14th September 2020

Broker-Dealer and AML

Broker-Dealers: AML Regulations and Compliance

Broker dealers are individuals or firms that buy and sell securities for their own account or on behalf of their customers. Since they deal with large sums of money and a range of financial instruments, and engage in frequent transactions on behalf of customers across the world, broker dealers represent a significant money laundering risk and are subject to strict AML/CFT regulations. 

In the United States, financial regulators often prioritize broker dealer firms as part of their AML efforts: in 2017, enforcement actions against broker-dealers represented 25% of all activity by the Securities and Exchange Commission (SEC). More recently, in conjunction with the US Treasury, the SEC has focused on the regulation of online broker-dealers, and in August 2020, it imposed a $38 million fine on Interactive Brokers for failing to implement an effective AML/CFT program. 

In order to avoid penalties, fines and reputational damage, broker-dealers must ensure that they understand their regulatory responsibilities and how to implement an effective AML/CFT program to deal with the money laundering threats that they face. 

Broker-Dealer AML Regulations

In the United States, broker-dealer AML regulations are drawn from two primary sources of legislation: the Bank Secrecy Act (BSA) and the USA Patriot Act

The Bank Secrecy Act: Adopted in 1979, the BSA sets out the AML compliance framework for all banks and financial institutions in the United States. Under the BSA, broker-dealers are subject to regulation issued by the US Treasury, including the requirement to keep records on financial transactions and file reports with the Financial Crimes Enforcement Network (FinCEN) when suspicious activity that might indicate money laundering is detected. 

The BSA sets out specific provisions for broker dealers in Part 1023 (31 C.F.R. §§ 1023.100 et seq.).

USA Patriot Act: The Patriot Act was introduced in 2001 in the wake of the September 11 terrorist attacks as a way to strengthen the BSA by enhancing customer due diligence and monitoring measures. The Patriot Act requires broker-dealers to develop and implement a written, risk-based AML program, featuring policies, procedures and controls that can be reasonably expected to deliver BSA compliance. Under the Patriot Act, broker-dealer AML requirements should facilitate: 

  • Customer identification and due diligence procedures. 
  • Transaction monitoring and suspicious activity reporting.
  • Information sharing upon the request of federal law enforcement authorities.
  • Compliance with any special measures introduced by the Treasury.

Broker-Dealer AML Compliance Programs

In compliance with the BSA and the Patriot Act, the AML programs that broker-dealers put in place should feature:

Customer identification: Section 326 of the Patriot Act requires broker dealers to accurately establish and verify the identities of their customers to ensure that they are who they say they are and are being truthful about the nature of their business. Practically, this means obtaining a customer’s name, address, date of birth and other identifying information, such as their social security number or equivalent.

These customer identification programs (CIPs) essentially entail the AML customer due diligence (CDD) obligation, which includes establishing beneficial ownership of legal entity customers. In the case of beneficial ownership, customers are considered beneficial owners if they own 25% or more of a company’s equity interests, or if they have significant responsibility to control, manage or direct a legal entity customer. 

After performing CDD, brokers-dealers must retain records of customer identities for future reference or for use in money laundering investigations. 

Transaction monitoring and reporting: Section 356 of the Patriot Act requires broker-dealers to implement a transaction monitoring process as part of their AML program. Under the regulation, broker-dealers must file a suspicious activity report (SAR) with the Treasury when a transaction involves funds, or aggregates funds, of $5000 or more and there is reason to suspect that the customer:

  • Is attempting to disguise illegal funds.
  • Is attempting to evade BSA requirements.
  • Has no apparent business reason or lawful purpose to conduct their transaction.
  • Is attempting to exploit broker dealer services for criminal purposes.

When reporting suspicious activity, broker-dealers must use form SAR-SF (also known as FINCEN FORM 101), a dedicated reporting form for the securities and futures industry. 

Sanctions screening: In addition to BSA AML requirements, broker-dealers must screen customers against sanctions imposed by the Office of Foreign Assets Control (OFAC). In practice, this means checking individual customers against OFAC’s Specially Designated Nationals and Blocked Persons (SDN) list and checking its broader, country-based sanctions list. 

When a broker-dealer finds an applicable sanction on the SDN list or country-based list, it must block the transactions proposed by the relevant customers along with their accounts and any other property or interests involved. 

Money Laundering Red Flags

Broker-dealers can optimize their AML compliance performance by ensuring that they are familiar with the ways in which criminals seek to exploit their services. In 2019, the US’ Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 19-18, which set out the “red flag” behaviors associated with money laundering in the securities industry. With that in mind, broker dealer AML red flags include: 

  • Customer backgrounds: Customers that are reluctant to disclose personal information during the due diligence process are often attempting to evade AML controls. Similarly, firms should be vigilant for customers that transact regularly with high-risk jurisdictions, that have legal proceedings against them or that have previously been rejected by another financial institution.
  • Depositing: Broker-dealers should scrutinize customers that deposit securities and then immediately sell those shares or transfer them to unrelated accounts. Similarly, customers that are engaged in money laundering may receive large amounts of securities that do not match their assets.
  • Securities trading: Broker-dealer firms should be vigilant for customers engaging with thinly-traded securities, making trades with no discernible purpose or trading in a manner which doesn’t match their profile and history. 

Structuring: Customers that are involved in money laundering may attempt to structure their deposits and withdrawals or break up large fund transfers in such a way as to avoid AML reporting and record-keeping. Broker-dealers should be vigilant for customers using third parties to transfer money, transfers involving high-risk jurisdictions and transfers with no discernible purpose. 

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