Alert January 25, 2011

SEC Staff Issues No-Action Letter Modifying Relief that Permits Broker-Dealers to Rely on Registered Advisers to Perform AML Customer Identification

The staff of the SEC’s Division of Trading and Markets (the “staff”) issued a no-action letter (the “2011 Letter”) to the Securities Industry and Financial Markets Association (“SIFMA”) that extends—and modifies—previously granted relief that allows broker-dealers to rely on registered investment advisers (“RIAs”) to satisfy the broker-dealers’ customer identification program (“CIP”) obligations for shared customers under certain conditions.

CIP Reliance Rule.  The applicable customer identification rule (31 C.F.R. §103.122, the “CIP Rule”) requires broker-dealers to either adopt and maintain a CIP for purposes of risk-based customer identification or rely on the CIP of certain other financial institutions in the case of shared customers.  Reliance on the CIP of another financial institution is permissible where (i) the reliance is reasonable under the circumstances; (ii) the relied-upon financial institution is regulated by a Federal functional regulator and is required to maintain an anti‑money laundering program (“AML Program”) in accordance with a rule applicable to the institution (“AML Program Rule”); and (iii) the relied-upon financial institution enters into a contract requiring it to certify annually to the broker-dealer that it has implemented an AML Program and that it (or its agent) will perform the specified requirements of the broker-dealer’s CIP.  Under the strict terms of these conditions, broker-dealers may not rely on the CIP of RIAs because RIAs are not currently subject to an AML Program Rule.

Previous SEC Relief.  On February 12, 2004, the staff issued a no-action letter permitting broker-dealers to rely on RIAs to satisfy the requirements of the CIP Rule with regard to shared customers so long as (i) such reliance is reasonable under the circumstances; (ii) the RIA is regulated by a Federal functional regulator; (iii) the RIA enters into a contract requiring it to certify annually to the broker-dealer that (a) it has implemented an AML Program in satisfaction of the Bank Secrecy Act (31 U.S.C. sec. 5518(h)) and (b) the RIA will perform the specified requirements of the broker-dealer’s CIP in accordance with Section 326 of the USA Patriot Act.  The SEC extended this relief in subsequent no-action letters, most recently on January 11, 2010 (the “2010 Letter”) (as discussed in the January 12, 2010 Alert.)

Modified SEC Relief.  The 2011 Letter qualifies the position set forth in previous no-action letters by:

  • specifying that reliance on the RIA must be “reasonable,” i.e., a broker-dealer must at the outset of the relationship “undertake appropriate due diligence” on the RIA “commensurate with the broker-dealer’s assessment of the anti-money laundering risk” presented by the RIA and the RIA’s customer base and update such diligence as appropriate; and
  • amending the terms of the contractual agreement between the broker-dealer and RIA to include (i) that the RIA will update its AML Program to conform with changes in applicable law and guidance; (ii) the RIA will “promptly disclose suspicious or unusual activity” identified through its CIP on behalf of a broker-dealer so that the broker-dealer may file a suspicious activity report as appropriate; (iii) the RIA will certify that the representations made in the contractual agreement are accurate and that the RIA is in compliance with such representations; and (iv) that the RIA will promptly provide books and records in connection with its performance of a broker-dealer’s CIP obligations to the SEC, a self-regulatory organization (“SRO”) that maintains jurisdiction over the broker-dealer, or to authorized law enforcement agencies, either directly through such broker-dealer or at the request of (a) the broker-dealer, (b) the SEC, (c) the SRO maintaining jurisdiction over such broker-dealer, or (d) an authorized law enforcement agency.

The SEC states that it anticipates that broker-dealers may cease to enter into reliance agreements pursuant to the terms set forth above and that in such cases the broker-dealer is permitted to discontinue obtaining further forward-looking certifications regarding the activities of RIAs with whom it had previously entered into contacts.  The SEC notes that a broker-dealer that chooses not to avail itself of the relief granted in the letter may still contractually delegate the implementation and operation of its CIP to an investment adviser; however, the broker-dealer will “remain solely responsible for assuring compliance with the CIP Rule” and therefore must “actively monitor the operation of its CIP and assess its effectiveness.”

SIFMA, in the request for no-action to which the 2011 Letter responds, stated: “We understand from our discussions that the Staff does not intend, by the addition of these new conditions, to ‘impose any supervisory obligations on the broker-dealer’ with respect to the RIA.”

Effective Date.  The 2011 Letter extends the previous relief granted by the 2010 Letter until May 11, 2011 to permit broker-dealers time to become compliant with the modified relief; thereafter, the 2010 Letter is withdrawn without further action and the terms of the 2011 Letter are effective.