AML Watch: FinCen Seeks Comments on Beneficial Ownership Reporting, SEC Issues Alert on SARs Compliance Deficiencies and Guidance

In a recent post, Bates noted that the new Anti-Money Laundering Act (“AMLA”), which became law on January 1, 2021, expanded the Bank Secrecy Act regulatory framework, requiring substantial attention to additional regulator guidance and AMLA-related proposed rulemakings. Core areas of the new law focus on (i) establishing a beneficial ownership database and reporting under AMLA Corporate Transparency Act (“CTA”) provisions and (ii) improving the monitoring, reporting and compliance systems necessary to strengthen existing AML efforts. Both areas were the subject of recent regulatory activity.

On April 1, 2021, FinCEN issued an Advance Notice of Proposed Rulemaking (“ANPRM”) on beneficial ownership reporting. On March 29, 2021, the SEC Division of Examinations (now referred to as “EXAMS”) issued a risk alert on AML program compliance, and, in particular, red flag areas where broker dealers can improve their suspicious activity monitoring and reporting. Here’s a closer look.

FinCEN First Steps

In the CTA, Congress mandated the creation of a database of beneficial ownership information to, according to FinCEN, prevent malign actors from exploiting “opaque legal structures to launder money, finance terrorism, proliferate weapons of mass destruction, traffic humans and drugs, and commit serious tax fraud and other crimes that harm the American people.” Under the new law, “reporting companies” must provide identifying information for “beneficial owners,” which include individuals who exercise “substantial control” of, or have at least a 25% ownership interest in, the company.

Reporting of beneficial ownership is primarily directed at smaller businesses or shell entities. (The Act excludes certain financial institutions, publicly traded companies, non-profits, government entities, and other entities that have (i) a physical operating presence in the U.S., (ii) more than 20 employees and (iii) sales or gross receipts in excess of $5 million.) Financial institutions already covered by FinCEN’s CDD Rule are not required to report beneficial ownership under the AMLA. However, in the ANPRM, FinCEN stated that it will propose revisions to existing financial institution customer due diligence regulations on beneficial ownership, as required by the CTA, in a separate rulemaking subject to notice and public comment.

In the ANPRM, FinCEN lists a series of questions on reporting, database maintenance and disclosure. The scope and detail of these questions suggest the enormous effort that will be necessary to fully address the CTA statutory requirements on beneficial ownership. There are many questions with many implications.

As to defining key terms, FinCEN challenges commenters to consider nothing less than (i) the inclusion or exclusion of the term “other similar entities” for reporting purposes; (ii) filing practices and state law; (iii) the term “beneficial owner” (i.e., should it be based on standards under the CDD Rule, new definitions for “ownership” and/or “control”?); (iv) the terms “reporting company” and “applicant”; (v) qualifications and standards for exemptions; and (vi) whether there should be different informational requirements for different types of entities. On reporting concerns, FinCEN asks for comment on broad general concerns (“what information should FinCEN require a reporting company to provide about the reporting company itself to ensure the beneficial ownership database is highly useful to authorized users?”) and detailed implementation questions (“should FinCEN allow or support direct batch filing of required information?”).

FinCEN also asks for comment on questions of privacy, access, form identifiers, and process. On privacy, for example, FinCEN asks how it can best “protect both the privacy interests underlying an individual's or entity's desire to use the FinCEN identifier, and the identifying information that must be provided to FinCEN by an individual or entity wishing to obtain and use the FinCEN identifier[.]” Thornier still, FinCEN asks for comment on how to handle requests from a host of interested parties, including from “Federal functional regulators or other appropriate regulatory agency [an undefined term].” Finally, FinCEN asks whether there are ways to reduce costs and minimize burdens the new law will place on many small entities. There are 48 questions (with many subparts) in all, not including a general request for comment on “any other aspects of implementation of the CTA.” Comments are due by May 5, 2021.

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SEC Warns Brokers to Improve their SARs

The AMLA requires FinCEN to consider ways to strengthen/streamline SARs and other reports (and to extract more law enforcement value from them). Functional regulators are pursuing a parallel track. In their alert, EXAMS staff focused on the results of observations of brokers and mutual funds’ AML programs and SAR processes. Recent attention to manipulation and trading in low-priced securities were a chief concern underlying the release of this alert. (See also Bates coverage highlighting FINRA’ increased attention to trading in penny stocks.)

In the SEC alert, EXAMS staff found inadequate firm policies and procedures affecting the ability to identify and report suspicious activity. These deficiencies included (i) failures to incorporate red flags—or inadequate red flags—in policies or procedures meant to enable the identification of activity or securities transactions that should trigger required diligence or reporting; (ii) failures to establish automated systems to monitor and report suspicious activity associated with trading in large volumes; (iii) failures to set SAR and other triggering thresholds appropriately; and (iv) overreliance on clearing firms to identify and report suspicious transactions in customer accounts. EXAMS staff also found program implementation deficiencies and inadequate due diligence that led to failures to trigger SAR filings. These include deficiencies in monitoring, procedural consistency, effective follow up, and compliance with firm trading prohibitions (on, for example, low-priced securities).

EXAMS staff learned that these program deficiencies led to SAR filing deficiencies. Their strongest warning to firms concerned broker-dealers that “knew, suspected, or had reason to suspect” improper sales of unregistered securities, pump and dump schemes, or market manipulation of low-priced securities and had failed to act on this knowledge. As to the latter, staff observed failures to follow up on red flag patterns around the high-risk activity. Among those low-priced securities failures were previously flagged patterns that should have raised concern, including: deposit, liquidation and withdrawal of proceeds from the sale of these securities; sales of large amounts of low-priced securities of multiple issuers by customers; trading in the stock of shell companies; and trading in stock after warnings issued by over-the-counter stock quotation systems. Finally, EXAM staff observed inaccurate or boilerplate information contained in SAR filings that lacked sufficient detail on the suspect activity.

Conclusion

It is no surprise that FinCEN and the SEC want firms to tighten their AML policies and procedures and to improve compliance. AML frameworks increasingly depend on more effective and efficient processes and a steady flow of quality SAR filings. The scope and detail of the questions presented by the ANPRM suggests a significant uptick in anticipated regulatory requirements (and cost), but the ANPRM is merely the beginning of a process toward a more complete regulatory regime.

In a broader context, the SEC EXAMS risk alert serves as a reminder that functional regulators are watching and expecting firms to be constantly improving their vigilance and controls. The attention to AML compliance by functional regulators is in alignment with FinCEN’s efforts. Edward Longridge, practice leader for Bates AML and Financial Crimes, notes that “The SEC’s focus on program compliance and the adequacy of SAR filings confirms that regulator’s expectations are increasing—particularly around red flag activity that has been the subject of prior investor alerts. The compliance picture is getting clearer: an expanding framework and increased expectations.” Bates will keep tracking developments.

How Bates Helps

Bates AML and Financial Crimes helps its clients meet their AML obligations through experience, resources, and ongoing guidance. Our services are tailored to the specific needs and requirements of our clients and that regulators are seeking, including in the areas of AML tuning and optimization, implementation of new systems, trade finance, and AI-driven process automation solutions, AML and sanctions system model validations; governance and oversight processes; redesign and updates to AML policies and procedures; AML and sanctions risk and gap assessments; regulatory response support; and staffing support for AML backlogs and lookbacks. For more information, please contact:

• Edward Longridge, Managing Director and Practice Leader, elongridge@batesgroup.com | 917-455-7765

• Dennis Greenberg, Managing Director, dgreenberg@batesgroup.com | 914-588-3965

Bates Compliance delivers guidance and tailored compliance consulting solutions to our broker-dealer, investment adviser and hybrid firm clients on an as-needed or ongoing basis. Our team—made up of experienced senior compliance, legal and former regulatory professionals—drafts and tests policies, procedures, and supervisory and compliance processes, recommending and implementing changes based on leading practices to enhance compliance and supervisory systems and to remediate regulatory, litigation and internal audit findings. For more information, please contact:

• Hank Sanchez, Managing Director, hsanchez@batesgroup.com | 504-450-9632

• David Birnbaum, Managing Director, dbirnbaum@batesgroup.com | 917-273-2682