On October 11, 2019, the leaders of the US Securities and Exchange Commission (SEC), the US Commodity Futures Trading Commission (CFTC), and the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued a joint statement (the Joint Statement) confirming that anti-money laundering (AML) and certain other obligations under the Bank Secrecy Act (BSA) apply to broker-dealers’ business activities involving digital assets.¹ In addition to the Joint Statement, broker-dealers should be mindful of FINRA’s 2019 Examination Findings Report, which was released on October 16, 2019, and highlights broker-dealer AML requirements.²

AML Background

The BSA requires certain financial institutions to monitor for, detect and report suspicious activity to the FinCEN, which includes the filing of suspicious activity reports (SARs) with FinCEN. In addition to SAR filings, the BSA and other AML rules administered by FinCEN generally require certain financial institutions to implement customer identification programs (CIPs), including verifying the identity of the beneficial owners of certain legal entity customers, and implementing written AML policies and procedures to comply with the requirements of the BSA. These requirements broadly apply to, among other financial institutions, banks, broker-dealers and investment companies.

The Joint Statement

The Joint Statement addresses the application of AML laws and rules to digital assets, regardless of whether those same digital assets also meet the definition of a “security” in the Securities Act of 1933 or a “commodity” in the Commodity Exchange Act. More specifically, the Joint Statement confirms that AML laws and rules apply to all activities involving digital assets, even if those assets are not subject to regulation by the SEC or CFTC.

As described in the Joint Statement, digital assets include instruments that may qualify under applicable US laws as securities, commodities, or security- or commodity-based instruments such as futures contracts or swaps. These digital assets do not have a uniform legal definition, and market participants refer to them by many different labels, including “cryptocurrencies,” “digital tokens,” “digital currencies,” “virtual assets” and even “initial coin offerings.” Although the labels may change, the Joint Statement emphasizes that financial institutions engaging in business activities involving digital assets may still be subject to the full scope of AML laws and rules. In addition to these AML laws and rules, the Joint Statement also reminds market participants that digital assets may be subject to SEC and CFTC regulation, depending on their specific characteristics.

For instance, as the Joint Statement describes, a digital asset “exchange” may not meet the definition of a “national securities exchange” under the Securities Exchange Act of 1934, and therefore would not be subject to substantive regulation by the SEC. However, to the extent this exchange is engaging in business activities involving digital assets, it may be subject to AML laws and rules and would have to file certain SARs with FinCEN when it reasonably suspects suspicious activity. It would also have to comply with certain other AML obligations.

The Joint Statement included brief remarks from the leaders of each of the respective regulators:

• SEC’s Chairman, Jay Clayton, advised securities market participants that business activities involving digital assets that qualify as securities would be subject to regulation by the SEC, as well as to comprehensive AML regulation and suspicious activity reporting requirements.
• FinCEN’s Chairman, Kenneth Blanco, confirmed that digital assets meeting the definition of securities under federal law must comply with federal securities law, including SEC regulation. In addition, if certain financial institutions meet FinCEN’s definition of a “money transmitter” as a result of their activities involving digital assets, they would be subject to applicable FinCEN regulations. Among other things, these regulations would include the development of an AML program and suspicious activity reporting requirements, as well as requirements under applicable CFTC or SEC regulations.
• CFTC’s Chairman, Heath Tarbert, emphasized that AML requirements to report suspicious activity and implement reasonably designed AML programs apply to digital assets that qualify as commodities, as well as activities that are not subject to regulation by the CFTC.

FINRA Examination Findings Report

Another important development related to broker-dealer AML compliance is the recent examination findings highlighted by the Financial Industry Regulatory Authority, Inc. (FINRA), the self-regulatory organization responsible for overseeing securities broker-dealers. In FINRA’s 2019 Examination Findings Report, which was released October 16, 2019, FINRA identified a pattern of ineffective implementation of broker-dealer AML programs.

In particular, FINRA noted the following deficiencies:

• Transaction monitoring was not sufficiently tailored to reflect the broker-dealer’s specific business, and transaction monitoring procedures were not updated to address evolving risks.
• There was an ongoing misconception by firms that securities trading does not need to be monitored for suspicious activity reporting purposes.
• Transaction monitoring processes were not reasonably designed to identify unusual or suspicious account activity.
• Introducing firms were primarily relying on their clearing firms to satisfy the transaction monitoring and suspicious activity reporting requirements under AML laws.

Key Takeaways

The Joint Statement, together with FINRA’s 2019 Examination Findings Report, should prompt broker-dealers and other financial institutions subject to AML laws and rules to review their existing AML programs to ensure that the business activities of their firms, including any business activities involving digital assets, are adequately addressed.

More importantly, the Joint Statement reflects a high degree of interagency coordination regarding the regulation of digital assets. As digital assets, including cryptocurrencies such as Bitcoin and Ether, gain more widespread attention and use, regulators are attempting to coordinate and share information to identify and detect potential AML violations. The need for interagency coordination is also enhanced in the context of digital assets, which may qualify for regulation under the regimes of multiple federal agencies. Broker-dealers and other financial institutions will need to adapt to these potentially overlapping regulations, particularly if any of their business activities involve digital assets.

____

[View source.]