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How to Avoid Going to Jail for a Very Long Time

Long before September 11, a Pakistani newspaper quoted Osama bin Laden as saying, Al Qaeda is comprised of modern educated youths who are as aware of the cracks in the western financial system as they are of the lines in their hands. In other words, his terror network had mastered the techniques used by criminals the world over to fund their activities by money (converting illegally obtained funds

Long before September 11, a Pakistani newspaper quoted Osama bin Laden as saying, “Al Qaeda is comprised of modern educated youths who are as aware of the cracks in the western financial system as they are of the lines in their hands.”

In other words, his terror network had mastered the techniques used by criminals the world over to fund their activities — by “laundering” money (converting illegally obtained funds to “clean” money by moving them through legitimate financial institutions).

Law enforcement officials have long been concerned about the potential to use brokerage accounts to launder funds. The anti-terrorism bill passed last Oct. 26, the USA Patriot Act of 2001, expands money laundering laws from banks to brokerage firms and does so in ways that will affect everyone in the securities industry. Beginning this spring, anti-money-laundering measures will become a major focus of compliance activity in securities firms.

The stereotype of money laundering is that of a drug dealer who hands a bag of money over the counter to a bank teller. This view is far too simplistic. Money laundering involves income derived from a wide range of criminal activities, including securities law violations such as insider trading, Ponzi schemes or sales of fraudulent securities. The money laundering laws apply not just to cash transactions but to all kinds of financial dealings.

Two main sets of laws cover money laundering: the criminal statutes that make money laundering illegal and the Bank Secrecy Act, which imposes reporting and record keeping requirements on financial institutions. The consequences of violating the criminal statutes can be severe, including fines as high as $500,000 and prison sentences of up to 20 years. Moreover, the courts have held that an individual who is found to be “willfully blind” to money laundering could also be liable.

This means that a bank employee — or broker — cannot afford to ignore “red flags” that might give reason to suspect possible money laundering. The Bank Secrecy Act requires financial institutions to make a variety of reports to FinCEN (the Financial Crimes Enforcement Network), including reports of currency transactions of $10,000 or more, and reports of “suspicious activities.” Penalties for failing to report, or for causing a financial institution to fail to report, can also be severe.

On The Front Line

The USA Patriot Act, formally known as the Uniting and Strengthening America by Proving Appropriate Tools Required to Intercept and Obstruct Terrorism Act, strengthens and expands the anti-money-laundering laws. Three provisions in particular will affect brokers in the securities industry and, in effect, put brokers and their firms on the front line in the fight against money laundering.

First, all broker-dealers (as well a variety of other financial institutions) must set up anti-money-laundering compliance programs by April 26. Thus, registered reps should expect to see changes in their firms in the form of tougher compliance procedures, training and similar measures.

Second, the Act mandates new regulations — to take effect by Oct. 26 — that set minimum standards for verification of the identity of any person opening an account. No one knows yet what the rules will be, but they could require customers to provide certain types of information or documentation to verify their identity.

Third, the Act mandates new regulations — to take effect by July 1 — that will make “suspicious activity reports” mandatory for all broker-dealers. (Under the old money-laundering statutes, only broker-dealers that are subsidiaries of banks or bank holding companies have been required to file these reports.) Thus, all registered reps should expect to see their firms issue new rules in coming months that will spell out how brokers are required to spot “suspicious activities.”

Those who deal directly with customers — brokers — are in the best position to identify suspicious activities that must be reported. However, just what is a reportable “suspicious activity?” Regulations require a transaction to be reported if the financial institution knows or has reason to suspect that the funds were derived from illegal activities.

Laundering List

There is no simple definition of “suspicious activities,” but learning to recognize the “red flags” that may signal money laundering is a good starting place.

Money is laundered in three stages. “Placement” occurs when cash generated from illegal activities is introduced into the financial system, for example, by breaking up large amounts of cash into less conspicuous small amounts that are deposited in a bank or used to purchase financial instruments.

In the “layering” stage, the funds are transferred or converted in a series of transactions that distance the proceeds from their source. Layering can involve, for example, buying and selling investment products or wiring funds through a series of seemingly unrelated accounts.

Typically, a suspicious transaction is defined as one that might seek to hide or disguise the ownership, nature, source, location or control of funds. However, concealment is not necessarily a requirement. An accurately documented, routine transaction, if it is part of the layering process, might be deemed suspicious — and something that a broker should report under the new rules.

In the “integration” stage, the funds are reintroduced into the economy in a way that makes them appear legitimate; for example, by combining assets acquired with illicit income with those in accounts holding legitimate assets or through further investments or purchases.

Most securities firms have a no-cash or limited-cash transaction policy. Nevertheless, firms and brokers are naive to think that such policies will keep them from taking in funds from money launderers. Law enforcement officials believe that securities firms are at particular risk of being used in the “layering” and “integration” stages of money laundering. Private banking services, which typically offer confidentiality, involve large-dollar transactions and use offshore accounts, may also be vulnerable to money laundering.

Firms offering online services, which provide little face-to-face contact with customers and the ability to transact with someone in a distant location, could be especially vulnerable.

Brokers should also be alert to certain transactions that should trigger alarms (See table). One of the most common red flags is a practice known as “structuring.” This is designed to circumvent the requirement that all cash transactions of $10,000 or more must be reported to FinCEN. In one case, a broker at a major wirehouse was convicted of money laundering after he assisted a customer to avoid reporting income to the IRS by opening a number of accounts in the names of various family members and then depositing sums of less than $10,000 in each.

Non-cash transactions can be red flags for “structuring” as well. If a customer purchases an investment with a series of money orders, traveler's checks or cashier's checks in amounts less than $10,000, this could be a sign the customer is structuring cash transactions at the money services business when he purchased the non-cash instruments — and potentially should be reported as a suspicious activity.

Protect Yourself

The most effective strategy to avoid being unwittingly used to launder money is to “know your customer.” With the heightened sensitivity to money laundering, this could mean digging for more in-depth knowledge than has been necessary in the past. At a minimum, a broker should obtain full identifying information, such as name, address, occupation, etc. If there are doubts, request verifications. (Some firms already require verification of identity such as a driver's license or passport.)

A broker should learn about the source of funds as well as the true ownership. If something doesn't make sense, the broker should ask questions, probe for further information and possibly request documentation. A broker should also ask the client what types of transactions could be expected in the account. Subsequent activity in the account should match this “transaction forecast,” and the broker should have a clear understanding of the reasons for any unusual activity later.

The broker should also conduct meaningful suitability reviews on all transactions, not only to satisfy this suitability rule, but as a part of knowing the customer. In general, it is good practice to update suitability profile information periodically, say once a year (See “From the NAIP” on page 79). Identifying information can be verified through routine contacts with the customer. The broker should be scrupulous in documenting identifying information and should promptly correct any information discovered to be incorrect.

The broker should never assist a customer in converting cash into checks, and should never acquiesce to a request to establish accounts for fictitious or nominal account owners, or to spread assets among multiple accounts in a manner that would obscure the origin or control of those assets.

Most of these suggestions are simply good business practice. If red flags pop up, the broker should seek direction from a supervisor, the legal or compliance department of the firm, or others the firm has designated to address money laundering concerns. If the broker reports a suspicious activity or learns that the firm has made such a report to the authorities, the broker should not discuss or disclose these facts to others. The law includes strict confidentiality rules concerning “suspicious activity reports” and prohibits revealing this information to the person who is the subject of the report or to any others.

Finally, a broker should refuse to do business with a customer if the broker can't get satisfactory information about his or her identity or source of funds — or to allay any concerns as to whether the client is on the right side of the law. Remember, under the new law, broker-dealers are part of the enforcement process; not to mention potential jailbirds if they fail to do their duty.

Writer's BIO: Sarah B. Estes
Partner with Sutherland Asbill & Brennan LLP

How to Spot A Money Launderer

Suspicious Client Behavior

Be wary of customers who:

  • Show unusual concern for secrecy, or are reluctant (or refuses) to provide basic identifying information.
  • Provide documents that appear to have been falsified or altered, or are otherwise suspicious.
  • Pay for a large investment in cash, or request help in converting cash into checks, money orders or other non-cash instruments.
  • Seek to open an account under a false name or as a “front” for someone else.
  • Walk-in without a clearly identified referral.
  • Have an unclear source of funds.
  • Seek to establish multiple accounts.

Signs of Possible Criminal Intent

Suspicious Transactions

Be on the lookout for:

  • A number of deposits or payments of less than $10,000.

  • An account that has inflows of funds beyond customer's resources.

  • Sudden bursts of unexplained or extensive wire transfers.

  • Extensive wire transfer activity with little or no corresponding long-term investment in the account.

  • Wire transfers that don't include the normal identifying information or suggest attempts to hide the identity of the originator or recipient.

  • Investments that don't make economic sense (such as large sums resting in money market accounts).

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