SIFMA shares this article ahead of our 2023 Anti-Money Laundering & Financial Crimes Conference, taking place from May 22-23 in New York City. It will be published at the end of the month in the 2023 Anti-Money Laundering Guide by Global Legal Group. To request your complimentary electronic copy, please contact the publisher.

The Securities Industry and Financial Markets Association (SIFMA) is the leading trade association for broker-dealers, investment banks, and other firms operating in the U.S. and global capital markets.^[1]  In this post, we discuss current hot topics in anti-money laundering and financial crimes with issues facing SIFMA’s members operating in the U.S. capital markets, including:

• AML Act of 2020 + CTA;
• Beneficial Ownership Reporting;
• AML for Investment Advisers;
• Marijuana and Broker-Dealers;
• Digital Assets; and
• Fraud.

Introduction

Unlike traditional banks, broker-dealers are typically more likely to see account takeovers or securities fraud than drug trafficking and organized crime. Broker-dealers conduct substantial surveillance of fund movements in addition to transaction monitoring; they use Know Your Customer (KYC) processes to look critically at sources of funds for their customers to identify suspicious account openings or account fundings; and they regularly analyze activity to identify illicit schemes that may be new to their firms. They file a significant number of suspicious activity reports (SARs), aiding law enforcement’s investigative efforts.

Never has it been a more dynamic and hopeful time for the dedicated and hardworking compliance and legal professionals on the front lines of broker-dealers’ efforts to combat illicit financial activity and do their part to protect and ensure the preeminence of the U.S. capital markets. The Anti-Money Laundering Act of 2020 (AML Act) is the most significant piece of AML-related legislation since the USA PATRIOT Act of 2001. Broker-dealers and other financial institutions hope that regulators tasked with implementing the Act remain faithful in their rulemakings to the AML Act’s purpose to modernize existing, cumbersome regulations that drain critical resources away from the most threatening illicit finance risks. Broker-dealers are also on the front lines of the budding marijuana industry and the exploding (or in some cases, imploding) digital asset industry. These new business lines and products may present the same illicit finance risks, or they may not, keeping AML professionals on their toes. What follows are current hot topics and issues facing SIFMA’s members operating in the U.S. capital markets.

AML Act of 2020 + CTA

The AML Act heralds a potential shift in focus for financial institutions to effective risk management by reducing unnecessary burdens so that they can direct limited resources to priorities set by the U.S. and those risks presented by their customer base, business model, and product lines. Apart from other initiatives to strengthen the Bank Secrecy Act (BSA), the AML Act improves measures to facilitate information sharing between the government and private sector to better identify risks related to financial crimes. These measures include the publication of first-ever government-wide priorities, allowing broker-dealers and other financial institutions to prioritize the use of their compliance resources efficiently on the most pressing illicit finance risks faced by the U.S. Other measures include a potential no-action process, similar to the long-standing and highly utilized process implemented by the U.S. Securities and Exchange Commission (SEC), to obtain guidance from the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN), and a pilot program to permit financial institutions to share SARs with foreign affiliates to better enable them to detect and combat illicit finance risks across jurisdictions. The most consequential element of the AML Act, though, and the one that will consume the most time and resources over the next couple of years to implement, is the Corporate Transparency Act (CTA), which establishes for the first time a corporate beneficial ownership registry in the U.S.

Beneficial Ownership Reporting

The CTA requires companies organized or registered to do business in the U.S. to name and share the identifying information of individuals who own or control them (i.e., “beneficial owners”) with FinCEN. In the hands of corrupt beneficial owners, seemingly legitimate companies are used to facilitate illegal activity—such as money laundering—within the U.S. International bodies, such as the Financial Action Task Force (FATF) have long cited the U.S. for insufficient corporate ownership transparency. Addressing this, the CTA requires FinCEN to promulgate three rulemakings to establish a centralized database of beneficial ownership information. The agency must: (1) establish who must report, what information must be reported, and when; (2) determine the level of database access and for what purposes beneficial ownership information can be used; and (3) make conforming revisions to the customer due diligence (CDD) rule for financial institutions.

FinCEN finalized the first rule requiring companies registered in the U.S. or doing business here to report beneficial ownership information largely as proposed on September 30, 2022 (the BOI rule).^[2] Implementing it will be a significant undertaking for broker-dealers and others ahead of the January 1, 2024 effective date and thereafter. As with any rulemaking of this magnitude, a lot of time will also be spent parsing the rule’s requirements and seeking guidance from FinCEN, for example, on the scope of exemptions. Firms spent years updating systems, procedures, and controls to implement the current CDD rule and to educate customers about the rule’s requirements; this rule will require a similar effort.

Broker-dealers themselves may also have reporting burdens of their own. For example, because FinCEN declined to apply the statutory exemptions for pooled investment vehicles (PIVs) to related entities that SIFMA advocated for, firms may need to report beneficial ownership information for these entities that are used by the PIV for acquisitions and investments if other exemptions are not available.^[3] This is an example where the rule may not realize the AML Act’s goal to reduce burdens on financial institutions, as the beneficial ownership information of these related entities is generally available to regulators, such as the SEC, and thus to law enforcement upon request; hopefully, FinCEN will be open to reconsideration if proves to be particularly burdensome.

The second rule that determines the level of access to the registry and permitted use of beneficial ownership information is in the proposal phase. It has garnered much controversy and raised many questions because of the limited access and use FinCEN proposed for financial institutions. Congress’ intended for financial institutions to have access to the registry and use beneficial ownership information broadly for customer due diligence purposes. Yet, FinCEN proposed that U.S. persons at financial institutions would have access specifically to fulfill their obligations under the CDD rule only Practically speaking, this means financial institutions could only obtain this information at account opening, deflated expectations of a one-stop shop for beneficial ownership information that would relieve burdens on financial institutions as database users and legal entity customers from having to provide their information multiple times for multiple purposes. Moreover, financial institutions would be restricted from sharing the information within their organizations. As SIFMA pointed out in comments, the inability to use beneficial ownership information for broader customer due diligence purposes hampers a financial institution’s compliance, legal, and risk functions and those functions’ interactions with regulators when information obtained from the registry must be ring-fenced to avoid being sanctioned for improper use.^[4] Without substantial changes to address commenters’ concerns, a  registry that cannot be used beyond obtaining beneficial ownership information at account opening, as proposed, would be of marginal benefit to users.

The third and final rule requiring FinCEN to revise the CDD rule is expected in November 2023. It also remains to be seen how FinCEN revises the CDD rule to align with the BOI Rule, particularly the defined terms. SIFMA advocated that key definitions of both rules should be aligned as closely as possible to avoid disrupting years of effort to update systems, procedures, and controls, and clients’ expectations.^[5]

Until such time as the CDD rule is revised, particularly challenging may be explaining to customers that these rules have different requirements and serve different purposes. Thus, customers expecting firms to use the registry when beneficial ownership information is needed may be frustrated when additional information is sought for CDD rule compliance. Although the hope is FinCEN will conduct educational outreach to companies to clarify the reporting requirements, the CDD rule, and how financial institutions commonly collect information beyond what is regulatorily or statutorily required to fulfill the requirements of risk-based AML policies and procedures, the agency faces significant resource constraints and firms may have to fill the void.

AML for Investment Advisers

SIFMA’s members also include investment advisers. Applying BSA requirements to investment advisers has been contemplated for years, with FinCEN last proposing a rule in 2015. Recent events, like the release of the Pandora Papers, and Russia’s invasion of Ukraine over a year ago have renewed interest in applying BSA requirements broadly.

Anticorruption is among the top priorities for the Biden Administration’s national security agenda. The Administration specifically identified potential enablers of financial crimes—such as attorneys, accountants, and private-equity firms—as stumbling blocks in anticorruption efforts and began calling on agencies to report on their anticorruption efforts—including how they planned to effectuate the CTA.^[6] In light of these concerns and the urgency resulting from the increased potential of Russian oligarchs to hide assets through U.S. investment vehicles, Congress attempted to pass the Enablers Act in 2022. Pertinently, the Act—which ultimately did not make it into annual omnibus legislation, the National Defense Authorization  Act —would have expanded the BSA’s definition of “financial institution” to include “person[s] engaged in the business of providing investment advice for compensation.”^[7]

As a result of focus from the Biden Administration and Congress, FinCEN could release a new proposal to establish AML standards and suspicious activity reporting requirements for investment advisers registered with the SEC (RIAs). Although some investment advisers may voluntarily comply with BSA requirements or be affiliated with organizations that have enterprise-wide requirements, this would be a significant undertaking for many, and special consideration must be given to imposing the same requirements on RIAs as other financial institutions.

Reiterating comments made by SIFMA and its asset management group in 2015, any re-proposal should be limited to RIAs within the U.S. to reduce conflicts with existing requirements, particularly to avoid conflict of law issues for non-U.S. firms.^[8] Any rule should also clarify that the non-U.S. activities of U.S. firms are exempt in situations where compliance would cause the firm to violate laws within the non-U.S. jurisdiction.

Further, certain advisory activities that present little or no risk of money laundering to investment advisers should be excluded. These activities either do not involve the management of client assets or investor information is limited, leaving investment advisers with little way of detecting and reporting illicit financial activity. For example, sub-advisers, which are typically sought for their expertise by a main fund that manages the assets, and advisers of wrap fee programs, in which investment advisory and brokerage execution services are provided for a single ‘‘wrapped’’ fee, do not manage assets or have underlying investor information. Any rule should either focus AML activities on risks presented by the direct clients of investment advisers or provide clear guidance on compliance expectations when investor information is limited and avoid requiring investment advisers to “look through” to the ultimate investors for their AML activities.

Any rule should also make clear that risk assessments can take different forms based on the facts and circumstances unique to each RIA since current statutory and regulatory provisions do not require customer-by-customer risk assessments. Additionally, any rule should authorize investment advisers to share SARs within their corporate organizational structures, a longstanding SIFMA position for any financial institution. Otherwise, the lack of ability to share reports internally would frustrate the company’s compliance efforts.

Hopefully, with the benefit of hindsight and feedback in the intervening years, FinCEN addresses SIFMA’s concerns and appropriately tailors a new rule proposal to the risks investment advisers face.

Marijuana & Broker-Dealers

Like traditional banks, broker-dealers are in somewhat of a cannabis conundrum. Currently, most financial institutions are hesitant to work with marijuana companies because the substance remains federally illegal.^[9] Many feel that doing business in this industry opens them up to legal risk.^[10] For example, money made from the sale of marijuana and then transferred across the country may implicate a servicing bank in wire fraud if the money is seen as the proceeds of illegal activity.^[11] As a result, the mainstream banking industry is inaccessible to marijuana companies. To settle this and other issues faced by companies in the marijuana industry, Congress attempted to pass the SAFE Banking Act.^[12] While the Act passed in the House of Representatives several times, it has yet to pass in the Senate and the path forward is hazy.^[13] If passed, the Act would prohibit federal banking regulators from enacting disciplinary measures against banks for providing services to legitimate marijuana-related companies. Moreover, the Act would exclude money acquired through marijuana-related transactions from being considered proceeds of illegal activity.

While the SAFE Banking Act does not explicitly address broker-dealers, because the Act excludes marijuana-related transactions from being considered proceeds of illegal activity, broker-dealers could allow secondary-market trading of marijuana-related securities to a much greater extent than some do now without fear of federal enforcement, and otherwise engage in more direct business with companies operating legally under applicable state law that “touch the plant.” Moreover, with proceeds involving cannabis not being considered unlawful activity, it would provide relief to all financial institutions from filings so many SARs. Unclear, however, is whether investment banks could provide capital-raising services to marijuana-related companies, which could stint their growth, or provide competitive advantages to less-regulated firms.

Digital Assets

Broker-dealers have been assessing the potential benefits and risks associated with digital assets. Client demand, as investors seek exposure to new asset classes, crypto as a payment mechanism, opportunities for greater financial inclusion, and new client opportunities, as Virtual Asset Service Providers (VASPs) seek traditional financial products and services (e.g., capital raising, FX, banking), have generated interest in the broker-dealer community. AML officers are presented with assessing the potential risks, particularly novel ones from digital assets. Those risks include a significant amount of innovation without mature compliance and corporate governance frameworks, a lack of transparency in self-hosted wallets, heightened risks of money laundering and sanctions circumvention, particular with mixers and tumblers, and risk of hacks and thefts and ransomware.

Regulators are making it a priority to understand the touchpoints of digital assets to broker-dealers and RIAs this year. For instance, the SEC will monitor and, as appropriate, examine potentially impacted registrants, with a focus on the offer, sale or recommendation of, advice regarding and trading in crypto assets and associated compliance, disclosure and risk management practices.  Broker-dealer and RIA examinations will focus on firms that employ digital engagement practices and related tools and methods.^[14]

To provide greater certainty, SIFMA has advocated for policymakers to enact strict illicit finance regulation to level the playing field across participants in the industry, and to modernize existing rules to account for unique operation of digital assets.^[15]

Fraud

It wouldn’t be a hot topics article without talking about new or evolving frauds that keep AML officers up at night, including identity theft, cyber security, and sanctions evasion.

For broker-dealers, identity theft or synthetic identity fraud in connection with account openings has been persistent and proliferating. Criminals use stolen or synthetic identities to open accounts and initiate fraudulent transfers of the customer’s assets (i.e., cash and securities) from the legitimate account to the new, fraudulent account. The assets are then liquidated entirely or simply a portion, and transferred yet again, complicating the trail, and masking the fraud. Keeping up with even more sophisticated criminals that can open hundreds or thousands of new accounts, new or changing typologies, and red flags is incredibly challenging. Firms, especially those that offer online account opening services, must be especially vigilant looking for and incorporating red flags of new account fraud into their customer onboarding process.

Regulators, including the SEC, FinCEN, and Financial Industry Regulatory Authority are also looking for AML officers to be vigilant and report significant (i.e., not the thousands of pings financial institutions experience daily) cybersecurity intrusions, and to be closely coordinated by cybersecurity colleagues monitoring for and preventing cyber-attacks.

These same regulators are increasingly looking for broker-dealers to be vigilant for sanctions evasion to ensure the effectiveness of effectiveness. Russia’s invasion of Ukraine last year, and the response of Russians oligarchs and individuals close to them after the announcement of sanctions, has put broker-dealers on heightened alert. They have been looking for material changes in the type or volume of activity and transfers of assets into the names of non-sanctioned family members or close associates.

Conclusion

This year presents many opportunities and challenges for broker-dealers. SIFMA’s members hope that FinCEN – tasked with implementing landmark legislation mandating a rethink of the past 20 years that resulted in cumulative and burdensome regulations that drain limited resources from focusing on the most important illicit finance risks faced by the U.S. financial system – will be faithful to the Congress’ intent envision in the AML Act. While implementing any rulemaking is challenging, it’s worth it for a noble purpose. It would also be helpful if Congress provided clarity on banking the legalized marijuana industry. Further, As Congress continues to assess whether to impose BSA requirements on investment advisers, any legislation and rulemaking should be thoughtful, so as to not impose requirements where none should exist, i.e., where the investment adviser does not have a relationship with the investor. Amidst all, AML officers have a day job to do, doing their best to identify and report illicit financial activity and protect the U.S. financial markets and ensure its preeminence. Any legislation or rulemaking that eases burdens and provides clarity helps them to do their jobs better.

—

These topics and more will be discussed at SIFMA’s 2023 Anti-Money Laundering & Financial Crimes Conference, taking place from May 22-23, 2023 in New York City.

 

Bernard Canepa is a Managing Director and Associate General Counsel in SIFMA’s Office of General Counsel, where he works on a variety of legal and policy issues, including anti-money laundering and financial crime compliance. He monitors and keeps SIFMA members apprised of relevant developments, engages in ongoing dialogue with regulators, and advocates industry positions. Bernard joined SIFMA in March 2016. Prior to that, he worked at FINRA for over seven years. Bernard has an undergraduate degree in foreign affairs from the University of Virginia and a law degree from the University of Miami.

 

Footnotes

^[1] For more information, visit www.sifma.org. Mr. Canepa appreciates the assistance of Rianna Felder, SIFMA’s Spring 2023 legal intern, who graduates from Howard University School of Law this May and will be joining Ropes & Gray law firm after graduation.

^[2] Beneficial Ownership Information Reporting Requirements, 87 Fed. Reg. 59498 (Sept. 30, 2022)

^[3] SIFMA Comment Letter (Feb. 7, 2022), https://www.sifma.org/resources/submissions/fincen-nprm-on-beneficial-ownership-information-reporting-requirements/

^[4] SIFMA Comment Letter (Feb. 14, 2023), https://www.sifma.org/resources/submissions/fincen-notice-of-proposed-rulemaking-on-beneficial-ownership-information-access-and-safeguards-and-use-of-fincen-identifiers-for-entities/

^[5] Supra note 3.

^[6] United States Strategy on Countering Corruption (Dec. 2021), https://www.whitehouse.gov/wp-content/uploads/2021/12/United-States-Strategy-on-Countering-Corruption.pdf

^[7] Establishing New Authorities for Businesses Laundering and Enabling Risks to Security Act (ENABLERS Act), H.R.5525, 117th Congress (2021-2022), https://www.congress.gov/bill/117th-congress/house-bill/5525

^[8] SIFMA Comment Letter (Nov. 2, 2015), https://www.sifma.org/wp-content/uploads/2017/05/sifma-and-sifma-amg-submit-comments-to-the-treasury-on-aml-program-and-suspicious-activity-report-filing-requirements.pdf

^[9] Bloomberg, Cannabis Banking Is Booming Despite Federal Uncertainty (Jan. 18, 2022), https://www.bloomberg.com/news/newsletters/2022-01-18/marijuana-banking-is-moving-forward-despite-federal-uncertainty#:~:text=Most%20big%20banks%20shun%20cannabis,paying%20workers%20and%‌20buying%20inventory.

^[10] Id.

^[11] Id.

^[12] SAFE Banking Act of 2021, H.R.1996, 117th Congress (2021-2022), https://www.congress.gov/bill/117th-congress/house-bill/1996

^[13] Forbes, Cannabis Stocks In 2023: The Impact Of The SAFE Banking Act Failure (Jan. 25, 2023), https://www.forbes.com/sites/qai/2023/01/25/cannabis-stocks-in-2023-the-impact-of-the-safe-banking-act-failure/?sh=756e63727930

^[14] SEC, 2023 Examination Priorities, https://www.sec.gov/files/2023-exam-priorities.pdf

^[15] Dr. Peter Ryan, US Digital Assets Policy Should Prioritize Investor Protection and Build Upon Our Robust Regulatory Frameworks, Pennsylvania + Wall blog (Nov. 16, 2022), https://www.sifma.org/resources/news/u-s-digital-assets-policy-should-prioritize-investor-protection-and-build-upon-our-robust-regulatory-frameworks/

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