A registered broker-dealer recently executed a Letter of Acceptance, Waiver and Consent (“AWC”) with FINRA regarding alleged violations of supervision rules applicable to suspicious transactions in customer accounts. In settling this matter, the member firm neither admitted nor denied FINRA’s findings, but consented to the entry of the findings, which are summarized in this article.
Background. FINRA Rule 3310(a) (formerly NASD Conduct Rule 3011(a)) requires that member firms must, at a minimum, “establish and implement policies and procedures reasonably designed to detect and cause the reporting of suspicious transactions” under certain federal anti-money laundering (“AML”) laws. The AWC relates to a customer’s use of his accounts to conduct a Ponzi scheme resulting in losses of over $17 million to the customer’s “investors.” According to the AWC, activity in the customer’s accounts between January 2005 and July 2007 frequently triggered potential money laundering concerns (e.g., the flow of funds into and out of the account and the unusual practice of writing checks in round dollar amounts to third parties later discovered to be the customer’s investors). When the Ponzi scheme was discovered, the customer pleaded guilty to first degree felonies for selling unregistered securities, perjury and forgery, was sentenced to prison and ordered to pay over $17 million in restitution. FINRA found that the member firm violated NASD Conduct Rule 3011 because it failed to implement policies and procedures reasonably designed to detect or report suspicious activity in the customer’s accounts.
Violative Conduct. During the relevant period, the AML policies and procedures the member firm had in place frequently generated compliance reports, referred to as exception reports, in connection with suspicious activity in the customer’s accounts. In addition to exception reports, the member firm became aware of several red flags suggesting that the customer’s account may have been used to engage in illegal activity. Despite such indicators of suspicious transactions, the member firm failed to adequately review, monitor or investigate the customer’s accounts.
In the AWC, FINRA cited specific failures of the member firm with respect to its AML obligations under NASD Conduct Rule 3011. FINRA found that the broker-dealer did not devote adequate resources to its AML program. For instance, the member firm’s program did not include a centralized database or other means of combining and vetting information generated under the AML program. The member firm’s investigation of certain red flags and exception reports was found to be inadequate because the AML officer failed to pursue concerns about the account activity directly, contact the branch manager or ascertain whether the registered representative or the branch manager had inquired about the account activity. Rather, the AML officer’s investigation did not extend beyond making an inquiry to the registered representative, who responded to the AML officer’s inquiries with general explanations about the customer and his account activity as well as what the registered representative indicated was personal knowledge of the customer’s successful businesses. Despite the unusual nature of the responses, neither the AML officer nor any of the member firm’s compliance personnel attempted to reconcile the transactions or further investigate the matter. For example, compliance personnel did not seek additional information about the high volume of payments in round dollar amounts to third parties to see if these were really payments to sellers of various assets as claimed by the customer.
FINRA found that after the broker-dealer became aware of suspicious activity, the member firm did not adequately consider such activity or monitor the customer’s accounts. According to the AWC, departments within the member firm failed to share information that might have revealed the illegal activity (e.g., the member firm’s legal department became aware of a criminal inquiry in connection with the customer’s conversion of funds deposited into his accounts). Even with other information suggesting that the customer’s accounts were being used to conduct suspicious or illegal transactions, the member firm did not implement policies and procedures to effectively monitor and review that information. Because of the failure to detect and investigate the suspicious transactions in the customer’s accounts as well as inadequate information sharing, the member firm failed to conduct adequate monitoring of the accounts.
AML Policies and Procedures. FINRA Rule 3310(a) does not prescribe specific policies and procedures that member firms must implement. Rather, the rule mandates programs that are “at a minimum . . . reasonably designed to detect and cause the reporting of suspicious transactions.” The AWC noted that a broker-dealer should consider certain factors when designing AML policies and procedures. For example, FINRA suggested that a member firm consider its size, location, business activities, the types of accounts it maintains, and the types of transactions in which its customers engage. Citing two Notices to Members issued by FINRA (02-21 and 02-47), FINRA emphasized that it is a member’s duty to detect red flags or other suspicious transactions and, if any are detected, to perform additional due diligence before proceeding with any such transaction or before terminating an investigation.
The AWC indicated that it is not sufficient to simply have policies and procedures to identify suspicious activity if a member firm resolves any red flags or any investigation into such activity with a general explanation from the registered representative. Rather, to meet the requirements under FINRA Rule 3310(a), a member firm is required to thoroughly consider, monitor and investigate any suspicious activity.
Sanctions. In accepting and consenting to entry of the AWC, FINRA imposed a censure on the member firm and levied a fine in the amount of $400,000. The AWC also required the broker-dealer to conduct a comprehensive review of the adequacy of its AML policies and procedures, systems, and internal training programs and to provide written certification to FINRA that its procedures are reasonably designed to achieve compliance with FINRA Rule 3310.