Anti-Money Laundering (AML)

Anti-Money Laundering (AML)
Criminals pulling in millions in cash must be careful not to draw the attention of both the police and the IRS. If one drives a $95,000 "Cadillac Escalade TM" while holding no job or owning no business that could explain it, soon stern professionals in dark suits show up asking questions and seizing documents or assets.

Therefore, criminals use elaborate schemes to take their "dirty" money and make it "clean." Maybe they buy a car wash and write up phony receipts for non-existent customers to match that up with a few hundred thousand dollars of illegal profits that end up being "cleaned" in the wash so to speak.
Money laundering is the process of taking illegal profits and disguising them as clean money. The three distinct phases of money laundering are:

• Placement
• Layering
• Integration

Placement is the first stage in the cycle in which illegally generated funds are placed into the financial system or are smuggled out of the country. The goals of the money launderer are to remove the cash from where it was acquired to avoid detection from the authorities, and to then transform it into other assets, e.g., travelers' checks, money orders, etc.

Layering is the first attempt at disguising the source of the ownership of the funds by creating complex layers of transactions. The purpose of layering is to disassociate the dirty money from the source of the crime through a complicated web of financial transactions. Typically, layers are created by moving money in and out of offshore bank accounts of shell companies, through electronic funds transfers (EFTS). Because there are over 500,000 wire transfers circling the globe every day, most of which are legitimate, there isn't enough information disclosed on any single wire transfer to know how clean or dirty the money is. This provides an excellent way for money launderers to move their dirty money.

Other forms used by launderers are complex dealings with stock, commodity and futures brokers. Given the sheer volume of daily transactions, and the high degree of anonymity available, the chances of transactions being traced are insignificant. In other words, broker-dealers are great places to launder money, which is why broker-dealers need to help the federal government clamp down on terrorists and other criminals trying to layer dirty money through a flurry of trading activity.

Integration is the final stage in the process. In this stage, the money is integrated into the legitimate financial system. Integration of the now-clean money into the economy is accomplished by making it appear to have been legally earned. By this stage, it is very difficult to distinguish "clean" financial assets from "dirty."

Broker-dealers are required to design AML programs based on the unique aspects of their business. Firms are expected to take a proactive approach to their AML programs, too. Those who treat it like an afterthought have been fined millions of dollars by FINRA, many also having their licenses revoked.

From a recent speech by Kevin W Goodman, from the SEC's Broker-Dealer Examination Program:
While at first blush AML obligations may seem to be the mechanical process of monitoring and reporting cash flows and securities transactions, AML programs are actually much more. When implemented well, they provide protections against misuse of the nation's financial system for criminal activity — activity that ranges from financial fraud (endangering people's financial security) to profiting from drug businesses to funding terrorist activities. For example, federal authorities
have used filed suspicious activity reports ("SARs") to identify fraud schemes such as purported investments in non-existent high yield investments, Ponzi or pyramid schemes, and market manipulation.

AML has a direct connection to investor protection. "Purported investments in nonexistent high-yield investments" means that investors were duped into turning over their money to financial criminals, who then got away with it through illegal money laundering activities.

So, in cases like that, regulators would be one problem. Another would be explaining to the customer what happened. Another would be making the customer whole with the firm's own funds.

FINRA lays out the rules for member firms' AML programs:
Anti-Money Laundering Compliance Program On or before April 24, 2002, each member shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the member's compliance with the requirements of the Bank Secrecy Act, and the implementing regulations promulgated thereunder by the Department of the Treasury. Each member's anti-money laundering program must be approved, in writing, by a member of senior management.   
 
Broker-dealers are required to report large cash transactions and retain records on wire transfers, whether any potential criminal activity is suspected.

FINRA-member firms must also monitor suspicious activity and report it to the U.S. Treasury's Financial Crimes Enforcement Network. Suspicious activity includes financial activity with no business or apparent lawful purpose. This includes not just money laundering by violent criminals, but also non-violent felonies such as Ponzi schemes and insider or other forms of manipulative trading.

If a transaction involves at least $5,000, and the broker-dealer knows, suspects, or has reason to suspect that it has no apparent lawful purpose, the member must file a Suspicious Activity Report (SAR) with FinCEN. The $5,000 figure covers any one transaction or series of transactions.

An SAR must be filed if the transaction falls within one of four classes:
•    the transaction involves funds derived from illegal activity or is in¬tended or conducted to hide or disguise funds or assets derived from illegal activity;
•    the transaction is designed to evade the requirements of the Bank Secrecy Act
•    the transaction appears to serve no business or apparent lawful purpose or is not the sort of transaction in which the customer would be expected to engage and for which the broker/dealer knows of no reasonable explanation after examining the available facts; or
•    the transaction involves the use of the broker/dealer to facilitate criminal activity

As a FINRA notice to members announces,
"To help the government fight the funding of terrorism and money laundering activities, federal law requires financial institutions to obtain, verify and record information that identifies each person who opens an account." 

The notice explains obligations under the Customer Identification Program (CIP) for financial institutions including banks and broker-dealers. The first thing member firms must do is establish a written policy for establishing and documenting the identity of each customer for whom the firm opens an account.

Under the Customer Identification Program, broker-dealers must obtain an individual's name, date of birth, residential address, citizenship, and social security/taxpayer ID. If the customer is not a U.S. citizen, the firm will need:

• taxpayer identification number
•  passport number and country of issuance
• alien identification card number or government-issued identification showing nationality, •
• residence and a photograph of the customer. Even the U.S. citizen may need to show a photo ID, just as you do when you take your Series 99 exam.

The federal government maintains an Office of Foreign Asset Control (OFAC) designed to protect against the threat of terrorism. This office maintains a list of individuals and organizations viewed as a threat to the U.S. Broker-dealers and other financial institutions must be sure they aren't setting up accounts for these organizations, or if they are must block/freeze the assets.

As the Department of Treasury explains, "As part of its enforcement efforts, OFAC publishes a list of individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries. It also lists individuals, groups, and entities, such as terrorists and narcotics traffickers designated under programs that are not country-specific. Collectively, such individuals and companies are called 'Specially Designated Nationals' or `SDNs.' Their assets are blocked and US. persons are generally prohibited from dealing with them."