[author: Joseph Crotty]

The U.S. Securities and Exchange Commission (SEC) is responsible for protecting investors and ensuring the integrity of the securities markets. As part of this mission, the SEC requires broker-dealers to comply with Anti-Money Laundering (AML) and Counter Terrorist Financing (CFT) requirements as detailed in the Bank Secrecy Act (BSA).[1] These requirements are designed to prevent criminals from using the securities markets to launder money or finance terrorism.

Alert Summary

On 31 July 2023, the SEC’s Division of Examinations published its “Observations from Anti-Money Laundering Compliance Examinations of Broker-Dealers” Risk Alert (Risk Alert). Based on the SEC’s examination of multiple broker-dealers, the Risk Alert highlights key observations about AML compliance by broker-dealers.[2] It also discusses compliance issues in the suspicious activity monitoring and reporting components of broker-dealers’ AML programs, as well as in the independent testing of firms’ AML programs and training of their personnel and the identification and verification of customers and their beneficial owners.[3]

The Risk Alert begins by noting that AML compliance is critical to the SEC’s and law enforcement’s pursuit of misconduct that could threaten the safety of investor assets and the integrity of the financial markets.

Through its examination, the SEC found that a number of broker-dealers had deficiencies in their AML compliance programs. These deficiencies include:

• Inadequate suspicious activity monitoring and reporting: The Risk Alert notes that many broker-dealers did not have adequate systems in place to identify and report suspicious activity. In particular, the Risk Alert found that broker-dealers often failed to:
  • Identify and monitor high-risk customers and transactions
  • Evaluate the effectiveness of their suspicious activity monitoring systems
  • Report suspicious activity to the Financial Crimes Enforcement Network (FinCEN) in a timely manner[4]
• Inadequate independent testing of AML programs: The Risk Alert notes that many broker-dealers did not have adequate independent testing of their AML programs. In particular, the Risk Alert found that broker-dealers often failed to:
  • Test the effectiveness of their AML programs on a regular basis
  • Use qualified independent testers
  • Document the results of their independent testing (including notification to the Financial Industry Regulatory Authority (FINRA))[5]
• Inadequate training of personnel: The Risk Alert notes that many broker-dealers did not provide adequate training to their personnel on AML compliance. In particular, the Risk Alert found that broker-dealers often failed to:
  • Train their personnel on the red flags of money laundering and terrorist financing
  • Train their personnel on how to identify and report suspicious activity
  • Train their personnel on the requirements of the BSA
• Inadequate identification and verification of customers and beneficial owners: The Risk Alert notes that many broker-dealers did not adequately identify and verify their customers and beneficial owners. In particular, the Risk Alert found that broker-dealers often failed to:
  • Obtain complete and accurate identifying information from their customers[6]
  • Verify the identity of their customers through independent sources
  • Identify and verify the beneficial owners of their customers

Key Implications

The SEC’s findings have a number of implications for broker-dealers. First, it is clear that broker-dealers need to devote more resources to AML compliance. This is especially true for smaller broker-dealers and those with clients in or connections to high-risk jurisdictions. Second, broker-dealers need to pay more attention to detail in their AML programs. This means having clear and concise policies and procedures and ensuring that personnel are properly trained and supervised. Third, broker-dealers need to have adequate policies and procedures in place to test the effectiveness of their AML programs. Finally, broker-dealers need to ensure that their personnel are adequately trained on AML requirements.

The Risk Alert is a wake-up call for broker-dealers. It is clear that the SEC is taking AML compliance seriously, and firms that do not comply with the rules may be subject to enforcement action. Broker-dealers that want to protect themselves from future action from the SEC and potential reputational harm need to take steps to strengthen their AML compliance programs.

In addition to the specific findings cited in the Risk Alert, the SEC also highlighted the following general risks that broker-dealers should be aware of:

• The increasing volume and complexity of financial transactions, which can make it more difficult to detect and report suspicious activity.
• The use of new technologies and payment methods, which can also be used to facilitate money laundering.
• The growing threat of cyber crime, which can be used to attack AML systems and steal customer data.

Broker-dealers that take the time to understand these risks and implement appropriate controls will be well positioned to protect themselves from the risks of money laundering and terrorist financing activities.

AML Program Requirements

Here are some of the necessary steps that broker-dealers must take in order to mitigate the risks outlined in the SEC’s alert:

• Devote sufficient resources to AML compliance. This includes hiring and training qualified personnel; developing and implementing effective policies and procedures; and conducting regular testing and evaluation.
• Pay attention to detail. This means having clear and concise policies and procedures to ensure that personnel are properly trained and supervised.
• Have adequate policies and procedures in place to test the effectiveness of the organization’s AML program. This will help to identify any gaps or weaknesses in the program and ensure that it is effective in detecting and reporting suspicious activity.
• Ensure that personnel are adequately trained on AML requirements. This includes training on the latest AML laws and regulations, as well as on the specific risks that broker-dealers face.
• Understand the risks of money laundering and terrorist financing. This includes being able to identify the types of transactions that are often used to launder money or finance terrorism, as well as the methods that criminals use to conceal their activities.
• Implement appropriate controls to mitigate these risks. This may include things like conducting enhanced due diligence on high-risk customers, monitoring transactions for suspicious activity, and filing suspicious activity reports (SARs).
• Stay up to date on the latest AML developments. The AML landscape is constantly changing, so it is important for broker-dealers to stay up to date on the latest laws and regulations. They should also be aware of new technologies and payment methods that could be used to facilitate money laundering.

By taking these necessary steps to meet AML program requirements, broker-dealers can help mitigate money laundering and terrorist financing risks and protect themselves from the penalties of noncompliance.

AML Program Enhancements

In addition to the necessary steps listed above, broker-dealers can also take the following steps to strengthen their AML compliance programs:

• Use technology to automate AML processes. This can help to free up personnel to focus on more complex tasks, and it can also help to improve the accuracy and efficiency of AML compliance.
• Partner with a third-party AML service provider. This can be a good option for broker-dealers that do not have the resources or expertise to develop and maintain an effective AML program on their own.
• Be proactive in identifying and reporting suspicious activity. Do not wait for regulators to come to you. If you see something suspicious, report it immediately.
• Have a strong culture of compliance. Make sure that everyone at your firm—from the executive suite to front-line workers—understands the importance of AML compliance and is committed to following the rules.

By taking these action steps, broker-dealers can help to ensure they are compliant with AML regulations and that they are doing their part to fight money laundering and terrorist financing.

Conclusion

AML compliance is essential for protecting the financial system from money laundering and terrorist financing. By following SEC and FinCEN guidance, broker-dealers can help to ensure that they are meeting their AML obligations and protecting the financial system from abuse. Broker-dealers that proactively review the Risk Alert and act on its recommendations will be well prepared to shield themselves and their clients from the intricate web of money laundering threats. By internalizing these insights and adopting a proactive stance, broker-dealers not only ensure regulatory compliance but also reinforce the trust of their clients, the markets, and regulators.

Resources for AML Program Compliance

The SEC and FINRA have a number of resources available to help broker-dealers comply with AML requirements. These resources include:

Broker-dealers can also contact the SEC’s Division of Examinations for more information about AML compliance at +1 202 551 EXAM or examhotline@sec.gov.[7]

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[1] The Bank Secrecy Act (BSA), initially adopted in 1970, establishes the basic framework for AML obligations imposed on financial institutions. Among other things, it authorizes the Secretary of the Treasury to issue regulations requiring financial institutions (including broker-dealers) to keep records and file reports on financial transactions that may be useful in investigating and prosecuting money laundering and other financial crimes. . Rule 17a-8 under the Securities Exchange Act of 1934 (Exchange Act) requires broker-dealers to comply with the reporting, recordkeeping, and record retention rules adopted under the BSA.

[2] “Observations from Anti-Money Laundering Compliance Examinations of Broker-Dealers,” U.S. Securities and Exchange Commission Division of Examination, 31 July 2023, https://www.sec.gov/files/risk-alert-aml-compliance-examinations-bd-073123.pdf.

[3] In 2021, the SEC Division of Examinations published a Risk Alert discussing compliance issues in the suspicious activity monitoring and reporting components of broker-dealers’ AML programs “Compliance Issues Related to Suspicious Activity Monitoring and Reporting at Broker-Dealers,” SEC Division of Examination, 29 March 2021, https://www.sec.gov/files/aml-risk-alert.pdf.

[4] The Financial Crimes Enforcement Network (FinCEN), a bureau within the U.S. Department of Treasury, has regulatory responsibilities for administering the BSA.

[5] FINRA is authorized by Congress to protect America’s investors by making sure the broker-dealer industry operates fairly and honestly. FINRA oversees more than 624,000 brokers across the country—and analyze billions of daily market events. FINRA uses innovative AI and machine learning technologies to keep a close eye on the market and provide essential support to investors, regulators, policymakers and other stakeholders.

[6] Information gathered as part of CDD should also be used for compliance with the Office of Foreign Assets Control (OFAC) regulations. All U.S. persons, including broker-dealers as well as investment advisers and registered investment companies, must comply with regulations promulgated by OFAC, which administers and enforces sanctions against certain jurisdictions and foreign persons based on U.S. foreign policy and national security interests (click here for OFAC’s best practices for compliance).

[7] Click this link for other useful contact information for FinCEN, FINRA, and the Office of Foreign Assets Control (OFAC).