In early December 2015, New York state proposed rules to aid in the fight against terrorism by making it increasingly difficult for terrorist and other criminal organizations to transfer funds globally. As a result of several investigations that uncovered weaknesses at financial institutions regarding governance, account and transaction monitoring, and senior executive accountability, Governor Andrew M. Cuomo and now-former Superintendent of the New York Department of Financial Services (“DFS”) Benjamin Lawsky announced Part 504 of the Superintendent’s Regulations (“Part 504”). These rules will apply to banks, trust companies, savings and loan associations, money transmitters, check cashers, and all non-U.S. bank offices chartered or licensed under the New York Banking Law (“DFS-regulated institutions” or “institutions”) and will be instituted in the DFS Regulations. A key part of the new law will require the chief compliance officer (“CCO”) or functional equivalent to personally certify annually, under penalty of criminal prosecution, that the financial institution has maintained actual compliance with the new regulations. Modeled on the Sarbanes-Oxley Act’s requirement that chief executive and financial officers certify financial statements, Part 504 will place the CCOs under pressure to ensure the integrity of the global financial system insofar as it pertains to the prevention of terrorist financing and other instances of money laundering.
In line with the recent federal approach to increase individual accountability,  these stringent state rules add a new layer of scrutiny on senior corporate officers’ efforts to ensure security of the financial system. In announcing the proposed rule, Governor Cuomo emphasized the importance of anti-terror regulations in the banking system:
Money is the fuel that feeds the fire of international terrorism. Global terrorist networks simply cannot thrive without moving significant amounts of money throughout the world. At a time of heightened global security concerns, it is especially vital that banks and regulators do everything they can to stop that flow of illicit funds.
Clearly, the impetus for the proposed rules is the concern that DFS-regulated financial institutions could become a “back door” for terrorist financiers due to the complacency of management and the shortcomings within the institutions’ monitoring and compliance regimes. As such, the rules mandate that the institutions maintain a transaction-monitoring program to detect Bank Secrecy Act (“BSA”) and Anti-Money Laundering (“AML”) rules violations and to institute a watch list filtering program to identify transactions prohibited by the Office of Foreign Assets Control (“OFAC”), politically exposed person lists, and various terrorist financing rules. All eyes will be on the CCOs, as they will be personally responsible for annually certifying compliance with these new regulations.
Although DFS-regulated institutions are already subject to federal bank secrecy and AML rules, the proposed rules add greater specificity and scrutiny to these institutions’ compliance programs by requiring ongoing, comprehensive risk assessments and by removing the ability of financial institutions to limit the alerts generated by the monitoring and filtering programs. Three key requirements of the new regulations include (1) the maintenance of a transaction monitoring program, (2) the implementation of a watch list filtering program, and (3) measures to ensure the integrity of these two programs.
Transaction Monitoring Program (“TMP”)
DFS-regulated financial institutions must maintain a program to monitor financial transactions, after their execution, for violations of BSA and AML rules and for suspicious activity. The TMP must reflect the current state of BSA/AML rules and must apply any relevant information available from the institution’s “know your customer,” “enhanced customer due diligence,” and fraud prevention and security initiatives. Additionally, the program needs to include protocols detailing how the institution will investigate TMP-generated alerts, the decision-making processes involved in filing actions resulting from these investigations, and the manner in which these decisions will be documented. Finally, the TMP requirement that will keep CCOs on watch is the requirement for constant testing. This requirement includes pre- and post-implementation testing of the program and ongoing evaluations of the regulations/laws, parameters, coding, and assumptions on which the TMP is based. Other requirements of the TMP include:
- basing the program on a comprehensive risk assessment of the institution;
- mapping bank secrecy and AML risks to the institution’s businesses, products, services, geography, and customers/counterparties;
- applying BSA/AML detection scenarios with threshold values and amounts set to detect potential money laundering or other suspicious activities; and
- incorporating easily understood documentation that articulates the institution’s detection scenarios and their underlying assumptions, parameters, and thresholds.
Watch List Filtering Program (“WLP”)
Another compliance challenge for DFS-regulated institutions and their CCOs is that the proposed rules require the maintenance of a WLP that identifies and stops transactions, before their execution, by individuals, firms, terrorist organizations, or countries on OFAC or other watch lists. Before personally certifying to compliance with these proposed rules each year, the CCO or the equivalent must ensure that the WLP is continually updated to reflect current watch lists and reviewed to ensure it remains relevant to the financial institution’s evolving risk profile. This system must also:
- be based on a comprehensive risk assessment of the institution due to its products, operations, customers, and geography;
- apply technology or tools to match names and accounts to the watch lists, balancing the institution’s particular risks with the financial transactions;
- include pre- and post-implementation testing of the WLP, including data mapping, an evaluation of whether the watch lists and program settings map to the risks of the institution, the logic employed in the matching technology or tools, and data input and output; and
- include easily understood documentation that articulates the intent and the design of the program tools or technology.
The DFS has included in the proposed rules assurances that these two programs remain transparent, maintain up-to-date data, and use top-of-the-line technology or tools. To maintain such transparency, financial institutions are prohibited from changing the TMP or WLP in a manner that avoids or minimizes the filing of suspicious activity reports, accommodates inadequate resources, or otherwise avoids complying with requirements. Additionally, for any policies and procedures governing changes to the TMP or WLP, the rules require a managed oversight system to ensure controls and audits over these changes. Finally, periodic training is required to prevent unqualified nonspecialists from involvement in the programs.
Alongside federal regulators, the DFS has been a formidable force in the fight against financial crime. With a jurisdictional reach over the world’s financial center (New York City), the agency has, in the past, taken aim at major institutions like Deutsche Bank and Standard Chartered for processing illicit transactions through their New York branches. Implementing these new rules demonstrates that the DFS is taking a greater stand against terrorism and other financial crimes in an age when the risk of illicit activity continues to rise. Placed on the front lines of this fight, heads of compliance face heavy risks as they are responsible for submitting annually to the DFS that, to the best of their knowledge, their financial institutions’ TMP and WLP comply with these new rules. Unfortunately, filing a false or incorrect certification can lead to individual criminal prosecution, while the institution also faces strict civil penalties for noncompliance.
With the weight of personal and institutional liability on their shoulders, heads of compliance will need a large amount of authority to force the institutions to enhance their practices to comply with the new rules. Without the power to make these changes, CCOs expose the institution to severe penalties for noncompliance and expose themselves to criminal prosecution if they incorrectly certify to the institution’s compliance. While outside counsel and consultants can assist, boards and senior managers will need to take the reins to protect their institutions by ensuring the CCO is vested with the oversight authority and staffing to ensure the corporation is in full compliance.