United States: Summary Of Notice And Request For Comments Regarding Suspicious Activity Report By The Securities And Futures Industries, Mutual Funds And Other Investment Companies, Investment Advisors And Certain Insurance Companies–Written Comments Due By October

Article by: Betty Santangelo and Margaret Jacobs

On August 5, 2002, the Financial Crimes Enforcement Network ("FinCEN"), a bureau of them Department of the Treasury ("Treasury"), issued a draft form, "Suspicious Activity Report by the Securities and Futures Industry (SAR-SF)."1 The form is designed for use by broker-dealers that are required to file suspicious activity reports with respect to transactions occurring after December 30, 2002,² pursuant to the SAR Final Rule implementing section 356 of the USA PATRIOT Act of 2001.³

Futures commission merchants ("FCMs") may use the form to report suspicious activity to Treasury on a voluntary basis. The form is also designed for use by mutual funds, other investment companies, investment advisors and certain insurance companies.

In the preamble of the SAR Final Rule, Treasury indicated that it would be developing a suspicious activity reporting form for broker-dealers entitled "SAR-BD."⁴ However, since the form additionally was developed for use by FCMs, the name was changed to "SAR-SF," and several fields were provided on the form for use by FCMs.⁵

The SAR Final Rule clarified that it applied to the activities of broker-dealers registered both with the Commodities Futures Trading Commission ("CFTC") as an FCM and with the SEC as a brokerdealer, and did not apply to dual registrants to the extent that their activities are subject to the exclusive jurisdiction of the CFTC.⁶ In a notice discussing the purpose and content of the draft form and requesting comments ("SAR Notice"), Treasury now encourages FCMs registered with the CFTC (clearly, those not already subject to section 356) to file SAR-SFs voluntarily.⁷ FinCEN anticipates issuing shortly proposed rules that would require all FCMs to report suspicious activities.⁸

Under the SAR Final Rule, Treasury explained that persons who are registered broker-dealers "solely to offer and sell variable annuity contracts issued by life insurance companies will be subject to the suspicious activity reporting rules . . . and all other BSA requirements to the extent they offer and sell such contracts."⁹ As discussed below, the draft SAR-SF form would require a reporting financial institution to provide certain identifying information, including whether it is a variable life insurance or annuities broker-dealer, an introducing or clearing broker, a securities dealer or some other type of institution or individual required to file or voluntarily filing the report.

In the SAR-SF Notice, Treasury indicated that it provided a draft form to solicit public comment, and that the SAR-SF should not yet be used until it issues a final version of the form. Until the final SAR-SF form is available, we suggest that broker-dealers and FCMs who are voluntarily filing reports of suspicious activities continue to use the bank SAR form.

Under the SAR Final Rule, within 30 days after a broker-dealer becomes aware of a suspicious transaction, the broker-dealer must report the transaction by completing a SAR form.¹⁰ If a brokerdealer is unable to identify a suspect on the date that the suspicious transaction is initially detected, the SAR Final Rule provides the broker-dealer with an additional 30 calendar days to identify the suspect before filing the SAR. However, in any event, the suspicious transaction must be reported within 60 calendar days after the date of initial detection of the suspicious transaction, whether or not the brokerdealer can identify a suspect.

Under certain circumstances, a broker-dealer is required immediately to notify authorities of suspicious activities. Specifically, the SAR Final Rule requires a broker-dealer to immediately notify by telephone an appropriate law enforcement authority "only in situations that require immediate attention, such as terrorist financing or ongoing money laundering schemes." In those situations, although not required under the SAR Final Rule, they may also contact the SEC to report such activities. Broker-dealers are also reminded that they may call FinCEN's Financial Institutions Hotline (1-866-556-3974) to report any terrorist activity. However, broker-dealers using this hotline still must file a timely SAR-SF to the extent required by the SAR Final Rule.¹¹

Under the SAR Final Rule, supporting documentation relating to the SAR-SF must be collected and maintained by the broker-dealer and made available to law enforcement or authorized regulatory agencies and SROs upon request. Page 7 of the SAR-SF provides examples of supporting documentation: "transaction records, new account information, tape recordings, e-mail messages, correspondence . . . " The rule requires that copies of this documentation and the SAR-SF must be maintained by the filing broker-dealer for 5 years.

The SAR-SF Form indicates that the completed form, without supporting documentation, should be sent to:

The information obtained through the SARs is made available to criminal law enforcement and regulatory personnel, to registered securities associations and national securities exchanges (SROs).

The SAR-SF Notice restated the broad protections from liability for reporting suspicious transactions included in the SAR Final Rule¹² and for failing to disclose such reporting contained in the safe harbor provision of the BSA.¹³ As with the bank SAR, the safe harbor is printed prominently on the top of page 5 of the SAR-SF. The first sentence on the SAR-SF makes clear, pursuant to the SAR Final Rule, that the safe harbor applies to voluntary reporting as well.¹⁴

The SAR Final Rule also indicates that a broker-dealer who files a SAR-SF may not notify a person involved in the transaction that the transaction has been reported. Therefore, during any proceeding, including an arbitration, the broker-dealer is prohibited from disclosing that a SAR-SF was filed. Any person subpoenaed or otherwise requested by anyone other than FinCEN, the SEC, another appropriate law enforcement or regulatory agency, or an SRO registered with the SEC, to disclose a SAR-SF or the information contained in a SAR-SF, must decline to do so and notify FinCEN of the request and response.¹⁵

As with the bank SAR, Page 5 of the SAR-SF contains a section entitled "Notification Prohibited," which prohibits a financial institution and its directors, officers, employees and agents who report suspicious transactions to the government from notifying any person involved in the transaction about the report.

The SAR-SF also contains a section entitled "When to file a report," which provides instructions regarding which transactions require reporting on SAR forms, the time frame for such reporting, the exceptions to such reporting and the rules for filing currency transaction reports (CTRs). These instructions reflect the relevant provisions of the SAR Final Rule as discussed above.

The two forms are substantially similar and differ mainly in the options provided to describe the suspicious transactions, as they reflect the differences between the banking and the securities and futures industries.¹⁶ The "When to File a Report" sections reflect the different suspicious reporting obligations of the banking industry,¹⁷ as opposed to the reporting obligations of the securities and futures industries (i.e., Rule 356).

Treasury has rearranged certain information on the SAR-SF, such as placing the "Subject Information," section first, followed by "Suspicious Activity Information," Law Enforcement or Regulatory Contact Information," "Reporting Financial Institution Information," and "Contact for Assistance," as opposed to the order on the bank SAR. Certain categories of information, such as account information, the suspect's relationship to the reporting institution and whether the suspect made an admission or confession, are included in different sections of the forms.¹⁸

Certain sections are identical to those in the bank SAR, but include additional items relevant to the securities and futures industries. For example, in item 20, the SAR-SF asks whether the subject is still an associated person with respect to the reporting institution, as defined in section 3(a)(18) of the Securities Exchange Act of 1934 or CFTC rule 1.3(aa), or is still affiliated with the reporting institution, as defined in CFTC rule 4.7(a)(1)(i).¹⁹ If the answer is affirmative, the SAR-SF requests an explanation in the "Narrative."

The items with respect to "Instrument Type," "Type of Suspicious Activity" and "Type of [Reporting] Institution or Individual," include the choices in the bank SAR, but contain additional selections that similarly reflect the specifics of the securities and futures industries:

"Instrument type" is requested in question 23 under "Suspicious Activity Reporting." It adds selections for bonds/notes, cash or equivalent, commercial paper, commodity futures contract, money market mutual fund, mutual fund, OTC derivatives, other derivatives, commodity options, security futures products, stocks, warrants, other securities, other non-securities, foreign currency futures, foreign currencies, and market where traded.

"Type of Suspicious Activity" is requested in question 30 under "Suspicious Activity Reporting." It adds selections for futures fraud, forgery, insider trading, mail fraud, margin violation, money laundering, market manipulation, prearranged or other noncompetitive trading, securities fraud, suspicious documents or ID presented, significant wire or other transactions without economic purpose, terrorist financing, and wash or other fictitious trading.

"Type of [Reporting] Institution or Individual" is requested in question 51 under "Reporting Financial Institution Information. That section contains selections for: agriculture trade option merchant; affiliate of bank holding company; commodity pool operator; commodity trading advisor; direct participation program; futures commission merchant; futures floor broker; futures floor trader; introducing broker-futures; investment advisor; investment company – mutual fund; market maker; municipal securities dealer; registered entity-futures; other registered futures association; securities broker – clearing; securities broker – introducing; securities dealer; securities floor broker; securities options broker-dealer; self regulatory organization (SRO); specialist; subsidiary of bank; U.S. Government broker-dealer; U.S. Government interdealer broker; variable life insurance or annuities broker-dealer; and "other."

The most substantive changes occur in the list of types of information that must be included in Part V, entitled, "Suspicious Activity Information - Narrative." Set forth below is the list of requested information, with items specific to the SAR-SF in italics:

a. Describe conduct that raised suspicion

b. Explain whether the transaction(s) was completed or only attempted.

c. Describe supporting documentation (e.g. transaction records, new account information, tape recordings, e -mail messages, correspondence, etc.) and retain such documentation in your file for five years.

d. Explain who benefited, financially or otherwise, from the transactions(s), how much and how (if known).

e. Describe and retain any admission, or explanation of the transaction(s) provided by the subject(s), or other persons. Indicate to whom and when it was given.

f. Describe and retain any evidence of cover-up or evidence of an attempt to deceive federal or state examiners, SRO, or others.

g. Indicate where the possible violation of law(s) took place (e.g., main office, branch, other).

h. Indicate whether the suspicious activity is an isolated incident or relates to another transaction.

i. Indicate whether there is any related litigation. If so, specify its status.

j. Recommend any further investigation that might assist law enforcement authorities.

k. Indicate whether any information has been excluded from this report; if so, state reasons.

l. Indicate whether U.S. or foreign currency and/or U.S. or foreign negotiable instrument(so were involved. If foreign, provide the amount, name of currency, and country of origin.

o. Indicate any additional account number(s), and any foreign bank(s) account number(s) which may be involved.

r. Describe subject(s) [sic] position if employed by the financial institution.²⁰

s. Indicate whether securities, futures or options were involved. If so, list the type, CUSIP number or ISID number, and amount.

There are certain sections of the draft form that may require clarification by FinCEN:

Part II, Suspicious Activity Info.: It is unclear as to the circumstances requiring a CUSIP number.

Part IV, Reporting Financial Institution Information – It is not clear why item 36, "Name of financial institution or sole proprietorship" includes the concept of a sole proprietorship.

Under item 51, "Type of institution or individual," it is not clear whether Treasury intended financial institutions that match more than one description to select every box that applies to them or choose one. Also, it is not clear which block or blocks a retail broker-dealer that is self-clearing (e.g., retail or institutional broker-dealers or government securities dealers) should check.

In addition, the list of financial institutions includes selections for "National Futures Association" ("NFA") and "Other Registered Futures Assn." There is a separate box for selfregulatory organizations. No guidance is provided as to when SROs would file SARs.

There are boxes for "Commodity pool operator," "Commodity trading advisor," "Investment advisor," and "Investment company – mutual fund." None of these are currently required to file suspicious activity reports, although to the extent any of them are required to have AML programs, the implementing rules call for procedures addressing suspicious activity reporting.²¹

Part VI, Narrative Section, Item "k": As adopted from the bank SAR, item "k" of the Narrative section requires the report to "[i]ndicate whether any information has been excluded from this report; if so, state reasons," (i.e., the reasons for the exclusion). This item is separate and apart from the requirement that a financial institution retain the supporting documentation for the report. As there is a clear intention that all relevant details be included in the report, it is not obvious what information Treasury is seeking here.

Part VI, Narrative Section, Item "t": The description of the type of institution filing the report includes an example of a hedge fund. However, Treasury has not indicated that hedge funds are subject to suspicious activity reporting requirements.

Safe Harbor: The safe harbor contained in the draft SAR-SF provides for "complete protection from civil liability for all reports of suspicious transactions made to appropriate authorities . . . " (emphasis added). The SAR Final Rule incorporates the limitation of liability provision under section 351, which refers to: "any financial institution that makes a voluntary disclosure of any possible violation of law or regulation to a government agency or makes a disclosure pursuant to this subsection or any authority . . . " (emphasis added). Although the draft SAR-SF seems to imply a safe harbor for disclosure to an SRO, section 351 does not provide for such broad coverage.

When to file a report, item 4: The SAR Final Rule for section 356 requires immediate notification of law enforcement only in the case of "terrorist financing" or ongoing money laundering schemes" (emphasis added).22 The draft SAR-SF includes conflicting instructions: a box inserted before the section on "When to file a report" limits reporting to ongoing money laundering activities, while item 4 of the section "When to file a report," indicates that situations involving violations that require immediate attention include money laundering schemes, without reference to the fact they should be ongoing.

1 67 Fed. Reg. 50751, 50753-61 (Aug. 5, 2002).
2 31 C.F.R. § 103.19. For a summary and analysis of the SAR Final Rule, see Schulte Roth & Zabel LLP
Memorandum to Clients, Summary of SAR Final Rule Requiring Broker-Dealers to File Reports of Suspicious Transactions, dated July 16, 2002. Available at www.srz.com/pubtemplate.asp?id=326.
3 Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001, Pub. L. No. 107-56, 115 Stat. 296 (2001).
4 67 Fed. Reg. 44048, 44051 (July 1, 2002). The SAR-SF Form repeats certain of the SAR Final Rule requirements and they are therefore included here for context.
5 67 Fed. Reg. 50751, 50751-52 (Aug. 5, 2002).
6 67 Fed. Reg. at 44052.
7 67 Fed. Reg. at 50751-52.
8 Id. at 50752 n.3.
9 67 Fed. Reg. at 44052 (emphasis added). Other insurance products offered or sold by such persons or entities, therefore, do not appear to be covered by the SAR Final Rule.
10 31 C.F.R. § 103.19(b)(3).
11 In the SAR Final Rule, FinCEN also notes that, "filing a report of a suspicious transaction [with FinCEN] does not relieve a broker-dealer from the responsibility of complying with any other reporting requirements imposed by the [SEC or an SRO]." 31 C.F.R. § 103.19(a)(1).
12 31 U.S.C. § 5318(g)(3) provides: "Any financial institution that makes a disclosure of any possible violation of law or regulation or a disclosure pursuant to this subsection or any other authority, and any director, officer, employee, or agent of such institution, shall not be liable to any person under any law or regulation of the United States or any constitution, law, or regulation of any State or political subdivision thereof, for such disclosure or for any failure to notify the person involved in the transaction or any other person of such disclosure."
13 See 31 U.S.C. § 5318(g)(3). There is a prohibition against disclosure contained in 31 U.S.C. § 5318(g)(2).
14 The SAR-SF Form reads: "Federal law (31 U.S.C. 5318(g)(3)) provides complete protection from civil liability for all reports of suspicious transactions made to appropriate authorities, including supporting documentation, regardless of whether such reports are filed pursuant to this report's instructions or are filed on a voluntary basis."
15 31 C.F.R. § 103.19(e).
16 Unlike the bank SAR, the SAR-SF contains an explanation under the heading that critical items are marked with an asterisk.
17 31 C.F.R. § 103.18 (issued by FinCEN). In collaboration with FinCEN, the federal bank supervisors concurrently issued suspicious transaction reporting rules under their own authority: 12 C.F.R. § 208.62 (Federal Reserve Board); 12 C.F.R. § 21.11 (OCC); 12 C.F.R. § 353.3 (FDIC); 12 C.F.R. § 563.180 (OTS); and 12 C.F.R. § 748.1 (NCUA).
18 Other information is included but arranged differently. Account information is requested in question 14 under "Reporting Financial Institution Information" on the bank SAR and in question 15 under "Subject Information" on the SARSF. The suspect's relationship to the reporting institution is requested in question 30 under "Suspect Information" on the bank SAR and in question "r" under "Suspicious Activity Information - Narrative" on the SAR-SF. The admission/confession information is requested in question 28 under "Suspect Information" on the bank SAR and in question "e" under " Suspicious Activity Information – Narrative" on the SAR-SF.
19 Question 20 under "Subject Information."
20 Covered in question 30 under "Suspect Information" on the bank SAR.
21 While mutual funds are now subject to the AML program rule, there is a temporary exemption for CPOs and CTAs,. However, the Interpretive Notice for the NFA's AML program rule, Compliance Rule 2-9, contains a provision addressing the reporting of suspicious activities. Recently, Treasury also issued proposed rules relating to AML programs for a number of types of investment companies.
22 31 C.F.R. § 103.19(3); 67 Fed. Reg. at 44,054.