Edited by Eric R. Fischer, Elizabeth Shea Fries and Jackson B. R. Galloway
Developments Of Note
- Broker-Dealer Settles with FINRA for Failure to Effectively
Detect and Prevent Suspicious Transactions
- SEC Releases Statement on Anticipated Sequencing of Dodd-Frank
Rules for Security-Based Swaps
- OCC Approves Application for Establishment of a Number of
Messenger Service Branches
- SEC Staff Provides FAQ on Form PF
Broker-Dealer Settles with FINRA for Failure to Effectively Detect and Prevent Suspicious Transactions
A registered broker-dealer recently executed a Letter of Acceptance, Waiver and Consent ("AWC") with FINRA regarding alleged violations of supervision rules applicable to suspicious transactions in customer accounts. In settling this matter, the member firm neither admitted nor denied FINRA's findings, but consented to the entry of the findings, which are summarized in this article.
Background. FINRA Rule 3310(a) (formerly NASD Conduct Rule 3011(a)) requires that member firms must, at a minimum, "establish and implement policies and procedures reasonably designed to detect and cause the reporting of suspicious transactions" under certain federal anti-money laundering ("AML") laws. The AWC relates to a customer's use of his accounts to conduct a Ponzi scheme resulting in losses of over $17 million to the customer's "investors." According to the AWC, activity in the customer's accounts between January 2005 and July 2007 frequently triggered potential money laundering concerns (e.g., the flow of funds into and out of the account and the unusual practice of writing checks in round dollar amounts to third parties later discovered to be the customer's investors). When the Ponzi scheme was discovered, the customer pleaded guilty to first degree felonies for selling unregistered securities, perjury and forgery, was sentenced to prison and ordered to pay over $17 million in restitution. FINRA found that the member firm violated NASD Conduct Rule 3011 because it failed to implement policies and procedures reasonably designed to detect or report suspicious activity in the customer's accounts.
Violative Conduct. During the relevant period, the AML policies and procedures the member firm had in place frequently generated compliance reports, referred to as exception reports, in connection with suspicious activity in the customer's accounts. In addition to exception reports, the member firm became aware of several red flags suggesting that the customer's account may have been used to engage in illegal activity. Despite such indicators of suspicious transactions, the member firm failed to adequately review, monitor or investigate the customer's accounts.
In the AWC, FINRA cited specific failures of the member firm with respect to its AML obligations under NASD Conduct Rule 3011. FINRA found that the broker-dealer did not devote adequate resources to its AML program. For instance, the member firm's program did not include a centralized database or other means of combining and vetting information generated under the AML program. The member firm's investigation of certain red flags and exception reports was found to be inadequate because the AML officer failed to pursue concerns about the account activity directly, contact the branch manager or ascertain whether the registered representative or the branch manager had inquired about the account activity. Rather, the AML officer's investigation did not extend beyond making an inquiry to the registered representative, who responded to the AML officer's inquiries with general explanations about the customer and his account activity as well as what the registered representative indicated was personal knowledge of the customer's successful businesses. Despite the unusual nature of the responses, neither the AML officer nor any of the member firm's compliance personnel attempted to reconcile the transactions or further investigate the matter. For example, compliance personnel did not seek additional information about the high volume of payments in round dollar amounts to third parties to see if these were really payments to sellers of various assets as claimed by the customer.
FINRA found that after the broker-dealer became aware of suspicious activity, the member firm did not adequately consider such activity or monitor the customer's accounts. According to the AWC, departments within the member firm failed to share information that might have revealed the illegal activity (e.g., the member firm's legal department became aware of a criminal inquiry in connection with the customer's conversion of funds deposited into his accounts). Even with other information suggesting that the customer's accounts were being used to conduct suspicious or illegal transactions, the member firm did not implement policies and procedures to effectively monitor and review that information. Because of the failure to detect and investigate the suspicious transactions in the customer's accounts as well as inadequate information sharing, the member firm failed to conduct adequate monitoring of the accounts.
AML Policies and Procedures. FINRA Rule 3310(a) does not prescribe specific policies and procedures that member firms must implement. Rather, the rule mandates programs that are "at a minimum . . . reasonably designed to detect and cause the reporting of suspicious transactions." The AWC noted that a broker-dealer should consider certain factors when designing AML policies and procedures. For example, FINRA suggested that a member firm consider its size, location, business activities, the types of accounts it maintains, and the types of transactions in which its customers engage. Citing two Notices to Members issued by FINRA (02-21 and 02-47), FINRA emphasized that it is a member's duty to detect red flags or other suspicious transactions and, if any are detected, to perform additional due diligence before proceeding with any such transaction or before terminating an investigation.
The AWC indicated that it is not sufficient to simply have policies and procedures to identify suspicious activity if a member firm resolves any red flags or any investigation into such activity with a general explanation from the registered representative. Rather, to meet the requirements under FINRA Rule 3310(a), a member firm is required to thoroughly consider, monitor and investigate any suspicious activity.
Sanctions. In accepting and consenting to entry of the AWC, FINRA imposed a censure on the member firm and levied a fine in the amount of $400,000. The AWC also required the broker-dealer to conduct a comprehensive review of the adequacy of its AML policies and procedures, systems, and internal training programs and to provide written certification to FINRA that its procedures are reasonably designed to achieve compliance with FINRA Rule 3310.
SEC Releases Statement on Anticipated Sequencing of Dodd-Frank Rules for Security-Based Swaps
The SEC has released a statement of general policy discussing its anticipated sequencing of compliance dates for final rules to be adopted by the SEC pursuant to the Dodd-Frank Act that focus primarily on security-based swaps and security-based swap market participants.
The statement groups the rules into five categories:
- Entity definition rules, product definition rules, and rules concerning the treatment of cross-border security-based swap transactions and certain non-US persons.
- Rules pertaining to security-based swap data repositories and the public dissemination of security-based swap transaction data.
- Rules pertaining to clearing.
- Rules pertaining to the registration and regulation of security-based swap dealers and major security-based swap participants.
- Rules pertaining to the mandatory trading of security-based swap transactions, including rules pertaining to security-based swap execution facilities.
The statement notes that the rules in the first category affect compliance with those in the other four categories, and therefore that the rules in the first category would generally need to be adopted and effective prior to the compliance dates for rules in the remaining four categories. As a result, the rules in the first category would generally be adopted earlier than those in the other categories. This contrasts with the approach taken by the CFTC, which has already finalized a number of rules whose effective or compliance dates are delayed until certain other rules are finalized, and which in some cases cannot be fully understood until such subsequent rules are adopted. The SEC's statement also indicates that comments received on rules in the first category could provide insights relevant to the formulation of rules in the remaining categories.
Although the statement does not provide specific compliance dates for any of the rules and does not provide a conclusive sequence of compliance dates, it does, in its own words, "explain how such dates could be sequenced in relative terms and, in this way, seeks to give security-based swap market participants clarity into and an opportunity to comment upon the general order in which they might expect to consider and prepare for compliance with these final rules." The statement notes that the SEC was guided by various principles, such as the intent to prioritize compliance with final rules involving swap data reporting so that the SEC could utilize the analysis of such data in subsequent rule-making, and the desire to provide regulated entities with "adequate, but not excessive" time to comply with rules applicable to them.
The SEC has invited public comment on the statement, and has asked a number of specific questions throughout the statement to solicit public input. Public comments are due by August 13, 2012.
OCC Approves Application for Establishment of a Number of Messenger Service Branches
The OCC issued a corporate decision ("Decision #2012-10") in which it approved a national bank's application to establish messenger service branches in a number of counties in Minnesota. A "messenger service" under 12 CFR 7.1012(a) is any service used by a national bank to pick up from, and deliver to, specific customers at locations, such as homes and offices, items involving branching transactions, e.g. deposits and loan payments, between the bank and its customers. In Decision #2012-10, the OCC said that the national bank may operate the messenger service only in those locations where the national bank could legally establish a permanent branch under applicable federal and state law and only within the geographic areas where the newspaper notice of the establishment of the proposed messenger service branch was published.
SEC Staff Provides FAQ on Form PF
The staff of the SEC's Division of Investment Management has posted an FAQ for Form PF on the SEC's website. The seven-question FAQ addresses issues regarding fund categorization, aggregation of parallel funds and managed accounts, and funds of funds.
Goodwin Procter LLP is one of the nation's leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.
This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. © 2012 Goodwin Procter LLP. All rights reserved.