Electronic Transaction Clearing, Inc., a registered broker-dealer, was charged by the Financial Industry Regulatory Authority for failing to consider whether suspicious activity reports should have been filed with the Financial Crimes Enforcement Network after the firm limited or stopped certain direct market access customers’ trading activity. ETC had restricted trading by certain of its customers after 30 instances where the firm identified problematic conduct, including prearranged trades or trading without an apparent economic reason – red flags, charged FINRA. However, in connection with these circumstances, ETC did not additionally consider whether to file a SAR, despite also being advised that FINRA intended to bring charges against the firm for prior incidents of the same type (click here to access a copy of the FINRA Order Accepting ETC’s Offer of Settlement dated February 19, 2016). FINRA also charged ETC with not having an appropriate due diligence program for customers who might be foreign financial institutions; miscalculating amounts required to be set aside for its customers for parts of each month from August 2013 through March 2014 (i.e., reserve requirement); and violating Securities and Exchange Commission Regulation SHO for improper short sales handling, among other charges. FINRA seeks monetary penalties and other sanctions. Last year, the SEC set aside a determination by the Chicago Board Options Exchange, Inc. that ETC and two of its principals, Kevin Murphy and Harvey Cloyd, Jr., failed to apply its customer identification program to individuals trading on behalf of two omnibus accounts; failed to apply margin rules to the same traders; and failed to implement adequate surveillance tools for identifying suspicious activities of its customers. (Click here for details of this SEC determination in the article “SEC Overturns CBOE Determination That Individual Traders of Two Omnibus Accounts Were Customers Requiring Application of Customer Identification Rule” in the June 19, 2016 edition of Bridging the Week.)
Compliance Weeds: Applicable law and FinCEN rules require broker-dealers and other covered financial institutions (banks, Commodity Futures Trading Commission-registered future commission merchants and introducing brokers and SEC-registered mutual funds) to file a SAR with FinCEN in response to transactions of at least US $5,000 which a covered entity “knows, suspects, or has reason to suspect” involve funds derived from illegal activity; have no business or apparent lawful purpose; are designed to evade applicable law; or utilize the institution for criminal activity. In August 2015, for example, FINRA fined Aegis Capital Corp US $950,000 for selling unregistered penny stocks and related supervisory violations, and suspended and fined two individuals – Charles Smulevitz and Kevin McKenna – who served successively as chief compliance and anti-money laundering officers for the firm. According to FINRA, Mr. Smulevitz and Mr. McKenna failed to “reasonably” detect and review red flags of potentially suspicious transactions. As a result, they did not make a “reasoned determination whether or not to report the suspicious transactions to the Financial Crimes Enforcement Network … by filing a Suspicious Activity Report … as appropriate.” (Click here for further details in the article “FINRA Fines and Suspends Two CCOs for Supervisory and AML Violations” in the August 14, 2015 edition of Bridging the Week.) Recently, FinCEN said that covered institutions might also have to file SARs following cyber-events. (Click here for background in the article “FinCEN Issues Advisory Saying Cyber Attacks May Be Required To Be Reported Through SARs in the October 30, 2016 edition of Bridging the Week.) Covered financial institutions should continually monitor transactions they facilitate and ensure they maintain and follow written procedures to identify and evaluate red flags of suspicious activities and file SARs with FinCEN when appropriate. (Click here for a helpful overview of anti-money laundering requirements for broker-dealers, including SAR requirements. Click here for a similarly helpful compilation of AML resources for members of the National Futures Association.) Moreover, covered institutions should ensure that problematic transactions identified by non-AML personnel (e.g., compliance staff) that may be violative of legal or regulatory standards are evaluated by AML personnel to determine whether a SAR should be filed with FinCEN. Indeed, the more of a consolidated ledger a firm can maintain of potential problems identified across otherwise separate surveillance functions, the more likely a firm will be able to recognize and act holistically upon material red flags.