable measures” to ensure that permitted foreign bank customers do not use their correspondent accounts to provide “banking services” to a foreign shell bank indirectly. The act does not explain what constitutes a “banking service” for this purpose, how a foreign bank might use its correspondent account to provide such services indirectly to a foreign shell bank, or what measures by a covered financial institution to prevent such usage would be deemed sufficiently “reasonable” within the contemplation of the statute. The Treasury proposal contemplates that such measures would consist of obtaining from a foreign bank its unqualified certification that it does not use its correspondent account for any such purpose. Given the ambiguity and uncertainty surrounding these provisions of � 313, a foreign bank understandably may have difficulty in even understanding what is being asked of it much less certifying to it without qualification. From the covered financial institution’s perspective, this quandary risks forcing it to close the foreign bank’s account since the rule’s safe harbor would apply only if the certification is made with respect to all requested matters, including those relating to indirect dealings with foreign shell banks. To avoid such an unduly harsh result, a reasonable alternative would be to incorporate into the certificate a standard permitting maintenance of the account so long as the foreign bank certifies that it does not knowingly use it for such purpose. The covered financial institution, of course, would still be required to close the account if it discovered information to the contrary. Diligent and strict enforcement of the Patriot Act is essential to combating money laundering and the financing of terrorism. Consistent with this purpose, the foregoing recommendations would strengthen the effectiveness of the Patriot Act by enabling banks and other covered financial institutions to concentrate their compliance efforts in those areas presenting the greatest risks. There is a critical need to delineate appropriate boundaries for what constitutes a correspondent account. The act contains an extremely broad definition. Richard Coffman is a partner with Clifford Chance Rogers & Wells.

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