Summary: The New York Department of Financial Services has issued a proposed regulation that sets forth minimum requirements for anti-money laundering transaction monitoring systems and watch list filtering systems. The proposed regulation would also require chief compliance officers of banks and money transmitters to annually certify that their monitoring and filtering programs are in compliance.

On December 1, 2015, the New York Department of Financial Services (NYDFS) announced proposed regulation that would hold chief compliance officers (CCOs) of New York-regulated banks and money transmitters (Regulated Institutions) personally and perhaps criminally liable for the effectiveness of the anti-money laundering (AML) transaction monitoring and economic sanctions filtering programs of their institutions.

The proposed regulation, announced by New York Governor Andrew Cuomo, would amend the state’s existing AML and economic sanctions regulations1 to require Regulated Institutions to maintain transaction monitoring and watch list filtering programs to include certain attributes. These attributes essentially codify current regulatory expectations as set forth in the Federal Financial Institutions Examination Council’s Bank Secrecy Act/AML Examination Manual2 and in recent enforcement actions.3

It would also require CCOs to annually certify that the transaction monitoring and watch list filtering programs at their institutions comply with these attributes, to the best of their knowledge. Should NYDFS determine, in its discretion, that a Regulated Institution falls short of these expectations, the proposed regulation would make the CCO of that institution liable for a “false or incorrect” certification.

The proposed regulation formalizes statements made earlier this year by then-Superintendent of Financial Services Benjamin Lawsky, who had indicated that NYDFS could start holding bank executives personally accountable for their institution’s AML and sanctions shortcomings.4

Compared to the certification requirement in the Sarbanes-Oxley Act of 2002 (SOX), on which it was modeled, the certification requirement of the proposed regulation may be more burdensome, subjective and open to enforcement.

Comments on the proposed regulation are due 45 days after the date of publication in the New York State Register. In the past, NYDFS has made substantive changes based on public comment, as it did with respect to this year’s “BitLicense” proposal.

Background

New York State-regulated banking institutions, including foreign banks with New York licenses, are subject to broad, risk-based federal AML rules issued by federal banking regulators and the Treasury’s Financial Crimes Enforcement Network. Similar, though somewhat less comprehensive, federal rules apply to “money services businesses,” a varied category of nonbank financial institutions including money transmitters and check cashers. These rules generally require covered institutions to report suspicious activity above certain dollar thresholds to the federal government in the form of highly confidential Suspicious Activity Reports. All US persons are subject to Office of Foreign Assets Control (OFAC) rules, which generally prohibit persons from engaging in transactions involving the targets of OFAC sanctions. In practice, financial institutions must screen transaction participants against lists of sanctions targets and embargoed countries to ensure that prohibited transactions are blocked and assets are appropriately frozen.

The federal AML and OFAC rules, however, do not specify the exact steps covered institutions must take to identify suspicious activity or sanctions targets. Rather, the AML rules require financial institutions to implement AML programs reasonably designed to satisfy these requirements, based on the institution’s money laundering risk. OFAC provides even less guidance, though it generally recommends that institutions maintain programs designed to ensure risk-based compliance. Nor do federal rules require any individual at an institution to certify that the institution has implemented the procedures required by these rules.

In issuing the proposed regulation, NYDFS stated that it identified “shortcomings” in the transaction reporting and sanctions transaction filtering systems within the institutions it regulates. NYDFS also concluded that “a lack of robust governance, oversight, and accountability at senior levels” contributed to the risk that money laundering and other criminal activity go undetected within legitimate financial systems.

The proposed regulation attempts to address both of these issues. First, it adds specificity to existing AML requirements by detailing the required aspects of transaction monitoring and watch list filtering programs. Although the proposed regulation would not change the underlying AML reporting and sanctions requirements, it would require institutions to maintain monitoring systems with specific features. Second, it seeks to hold accountable compliance executives through the certification requirement.

While the certification requirement itself is largely unprecedented, it reflects an increased focus by regulators on holding individuals accountable for AML and sanctions compliance failures.5 Thus NYDFS appears to be advancing the movement towards individual liability, even as the industry warns of potential chilling effects on keeping qualified AML compliance officers in senior positions at multinational banking organizations where it is more difficult for a single person to make such certifications with confidence.

Coverage

The proposed regulation would cover the following entities currently subject to NYDFS AML regulations: all banks, trust companies, private bankers, savings banks, and savings and loan associations chartered pursuant to New York Banking Law; all branches and agencies of foreign banking corporations licensed pursuant to New York Banking Law to conduct banking operations in New York; and all check cashers and money transmitters licensed under New York Banking Law. The practical effect of the proposal may be even broader. For large banking organizations that include a Regulated Institution (such as international banks with a New York branch) and that have enterprise-wide AML and sanctions monitoring systems, the system requirements in the proposal could have a spillover effect on entities not subject to NYDFS regulations, such as broker-dealers.

The proposed regulation would not cover federally chartered depository institutions; persons subject to NYDFS’ new “BitLicense” digital currency regulations, which have separate AML requirements; or insurance companies, which are also regulated by NYDFS and in some cases are subject to federal AML rules.

Transaction Monitoring Requirements

The proposed regulation would require each Regulated Institution to maintain a manual or automated, risk-based transaction monitoring program to monitor transactions for potential Bank Secrecy Act/AML violations and to report suspicious activity.

The list of eight required attributes supplements the broad transaction monitoring requirement in the federal AML rules by providing guidance as to the minimum requirements for a reasonable transaction monitoring system. Many of these requirements are not controversial and reflect longstanding concern (as evidenced by recent NYDFS and federal enforcement actions) that some financial institutions’ transaction monitoring systems are inadequate. Several attributes, however, could pose significant compliance challenges to Regulated Institutions depending on how strictly they are interpreted by NYDFS.

First, the requirement that systems reflect “all” AML laws and alerts, as well as “any” relevant information from the institution’s related programs, does not expressly provide any time allowance for institutions to adjust their systems to respond to changes in alerts and other information. During such periods, the system arguably would not be in compliance with the strict terms of the rule.

Second, the proposed regulation requires that monitoring systems have threshold values and amounts “set to detect potential money laundering or other suspicious activities,” and it also prohibits institutions from modifying the system to “avoid or minimize” suspicious activity report filing, or because the system is generating too many alerts for the institution to process given its resources.

These requirements reflect prior criticism and enforcement against institutions that were alleged to have weakened their transaction monitoring systems in an attempt to limit their reporting or other compliance burden. Other institutions, however, may seek to tune their systems in response to high numbers of false positives, which necessarily provide some risk that a legitimate alert might also be overlooked.

Third, the rule would require that systems include “easily understandable documentation” describing detection scenarios and the underlying assumptions, parameters and thresholds. NYDFS appears to be concerned that these systems cannot be used by staff (or evaluated by regulators) who are unable to understand how they work.

Nevertheless, the proposal does not yet clarify whether highly complex systems must be explained in a way “easily understandable” by monitoring experts, regulators specializing in AML, or any bank examiner.

Other Program Requirements

The proposed regulation would also require Regulated Institutions to maintain a “Watch List Filtering Program” to interdict transactions prohibited by OFAC and other applicable sanctions requirements. The Watch List Filtering Program attributes largely mirror the Transaction Monitoring Program attributes (and thus could raise similar compliance challenges), though they more clearly tie program requirements to the sanctions risks of the institution.

Finally, the proposed regulation would require that both transaction monitoring and watch list filtering programs include data accuracy and integrity safeguards, governance and management oversight, and adequate staffing funding, and training.

Certification Requirement

The proposed regulation would require each Regulated Institution to submit an annual certification executed by the institution’s CCO or equivalent. The certification, which is included in the proposal, would require the CCO to attest that, “to the best of their knowledge,” the institution’s monitoring and filtering programs comply with the requirements in the proposed rules. The CCO would also have to certify that he or she reviewed, or caused to be reviewed, those programs.

Although the proposed certification was “modeled” on officer certifications under SOX, the proposed form of certification goes far beyond SOX. The SOX certifications are generally limited by “materiality.” Under SOX, a company’s officers are required to certify that they have designed or caused to be designed systems of controls, but the officers do not make substantive representations regarding whether such controls are effective or in compliance with any regulations. By contrast, the certification in the proposed regulation lacks a materiality standard and requires the signer to certify compliance with substantive and subjective requirements for AML transaction monitoring and watch list filtering programs. It does not merely require a certification that those risk-based programs are reasonably designed to detect money laundering and block sanctioned transactions. A CCO who believes in good faith that the subjective requirements are satisfied may nonetheless be held personally liable if NYDFS takes a different view.

Consequences for Non-Compliance

Failure to meet the requirements of the proposed regulation could subject a Regulated Institution to all applicable penalties under the New York Law. Those penalties can be quite severe. Since 2012, NYDFS has fined several institutions each well over $100 million for alleged sanctions and AML violations. The proposed regulation also states that a person who files “an incorrect or false” certification may be subject to criminal penalties, yet it does not provide an intent standard for imposing such penalties.