Philip M. Berkowitz

U.S. states, as well as municipalities such as New York City, have been proactive in recent years passing “ban-the-box” legislation that severely restricts the right of employers to check, much less consider, the credit and criminal histories of job applicants.

On the other hand, a number of federal laws, including the Foreign Corrupt Practices Act (FCPA) and others, impose significant background check obligations. Regardless of local laws, FCPA-governed employers must carefully screen applicants to determine whether they are former foreign officials—which may include employees of state-owned enterprises—or if they have criminal records.

The laws that impose background-check obligations are not limited to the FCPA. As discussed below, these obligations stem from an array of federal laws that regulate most publicly traded entities and many financial services companies.

While these laws do not necessarily prohibit hiring individuals with criminal records or bad credit records or who are former government officials, they do require employers to identify these individuals and assess whether their hire would violate the laws outright or whose hire would pose a threat or an administratively difficult burden to monitor their activities. Getting it wrong can be costly indeed.

Foreign Corrupt Practices Act

In August 2015, various Asian and U.S.-based JPMorgan Chase & Co. (JPMC) entities agreed to pay a total of $264.4 million in criminal and regulatory penalties for allegedly seeking to gain advantages in winning banking deals by awarding prestigious jobs to relatives and friends of Chinese government officials. The hiring proposal, implemented no doubt with the best of intentions, was called the “Sons and Daughters Program.”

The government argued that this program violated the FCPA, which prohibits issuers and domestic concerns1 from activities whether committed in the U.S. or overseas, made in furtherance of a corrupt payment to a foreign official using the U.S. mails or other means or instrumentalities of interstate commerce. To be unlawful, the payment or benefit must be intended to induce the recipient to exploit his or her official position in order to direct business to any party.

Entities that are governed by the FCPA must screen applicants to determine whether they may be considered a “foreign official” under the FCPA. The FCPA defines “foreign official” in part as “any officer or employee of a foreign government or any department, agency or instrumentality thereof.”

Even purely commercial enterprises owned by foreign governments could well be found to be instrumentalities in certain circumstances. This would most likely be the case if (1) the entity has a monopoly on what is normally a government function; (2) the government subsidizes the entity’s operations; (3) services are provided by the entity to the public in the country of ownership; and (4) the public and the government of that foreign country generally perceive the entity to be performing a governmental function.

If the entity has been formally designated as government-controlled, or if the government has a majority ownership stake in the entity, or if the government can select management or retains profits and covers shortfalls, then a court may decide that the entity is controlled by the government.

Politically Exposed Persons

A “Politically Exposed Person,” or PEP, is someone who, through their prominent position or influence, is more susceptible to being involved in bribery or corruption.

The term PEP generally includes a current or former senior foreign political figure, their immediate family, and their close associates. A “senior foreign political figure” is a senior official in the executive, legislative, administrative, military or judicial branches of a foreign government (whether elected or not), a senior official of a major foreign political party, or a senior executive of a foreign government-owned corporation.

In addition, a senior foreign political figure includes any corporation, business, or other entity that has been formed by, or for the benefit of, a senior foreign political figure. With respect to SOEs, a PEP would typically be anyone from a senior executive upwards. However, even former members of the board of directors no longer associated with an organization may retain influence and still be flagged as PEPs.

Bank Secrecy Act

Bank obligations to screen for PEPs emanates from three sources: the Bank Secrecy Act, the Financial Action Task Force (FATF) and the Federal Financial Institutions Examination Council (FFIEC).

The Bank Secrecy Act establishes guidelines and requirements for financial institutions to identify and prevent money laundering. Among other things, the Bank Secrecy Act requires financial institutions to keep records on cash purchases, to file reports of cash purchases that are $10,000 or more, and to report suspicious activity.

Neither the Bank Secrecy Act nor any applicable regulations mandate that banks conduct a background check to determine whether an employee or an employee’s immediate family member or close associate is a PEP. Nevertheless, over the past several years, U.S. banking regulators have indicated to banks and other financial institutions that they should have enhanced processes to identify PEPs, including seeking to identify whether a candidate is a PEP as part of the hiring/onboarding process, and implementing appropriate controls and procedures to monitor the accounts and transactions of PEPs.

FDIC-Insured Banks and Loan Originators

Section 19 of the Federal Deposit Insurance Act prohibits, without the written consent of the Federal Deposit Insurance Corporation (FDIC), any person convicted of any criminal offense involving dishonesty, breach of trust or money laundering, or who has agreed to enter into a pre-trial diversion or similar program in connection with a prosecution for such offense, from becoming employed with, or continuing employment with, or otherwise participating directly or indirectly in the affairs of, an insured depository institution.

The Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act), which applies to national and state banks, branches of foreign banks, credit unions, and other financial institutions, requires that mortgage loan originators who originate residential mortgage loans obtain an appropriate license.

Regulation Z of the Truth in Lending Act (TILA) generally applies to “loan originators” involved in consumer credit transactions secured by a dwelling (including any real property attached to the dwelling). Regulation Z defines “Loan Originator” more broadly than under the SAFE Act.

All loan originators who must be licensed pursuant to the SAFE Act and TILA must receive background checks, including credit checks. The organization must determine that the employee has not, during the past seven years, been convicted of or pleaded nolo contendere to a felony in a domestic or military action, and has never been convicted of or pleaded nolo contendere to a felony involving an act of fraud, dishonesty, a breach of trust, or money laundering.

Also, the individual must have demonstrated financial responsibility, character, and general fitness that indicate that he or she will operate honestly, fairly and efficiently. This involves an assessment of outstanding judgments and tax liens and other information related to their credit history.

Broker Dealers

FINRA Rule 3110(e) requires each member to investigate the good character, business reputation, qualifications and experience of an applicant before the member applies to register the applicant with FINRA. Each member is required to establish and implement procedures to verify the accuracy and completeness of Form U4 (Uniform Application for Securities Industry Registration or Transfer), which “at a minimum, provide for a search of reasonably available public records to be conducted by the member, or a third-party service provider, to verify the accuracy and completeness of the information contained in the applicant’s initial or transfer Form U4.”

Complying with FINRA Rule 3110(e) necessarily requires a member to run a comprehensive background check, including a criminal record and credit check, on FINRA registered employees and applicants for a FINRA registered position.

Rule 17a-3(a)(12) of the Securities Exchange Act of 1934 (SEA) requires members and broker-dealers to make and keep current certain books and records with respect to “associated persons” of the firm, including an executed “questionnaire or application for employment” containing information regarding the “associated person,” including, without limitation, a record of any arrests and indictments for any felony or certain enumerated misdemeanors (e.g., securities, banking, insurance or real estate related crimes, fraud, false statements or omissions, wrongful taking of property, bribery, forgery, counterfeiting, extortion), and the disposition of such arrests and indictments.

Likewise, the SEA prohibits FINRA members and broker-dealers from associating with persons who have certain criminal convictions without the consent of the SEC, including those who perform merely clerical or ministerial positions.  Covered criminal convictions include any felony conviction within the past 10 years, or certain specified felony or misdemeanor convictions.

Conclusion

Ban-the-box laws did not make the decision whether to carry out background checks any easier for publicly traded companies and financial institutions. These companies must be familiar with the requirements of these various laws. Failing to get this right can have dire consequences.

Endnotes:

1. An issuer is a corporation that has issued securities registered in the United States, or a company that is required to file periodic reports with the SEC, while a domestic concern is “any individual who is a citizen, national, or resident of the United States, or any corporation, partnership, association, joint-stock company, business trust, unincorporated organization, or sole proprietorship which has its principal place of business in the United States, or which is organized under the laws of a State of the United States, or a territory, possession, or commonwealth of the United States.” 15 U.S.C. §78dd-2(h)(1).

Philip M. Berkowitz is a shareholder of Littler Mendelson and co-chair of the firm’s U.S. international employment law and financial services practices.