• In First Case of its Kind, FINRA Hearing Panel Finds Clearing Firm Had a Reasonable and Adequate AML System
  • March 25, 2010 | Authors: Gerald J. Russello; Paul M. Tyrrell
  • Law Firms: Bingham McCutchen LLP - New York Office ; Bingham McCutchen LLP - Boston Office
  • On March 5, 2010, a FINRA hearing panel (the “Hearing Panel”) issued its decision in Department of Enforcement v. Sterne, Agee & Leach, Inc. (“Respondent” or “Firm”) (CRD No. 791, Disciplinary Proceeding No. E052005007501, March 5, 2010) (the “Decision”). As set forth in the Decision, FINRA had charged Respondent, a clearing firm, with violating NASD Conduct Rules 3011 and 2110, and MSRB Rule G-41, by failing to develop and implement an adequate anti-money laundering (“AML”) program from April 24, 2002, through July 11, 2005, and July 1, 2006, through April 20, 2007, due to certain alleged deficiencies in the program. After a trial before a Hearing Panel, the Firm prevailed on every issue for the earlier period, and it prevailed on the overall reasonableness of its program for the later period, although the Hearing Panel found violations with certain specific allegations in that later period. The Hearing Panel imposed sanctions far lower than FINRA Enforcement had sought.

    As the first major adjudicated decision on AML issues, this decision is important in articulating what constitutes a reasonable AML program, what types of AML training may support a finding of reasonableness, and other issues. The Decision also provides further guidance for the appropriate penalty ranges for certain AML violations.1

    The Hearing Panel found that the Respondent’s AML system for monitoring, detecting, and reporting suspicious activity was reasonable. Specifically, the Hearing Panel found:

    • that FINRA failed to meet its burden of proof that the Firm’s system for monitoring for suspicious activity, which included both manual and automated systems, was unreasonable or inadequate;
    • that FINRA failed to show that the Firm’s written procedures did not adequately describe how to identify and review transactions and how to escalate red flags;
    • that FINRA failed to show that the Firm’s system relating to review of physical securities and journal transfers for potentially suspicious activity were unreasonable during the period of 2006 through 2007;
    • that FINRA failed to sustain its burden of proof in attempting to demonstrate that the Firm’s systems and procedures for monitoring, detecting, and reporting suspicious activity was unreasonable, despite FINRA’s allegations that the firm’s system and procedures did not permit them to adequately detect activities
    • that required investigation or reporting under AML regulations;  
    • that FINRA failed to sustain its burden of proof to demonstrate that
    • the Firm failed to have a reasonable AML training program; and 
    • that FINRA failed to show that Respondent’s use of both manual and automated systems to monitor, detect, and report suspicious activity resulted in the untimely filing of suspicious activity reports (“SARs”).

    As a result, the Hearing Panel found that the Respondent had made substantial AML compliance efforts and the AML policies and procedures were reasonably expected to, and did, detect and cause the reporting of suspicious activity and transactions from April 24, 2002, through July 11, 2005, under the Bank Secrecy Act and implementing regulations. The Hearing Panel found that Respondent’s AML program was well-organized with a full-time AML Compliance Officer, adequate monitoring for AML issues by operational personnel, and the written AML procedures were sufficiently specific to enable personnel to identify suspicious activity.

    Respondent’s written procedures adequately described how to identify and review transactions and how to escalate red flags. Enforcement argued that that the AML procedures provided insufficient guidance to Respondent’s staff in identification and review of transactions for AML issues. The Hearing Panel disagreed, and found that Respondent’s staff did not have difficulty understanding what would constitute a red flag that should be escalated to supervisors or the AML compliance officer.

    Respondent’s monitoring system evolved and ultimately became a combined manual and automated monitoring system. The Hearing Panel found this system to be reasonable since there was little guidance at the time on the degree of automation required under the PATRIOT Act and Conduct Rule 3011. Furthermore, Respondent consulted with other broker-dealers in the industry for guidance on which monitoring systems were efficient and useful. Other automated systems that were available at the time were a financial burden and were not proven to be efficient. The Hearing Panel rejected FINRA’s argument that Respondent’s system could not adequately detect suspicious activity or missed transactions that a more fully automated system would have caught.

    Notably, the Hearing Panel found that FINRA failed to sustain its burden of proof to establish that Respondent was unreasonable in its reliance on a largely manual system for monitoring transactions. Indeed, the Hearing Panel noted that the Respondent detected, and filed two SARs with respect to, the very transactions that FINRA identified in its complaint. Furthermore, the Hearing Panel rejected FINRA’s allegation that SARs should have been filed sooner than Respondent determined based on its review of the transactions.

    With respect to training, Respondent’s AML training consisted of a video and an online program. The Hearing Panel held that the training was more than sufficient. In addition, the Hearing Panel found that the failure of five employees in the Margin Department to participate in the training program in 2003 on its own was not sufficient to support that the AML program was inadequate. In addition, the Hearing Panel found that the Respondent’s AML training program was reasonable.

    The Hearing Panel also rejected FINRA’s allegations that, for a variety of reasons, Respondent had a deficient and unreasonable AML program for the period July 1, 2006, through April 20, 2007. Notably, the Hearing Panel found that Respondent’s written AML procedures with respect to the deposit of physical certificates were reasonable. Similarly, the Hearing Panel found that the written procedures for monitoring journal transfers and identifying direct foreign financial institution accounts were also reasonable.

    Although the Hearing Panel found that the Respondent’s AML program was reasonable during the periods alleged in FINRA’s complaint, the Hearing Panel fined the Respondent $40,000 for certain deficiencies in its AML program for the period July 1, 2006, through April 20, 2007, as discussed below. This sanction was far less than the amount sought by the FINRA Enforcement staff, and far less than recent settlements FINRA has announced for AML-related violations.

    Specifically, the Hearing Panel also found that Respondent did not include the due diligence requirements of Section 312 of the PATRIOT Act in its written AML procedures. Section 312 of the PATRIOT Act requires financial institutions to establish due diligence requirements in their AML policies and procedures for correspondent accounts maintained for foreign financial institutions. Further, the Hearing Panel found that Respondent failed to identify certain foreign banks and subsequently failed to obtain foreign bank certifications or equivalent information for three banks. These failures violated NASD Rules 3011 and 2110, and MSRB Rule G-41. The Hearing Panel also found that Respondent violated NASD Rule 3011 for failure to send special measures notices to those three banks.

    Finally, the Hearing Panel found that, for the nine-month period from July 1, 2006, through April 20, 2007, alleged in the complaint, the Firm failed to implement the customer identification procedures contained in the Firm’s written supervisory policies for delivery versus payment (DVP) accounts, which violated NASD Rules 3011 and 2110, and MSRB Rule G-41.

    In determining the appropriate sanctions, the Hearing Panel considered each violation individually and not in the aggregate. The Hearing Panel relied on the FINRA Sanctions Guidelines, particularly the guidelines for deficient written supervisory procedures, as well as the General Principles Applicable to All Sanction Determinations and the Principal Considerations in Determining Sanctions, in assessing the appropriate dollar amount for each violation it found.

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    1 Consistent with FINRA Rules, the Decision will become the final decision of FINRA 45 days after service of the Decision upon the parties unless either party appeals to the National Adjudicatory Council (the “NAC”), or the NAC calls the Decision for review. The parties have 25 calendar days from the date of the Decision to file an appeal.