Action Item: Benjamin Lawsky, the Superintendent of Financial Services for New York State, one of the country’s most aggressive regulators, is seeking to increase regulatory pressures on the financial services industry, beyond the measures imposed by federal regulators. He is proposing new anti-money laundering requirements and cybersecurity procedures that are sure to have significant effects on New York-chartered financial institutions and their top-level business executives.
The New York State Department of Financial Services ("DFS") supervises all New York State-chartered banks, the majority of United States-based branches and agencies of foreign banking institutions, and all insurance companies in New York. It also regulates all of New York State’s mortgage brokers, mortgage bankers, check cashers, money transmitters, budget planners, and similar providers of financial services. Entities supervised by DFS number more than 3,800, with assets of more than $7 trillion.
On February 25, 2015, Superintendent Lawsky delivered remarks entitled "Financial Federalism: The Catalytic Role of State Regulators in a Post-Financial Crisis World."Mr. Lawsky recognized the expertise and resources of federal regulators, but noted that federal policing of Wall Street has not always been effective. He proposed that state governments experiment with innovative new regulatory measures in order to combat financial fraud. To enhance enforcement efforts in New York, DFS is proposing new anti-money laundering measures and cybersecurity procedures that are sure to have significant effects on New York-chartered financial institutions.
Random Audits of Transaction Monitoring and Filtering Systems
Every day, hundreds of millions of transactions are processed through bank payment systems, which results in hundreds of billions of dollars being moved around the globe. Because financial firms cannot manually monitor every transaction, the industry relies on automated transaction monitoring and filtering systems ("AML control systems") to identify potential money laundering transactions for further review by compliance professionals. These AML control systems automatically flag transaction activities that exhibit certain criteria commonly associated with criminal activity, including terrorism ("banned transactions").
Mr. Lawsky identified two potential problems with AML control systems. First, they could be inadequate, defective, or improperly managed by the employees responsible for their operation, enabling banned transactions to pass through the banking system without being flagged, investigated, and reported. Second, Mr. Lawsky suggested that bank employees are "turn[ing] down the sensitivity of the filters so the systems do not generate enough alerts and therefore suspicious transactions go undetected." Mr. Lawsky was likely referring to Commerzbank AG, which settled with DFS, the U.S. Attorney’s Office, and the Manhattan District Attorney’s Office on March 12, 2014, by agreeing to pay $610 million to DFS, terminate employees who engaged in misconduct, and install a monitor in connection with transactions the Bank engaged in on behalf of Iran, Sudan and a Japanese corporation that engaged in accounting fraud. Commerzbank AG employees sought to alter the Bank’s transaction monitoring system so that it would create fewer alerts of potential misconduct.
To address potential AML control failures, Mr. Lawsky proposes random audits of financial firms’ AML controls, rather than relying upon traditional self-reporting by firms, and the use of independent monitors. DFS may partner with technology consulting firms to audit and independently monitor the robustness of financial firms’ AML controls.
Personal Liability of Senior Business Executives for Inadequate AML Control Systems
The other new anti-money laundering enforcement measure proposed by Mr. Lawsky is a regulatory scheme requiring senior business executives—not just legal or compliance employees—to attest personally to the adequacy and robustness of their firms’ AML controls. This is a concept modeled on the Sarbanes-Oxley approach to accounting fraud in order to increase personal accountability of senior executives in the financial services industry.
Section 302 of the Sarbanes-Oxley Act of 2002, 15 U.S.C. § 7241, requires that the CEO and CFO of publicly traded companies personally attest to the truthfulness and adequacy of their companies’ financial statements. This provision makes top-level executives personally responsible for accounting fraud. Mr. Lawsky wants to implement a similar requirement for a firm’s AML controls.
In the case of Commerzbank AG, the Bank agreed with DFS to terminate four individuals who played a central role in the Bank’s improper conduct. DFS’ investigation had already resulted in the resignation of the Head of AML, Fraud and Sanctions Compliance for the Bank’s New York Branch.
Mr. Lawsky is concerned that within the next decade we will experience an "Armageddon-type" or "cyber 9-11" event that will cause a catastrophic disruption in the financial system. In order to prevent such an act, DFS is revamping its regular examinations of banks and insurance companies to incorporate new, targeted assessments of those institutions’ cybersecurity preparedness. By grading banks and insurers on their defenses against hackers as part of examinations, those companies will be incentivized to prioritize and increase their cybersecurity protections. In addition, DFS is considering steps to address the cybersecurity of third-party vendors. Third-party vendors have access to a financial institution’s information technology systems for a broad-range of services, providing an additional way for hackers to infiltrate a company’s systems. Therefore, DFS may require that regulated financial institutions receive "robust representations and warranties" from third-party vendors that those vendors have significant cybersecurity protections in place.
Finally, Mr. Lawsky discussed "multi-factor authentication." Generally, banks and insurance companies allow customers to access their accounts after entering a username and password to verify the customer’s identity. He believes this system is very vulnerable and should be replaced with a multi-factor authentication system that would include a second layer of security—such as a randomly-generated password sent to a mobile phone—in addition to the username and password.
Superintendent Lawsky’s February 25, 2015 remarks indicate that DFS will seek to increase regulatory pressures on the financial services industry, beyond the measures imposed by federal regulators. While Mr. Lawsky has indicated his intent to resign from DFS this year, we anticipate that DFS will continue its more active role in enforcement of AML and cybersecurity rules. In particular, top-level business executives may be subject to personal liability if their companies’ AML compliance measures are found to be inadequate. And, regulated entities and their third-party service providers will likely find themselves investing in more comprehensive cybersecurity measures in order to address potential vulnerabilities in information technology systems.