The New Paradigm: Proposed Reforms of the AML/CFT Regime by The Clearing House

Ballard Spahr LLP

Ballard Spahr LLP

[co-author: Greg Baer - The Clearing House]

A Guest Blog by Greg Baer, President of The Clearing House

Today we are very pleased to welcome guest blogger Greg Baer, who will address a series of significant issues posed by a detailed paper published by The Clearing House, a banking association and payments company that is owned by the largest commercial banks and dates back to 1853.  The paper, titled A New Paradigm: Redesigning the U.S. AML/CFT Framework to Protect National Security and Aid Law Enforcement (The New Paradigm), analyzes the effectiveness of the current AML and Combatting the Financing of Terrorism (CFT) regime, identifies problems with that regime, and proposes a series of reforms to remedy them.

Mr. Baer is the President of The Clearinghouse Association L.L.C. and the Executive Vice President and General Counsel of The Clearing House Payments Company L.L.C. The Clearing House Association represents the interests of The Clearing House’s commercial bank ownership on a diverse range of regulatory and legislative matters. Its affiliate, The Clearing House Payments Company, is the only private-sector ACH and wire operator in the United States, clearing and settling nearly $2 trillion in U.S. dollar payments each day, representing half of all commercial ACH and wire volume. Prior to joining The Clearing House, Mr. Baer was Managing Director and Head of Regulatory Policy at JPMorgan Chase. He previously served as Deputy General Counsel for Corporate Law at Bank of America, and as a partner at Wilmer, Cutler, Pickering, Hale & Dorr. He also served as Assistant Secretary for Financial Institutions at the U.S. Department of the Treasury, after serving as Deputy Assistant Secretary. Finally, Mr. Baer was managing senior counsel at the Board of Governors of the Federal Reserve System.

The New Paradigm is the product of two closed-door symposia that convened approximately 60 leading experts in the field of AML/CFT. The group included senior former and current officials from law enforcement, national security, bank regulation and domestic policy; leaders of prominent think tanks in the areas of economic policy, development, and national security; consultants and lawyers practicing in the field; FinTech CEOs; and the heads of AML/CFT at multiple major financial institutions. This blog post takes the form of a Q & A session, in which Mr. Baer responds to questions posed by Money Laundering Watch and explains the main positions set forth in The New Paradigm, and also replies to some potential counter-arguments. We hope you enjoy this discussion of these important issues.

Money Laundering Watch (MLW): Please summarize the main points of The New Paradigm.

In developing our report, we worked not just with banks but also closely with law enforcement and national security experts – what we call the “end users” of AML/CFT information – as well as global development experts who study the collateral damage imposed when banks “de-risk” customers.   What these end users told us was that the current system wasn’t working for them – that it was not providing value to them that is in any way commensurate with the billions of dollars being spent by the industry for that purpose.

There were several reasons. The system is antiquated, and ill-suited for a world where technology, specifically artificial intelligence and machine learning, can be the most effective tool to detect wrongdoing. The end users have no voice in how those billions of dollars are allocated, and the sort of priority setting one would expect from any decent law enforcement or military service does not occur for the financial institutions who have been “deputized” by the government to provide actionable intelligence. Rather, banks’ BSA/AML priorities are set implicitly by bank examiners, whose focus is on requiring banks to adopt clear, auditable policies and procedures and demonstrate compliance with them. Those examiners are divorced from the end users, and do not generally include in their evaluation of a bank’s program how effective its reporting has been, in part because they themselves are not privy to that information. Finally, the current system contains no consistent, comprehensive, or timely mechanism for providing feedback to banks on whether the SARs they file are useful. It is a broken system that needs to be completely rethought.

MLW: The New Paradigm states that the regime for filing SARs is outdated, and that “the combined data set [from filed SARs] has massive amounts of noise and little information of use to law enforcement.”  Yet law enforcement representatives publically tout in other contexts the apparent value of SARs and SAR review teams as investigative leads for law enforcement.  Please explain what the concerns are about the SAR filing regime, and how you believe it should be reformed.

Historically, SARs did function as leads – they were farmed out to U.S. Attorney’s offices and read by an AUSA. With annual SAR filings now numbering close to two million, that is no longer possible. Thus, SARs are more a resource to be checked once there is reason for law enforcement to be suspicious about a bank customer rather than a starting point for an investigation. So instead of being read in full, SARs are queried by word search. Of course, that evolution does not mean that SARs must necessarily be less (or more) valuable, just that they serve a different purpose.

The use of word searches does mean that there is no “haystack and needle” problem for law enforcement to the extent that the number of SARs filed increases. More SARs is simply more data to query. So, one could just say the more the merrier. However, every SAR filing means that a financial institution had to conduct a laborious investigation to produce that SAR, using resources that could have been devoted to more innovative approaches to detecting illicit activity. So, having banks file SARs with respect to activity that no federal law enforcement agency would ever prosecute – for example, bank insider abuse for which there is no dollar threshold – is not a good use of resources.

However, every SAR filing means that a financial institution had to conduct a laborious investigation to produce that SAR, using resources that could have been devoted to more innovative approaches to detecting illicit activity. So, having banks file SARs with respect to activity that no federal law enforcement agency would ever prosecute – for example, bank insider abuse for which there is no dollar threshold – is not a good use of resources.

Certainly, that SAR could be the small piece in a much larger puzzle. But the odds are that having the bank spend its resources looking for whole puzzles would be much more productive. That work is done by financial intelligence units at banks, which compete for funding with banks’ SAR investigations and general AML/BSA compliance efforts, and are not favored by banking regulators, because they tend to operate without set policies and procedures, and do not produce auditable metrics.

Finally, we understand from artificial intelligence experts that one reason the odds are long that a SAR will fill out a puzzle is that the SAR database includes no feedback loop. Again, partly because so many SARs are filed, and partly due to staffing and technological limitations at FinCEN, there is no mechanism for law enforcement to provide feedback on whether a given SAR produced a lead or was never utilized.

MLW: Is there a risk that some changes to the SAR regime might put financial institutions even more into the position of having to investigate potential misconduct and making substantive conclusions about the nature of customers’ conduct, as opposed to simply reporting potentially questionable conduct to the government, which then can make its own conclusions?  If not, why not?

Inevitably, banks will have to make a subjective decision about whether or not to file a SAR. By lowering the substantive threshold for filing a SAR and increasing the penalties for failing to file a SAR, the banking agencies and the Justice Department have increased the number of SARs filed. As already noted, we believe that there is little reason to conclude that doing so has resulted in catching more bad guys – and a lot of reason to believe it has resulted in catching fewer.

One possibility that we have considered is reducing the cost and time currently required to make a SAR filing by simply having the bank provide the government with bulk data on customers, rather than conducting further examination and filing a detailed, time-and-resource intensive narrative. Under the new paradigm where SARs are queried rather than read, filing bulk data could be useful. But we need to consider how those queries would work.

MLW: The New Paradigm recommends that FinCEN “should reclaim sole supervisory responsibility for large, multinational financial institutions that present complex supervisory issues[.]”  Why?  Further, FinCEN staff currently do not have examination experience – the federal banking agencies do.  Doesn’t this recommendation potentially pose practical problems, at least for a period of time?

Certainly, FinCEN could hire people with examination experience if that were considered necessary, but we believe it is not necessary, or even advisable. Examiners are auditors, and they look to find written policies and procedures and compliance regimes for ensuring they are followed to the letter. Under the current regime, examiners are not even privy to information about whether law enforcement, the intelligence community or national security actors find a given institution’s AML/CFT data to be useful. Good financial intelligence units don’t work that way.

Under the current regime, examiners are not even privy to information about whether law enforcement, the intelligence community or national security actors find a given institution’s AML/CFT data to be useful. Good financial intelligence units don’t work that way.

An analogy we have used is evaluating an army officer for promotion based not on how his or her unit performs in battle but rather by having an auditor, not cleared to learn what happened in battle, evaluate the officer based on whether expense reports are filed on time. That system produces McClellans not Pattons.

Consider what a dedicated examination team at FinCEN could look like. It would include a few dozen people, focused on only the very largest banks that file most of the SARs and do almost all of the cross-border business that raises the most difficult issues and produces the most valuable reports. All of those examiners could have security clearances, meet regularly with and receive guidance from senior law enforcement and national security officials to establish priorities for banks; determine whether a bank is producing actionable intelligence; and provide useful feedback to the bank. Those examiners could also meet with diplomatic and development officials to discuss the downsides of de-risking, and consider those in establishing priorities and evaluating banks. None of these things can happen under the existing system, where examiners work for banking agencies whose institutional priorities and incentives lie elsewhere. And if this exam team needed training in how bank examiners do their job, they can certainly receive it.

MLW: Federal banking agencies take the position that they do and should examine and supervise a financial institution holistically – that is, a given agency looks at all of the potential risks for a particular institution, not just AML/BSA risks.  What do you say to the argument that FinCEN should not assume sole supervisory responsibility for certain financial institutions because then oversight of AML/BSA issues would occur in isolation?

We strongly believe that AML/BSA should be evaluated in isolation because it is a dramatically different task to catch criminals and identify terrorist financing than to make loans or trade bonds. The individuals in charge of the AML/BSA program at a bank have very different backgrounds and expertise from loan officers and traders. Therefore, the people examining the bank on behalf of the government should have very different backgrounds and expertise from bank examiners. However, as we acknowledge in The New Paradigm, there would also necessarily be some coordination among the FinCEN exam team and the other regulators, who would remain responsible for safety and soundness examinations, even if banking regulators were to delegate all of their BSA/AML examination-related authorities. Further, the banking regulators would, at a minimum, necessarily be privy to certain information about an institution’s BSA/AML program, as section 327 of the USA PATRIOT Act requires the regulators to consider the effectiveness of a banking organization in combating money laundering activities in evaluating its applications to, among other things, acquire or merge with another institution.

MLW: The New Paradigm recommends that FinCEN establish a procedure for “no action” letters.  What is the reason for seeking such a procedure, and what would work best?

A no-action letter process could be effective in enhancing communication and transparency, in an efficient manner, between FinCEN and the industry. In this manner, FinCEN could provide a shield from liability on questions posed by banks.  We believe that this is a practical way to reduce de-risking, whereby banks exit correspondent relationships out of fear of regulatory criticism – given their role as gatekeepers of the financial system.  Of course, the best way to fix this problem is by changing how banks are examined, but even under our proposal, FinCEN would have examination authority over only a few banks.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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