November 13, 2001

The New Money Laundering Legislation

Gregory A. Baldwin

Never before have financial institutions been more on the front line in the war against money laundering than they are now with the October 26 passage of the "USA Patriot Act." And the definition of "financial institution" is not limited to banks. It also includes, among others: the US branches and agencies of foreign banks; securities and commodities brokers; investment companies; issuers of travelers' checks; currency exchanges; money transmitters; insurance companies; travel agencies; loan or finance companies; dealers in precious metals or jewels; automobile, boat and airplane dealers, casinos and persons involved in real estate closings and settlements.

Some of the Act's provisions directly affect all "financial institutions," even those which up to now have been excused from some of the more burdensome anti-money laundering regulations. Other provisions of the Act apply specifically to banks and securities brokers or dealers, particularly addressing Private Banking, Correspondent and Payable-Through Accounts. Still other provisions are aimed directly at securities brokers and dealers, requiring new regulations for reporting suspicious transactions. And there are significant new amendments to the Money Laundering Control Act as well as major changes in reporting large cash transactions by businesses. The full text of the Act cannot be summarized in the space available here, but this article will summarize some of these key provisions.

Mandatory Anti-Money Laundering Programs

Prior to October 26, Treasury had discretion in deciding which "financial institutions" as defined in the Bank Secrecy Act would be required to institute anti-money laundering programs. The definition of "financial institution" is, of course, very broad, including such diverse businesses as securities and commodities brokers, investment companies, issuers of travelers' checks, currency exchanges, money transmitters, insurance companies, travel agencies, loan or finance companies, dealers in precious metals or jewels, automobile, boat and airplane dealers, casinos and persons involved in real estate closings and settlements had to implement anti-money laundering programs. Using its discretion, Treasury had limited the requirement that financial institutions implement anti-money laundering programs largely to banks and their affiliates. In a much overlooked but potentially sweeping change, however, §352 of the Act requires that "each financial institution shall establish anti-money laundering programs."

An anti-money laundering program requires at a minimum: the development of internal policies, procedures and controls; the designation of a compliance officer; an ongoing employee training program; and an independent audit function to test programs. 31 USC §5318(h). This new mandate applies to potentially hundreds of thousands of US businesses and to foreign banks as well, which, up to now, have avoided this requirement. This provision goes into effect in late April, 2002. Only if affirmatively exempted by Treasury will these businesses continue to avoid having to implement anti-money laundering programs. Treasury has until April, 2002 to consider exemptions based upon the size, location and activities of the businesses potentially affected, but the intent of Congress is clear. After that, every financial institution must have anti-money laundering programs unless Treasury has exempted it on the basis of its size, location or activity. Given the suspicions that brokerage accounts were used by terrorists to take advantage of market conditions after the September 11 attacks, those securities brokers and dealers which have so far avoided mandatory anti-money laundering programs can hardly expect to be exempted.

Special Treasury Regulatory Powers

Section 311 of the Act creates another new section of the Bank Secrecy Act (31 USC §5318A) that permits Treasury to impose certain "special measures" if it finds that a foreign jurisdiction, a financial institution operating outside the US, a certain class of transactions, or a certain type of account are "of primary money laundering concern." The Act sheds no light on exactly what is meant by the phrase "of primary money laundering concern." Presumably, like the famous definition of obscenity, Treasury will know it when it sees it.

There are five "special measures" Treasury may take. These include: (1) enhanced record keeping and reporting on transactions, including the identity and address of each participant in the transaction, the beneficial owner of the funds involved, and a description of the transaction; (2) obtaining additional information about the beneficial ownership of any account held by a foreign person; (3) obtaining the identity of each customer permitted to use a foreign bank Payable-Through Account, and with respect to each such customer, require the same information as the bank is normally required by its KYC procedures to obtain generally; (4) obtaining the identity of each customer whose transactions are routed through a foreign bank Correspondent Account as a condition of opening or maintaining such accounts; and the flat prohibition, and with respect to each such customer, require the same information as the bank is normally required by its KYC procedures to obtain generally; and (5) imposing other conditions, or even prohibiting, foreign bank Correspondent or Payable-Through Accounts.

In short, Section 311 gives Treasury the power to basically stop banking business with certain foreign banks, countries, persons or entities if it finds them to be of "primary money laundering concern."

Enhanced Due Diligence Over Private Banking and Correspondent Accounts

Section 312 of the Act adds another new section (31 USC §5318(i)) to the Bank Secrecy Act which requires banks to establish enhanced due diligence policies in opening and maintaining some Private Banking and Correspondent Accounts.

For Private Banking Accounts (defined generally as accounts assigned to the supervision or management of a particular officer, employee or agent and requiring minimum aggregate deposits or other assets of at least $1 million), this special due diligence must include: ascertaining the identity of the nominal and beneficial owners of the account; ascertaining the source of the funds deposited into the account; guarding against the account being used for money laundering and reporting suspicious transactions; and conducting "enhanced scrutiny" of the account if opened or maintained by or on behalf of "a senior foreign political figure," an immediate family member or a close associate.

For Correspondent Accounts, the enhanced due diligence must include: ascertaining the identity of the owners of the correspondent bank (unless it is publicly traded); ascertaining the nature and extent of each owner's interest; conducting "enhanced scrutiny" of the account to guard against money laundering and to report suspicious transactions; and ascertaining whether the correspondent bank provides Correspondent Accounts to other foreign banks, and if it does, the identity of those foreign banks and their ownership. Congress has directed Treasury to issue regulations that "further delineate" the required due diligence by late April, 2002. After that, banks and brokers and dealers will have until July, 2002, when §312 becomes effective, to implement those new regulations.

It is important to understand that §312 does not apply to all Correspondent Accounts. Instead, it defines a Correspondent Account as one opened or maintained by a foreign bank that is operating under an "offshore banking license," or that is licensed by a country that has been designated by the US Government as "noncooperative" in international anti-money laundering efforts. An "offshore banking license" is one that permits banking activities but prohibits them from being conducted with the citizens of the licensing country. However, §313 flatly prohibits all Correspondent Accounts with foreign "shell banks," defined as foreign banks without a physical presence (i.e., no fixed street address, no full time employees, no operating records and no banking supervision in the licensing country). In addition, for all foreign Correspondent Accounts steps must be taken to ensure the Account is not being used by the foreign correspondent bank to indirectly provide services to a shell bank.

But what Congress gives with one hand it takes away with the other. In §319 of the Act, Congress has created yet another new section (31 USC 318(k)) to the Bank Secrecy Act. This requires, among other things, that U.S. banks opening or maintaining Correspondent Accounts for foreign banks must maintain records in the U.S. identifying the owners of the foreign correspondent bank, and these records must be maintained in the United States. This section of the Act applies to all foreign bank Correspondent Accounts. Unlike §312, this section attempts to incorporate a broad definition of Correspondent Account, one which does not limit the section's application only to those maintained for "offshore banks," and one which does not limit the owner identification requirement to non-publicly traded foreign banks.

This is therefore a particularly confusing section of the Act. In light of this section, for example, there seems little sense in having passed §312 – which requires U.S. banks to learn the ownership of non-publicly traded foreign banks that have Correspondent Accounts in the U.S., and which limits that requirement to Correspondent Accounts of "offshore banks." Certainly it would appear that §319's provisions, which are not limited to non-publicly traded foreign banks or to "offshore banks," completely swallow up the more limited §312 requirements. Section 319 also raises the very real problem of exactly how a U.S. bank is to determine the identity of every owner of a foreign bank. For publicly traded foreign banks this problem appears literally insurmountable. And yet the same section requires U.S. banks to have this information available in their records by the end of December, 2001. Clearly, either Congress or Treasury will have to clarify this situation, and quickly.

Other Record Keeping and Record Disclosure Provisions

In addition to requiring the records of foreign bank ownership to be kept in the U.S., §319 of the Act provides that Treasury or the Attorney General may issue a summons or subpoena to any foreign bank that maintains a Correspondent Account in this country for "records related to such correspondent account, including records maintained outside the United States relating to the deposit of funds into the foreign bank. Note that this provision is not limited just to customers of the foreign bank whose funds are transmitted through the Correspondent Account: the provision is much broader than that. Essentially, it means that to open or maintain a Correspondent Account in the U.S., a foreign bank must agree to make virtually all of its records available to U.S. law enforcement – even records maintained in other countries. This provision stretches the principles underlying the Bank of Nova Scotia cases well beyond the breaking point. More importantly, how this provision can possibly be reconciled with the secrecy laws of other nations is impossible to imagine. What is clear, though, is that foreign banks operating in bank secrecy jurisdictions now face a Hobbs choice when opening or keeping a Correspondent Account in the U.S.

Another very confusing aspect of §319 is the provision that the U.S. bank maintaining the records of ownership of foreign banks must also maintain records identifying the name and address of a person residing in the U.S. who is authorized to accept service of process "for records regarding the correspondent account." This is substantially narrower than the section making available foreign bank records "relating to the deposit of funds into the foreign bank." Is this "person who resides in the United States" limited to accepting service only for records related to the Correspondent Account, or to also accepting service for records of deposits made into the foreign bank? The two categories are clearly not the same. Since the Act was rushed through Congress with such break-neck speed, there is literally no Congressional history to turn to in order to determine the intent of Congress.

These considerations, as well as privacy restrictions that may apply to the foreign bank in its home jurisdiction, seriously raise the cost of having a Correspondent Account in the United States, probably to the point that completely legitimate foreign banks may decide the price is simply too high.

In any case, §319 also creates a new "120-Hour Rule" for bank records. Under this Rule, banks receiving a "request" by its supervisory agency for information related to anti-money laundering compliance must provide those records, or make them available, within 120 hours of receiving the request. The records requested may be any information and account documentation for any account opened, maintained, administered or managed in the United States.

One other records disclosure provision of the Act deserves mention. Section 215 amends the Foreign Intelligence Surveillance Act of 1978 to provide the government secret access to "business records" pursuant to court order. The term "business records" is not defined, and there appears no reason to expect that it will not be interpreted to include records maintained by banks. Specifically, §215 allows the FBI to ask a federal court for an order requiring the production of books, records, papers, documents and tangible things for the purpose of an investigation to protect against international terrorism or clandestine intelligence activities. There is no standard of reasonable belief or probable cause. The order may be ex parte, and the Act specifically provides that neither the order, the application for the order or the production of any documents may be disclosed by any person or entity. Given the current intense efforts to cut off terrorist organizations from their funds, banks can expect to see these orders in the not too distant future. In that regard, the Act provides a safe harbor for any person or entity that produces documents and records "in good faith." It also provides that the production hall not be deemed to constitute a waiver of any privilege in any other proceeding.

New Forfeiture Provisions

The Act expands the scope of civil forfeiture in ways that banks should be aware of. Section 319 of the Act provides that if forfeitable funds are deposited into a foreign bank, and that foreign bank has an interbank account in the U.S., the funds shall be deemed to have been deposited into the interbank account and may be seized from that account without any tracing requirement on the government's part. In other words, §319 permits a sort of forfeiture by proxy, although it expressly allows an innocent owner to present a defense to the forfeiture.

Amendments to The Money Laundering Control Act

The Money Laundering Control Act ("MLCA") provides for both criminal enforcement and civil remedies. Both parts of this law have been substantially changed by certain provisions of the Act, some of which may require updating of anti-money laundering and employee training programs.

Criminal: Section 315 expands the MLCA to include the Foreign Corrupt Practices Act in the list of "specified unlawful activity," thereby potentially rendering bribery of foreign officials by US companies an act of money laundering.

: Section 315 expands the MLCA to include the Foreign Corrupt Practices Act in the list of "specified unlawful activity," thereby potentially rendering bribery of foreign officials by US companies an act of money laundering.

In addition, before the Act the only foreign laws included in the MLCA list of "specified unlawful activity" were violations of foreign narcotics laws, murder, kidnapping, robbery, extortion, or destruction of property by explosives or fire, and fraud by or against a foreign bank. Now, however, financial transactions involving proceeds derived from foreign public corruption are included in the MLCA. Specifically, proceeds derived from the bribery of foreign public officials, the theft or embezzlement of public funds in a foreign country by or for a foreign public official, and smuggling or export control violations of foreign law can now be considered illegal money laundering. To the extent that financial transactions involving the proceeds of foreign public corruption, smuggling or export control violations of foreign law have now become potential money laundering offenses, banks should consider updating those portions of their compliance programs and issuing training bulletins to their employees.

An additional concern is that the Act also adds to the list of "specified unlawful activity" any violation of foreign law for which the United States would be required to extradite under the terms of a current treaty with the appropriate country. This means that the list of specified acts could be different from country to country, and could even involve violation of foreign tax laws if those violations are included in a nation's extradition treaty with the United States. These provisions expanding the MLCA render suspicious transaction reporting and employee training a Herculean task.

Civil: Of course, the changes in the list of "specified unlawful activity" apply not only to criminal violations of the MLCA, but to civil violations as well. But additional major changes have been made to the civil enforcement provisions of the MLCA (§1956(b)) as well.

: Of course, the changes in the list of "specified unlawful activity" apply not only to criminal violations of the MLCA, but to civil violations as well. But additional major changes have been made to the civil enforcement provisions of the MLCA (§1956(b)) as well.

Section 317 of the Act specifically creates "long arm jurisdiction" over foreign individuals and entities if service of process is made either under the Federal Rules of Civil Procedure or under the laws of the country in which the person or entity is found, and: (i) the defendant has violated §1956(a) of the MLCA involving a financial transaction that occurs in whole or in part in the U.S.; (ii) the foreign person or entity converts to his or its own use property the U.S. has an ownership interest in by virtue of the entry of a U.S. forfeiture order.; or (iii) the foreign person is a financial institution with an account in the U.S.

Although part (iii) refers specifically to "financial institution," it must be kept in mind that the MLCA defines that term as broadly as the Bank Secrecy Act does. It therefore includes many more foreign businesses than just foreign banks. And the other parts of the long arm definition are also of significance to foreign banks, because the term entity necessarily includes them. The first part essentially asserts civil jurisdiction (with its full panoply of civil discovery) over all foreign persons and entities if the financial transaction in question is alleged to have occurred in whole or in part in this country. In other words, express long arm jurisdiction for civil enforcement of the MLCA may now be asserted over every Sony entity in the world whose financial transactions pass through the United States if the government claims the transaction was in violation of §1956(a). As for the second part, it is unclear whether the order of forfeiture referred to needs to have been entered before the foreign person or entity converts the property in question to his or its own use. Arguably, in light of the "relation back" doctrine, this provision could apply to property or money that was only subject to forfeiture at the time of the financial transaction giving rise to the civil enforcement proceeding but which had not already been forfeited. In other words, civil sanctions could be imposed on a foreign entity accused of having violated the MLCA by dealing in property found to be forfeitable after the property was handled.

As part of the long arm provisions, the Act also authorizes the court to issue a pretrial restraining order to insure that the bank account or other property held by the defendant in the U.S. is available to satisfy a civil judgment.

The implications of §317 seem clear. All foreign persons and entities, including foreign banks, could be subject to long arm jurisdiction for civil violations of the MLCA on the basis of a questionable financial transaction occurring in part in this country, or possibly on the basis of a financial transaction later subject to a civil forfeiture action. And, in the event of a civil forfeiture action, the penalty is not merely losing the funds, it is that plus a civil fine. The appropriate compliance programs and employee training should be updated to reflect these dangers.

Enhanced Information Sharing and Disclosure

One aim of the Act is to foster cooperation among banks, their regulatory authorities and law enforcement, so §314 requires Treasury to adopt regulations by the end of April, 2002 designed to accomplish this. Treasury is also mandated to report semiannually to the financial services industry on patterns of suspicious money laundering activity, as well as other investigative insights. The new regulations may require each bank to designate at least one person to receive information about, and to monitor the accounts of, persons, entities or organizations "reasonably suspected based on credible evidence" of engaging in money laundering or terrorism. A safe harbor provision is included in §314, but it does not apply where the sharing of information violates this section. This means banks can expect to litigate their "reasonable suspicion based on credible evidence" whenever they are sued for a disclosure. No similar exception exists in the safe harbor for filing of SARs.

In addition, §355 specifically permits (but does not require) banks to disclose, in a written employment reference about a current or former employee made in response to a request from another bank, information concerning the employee's "possible involvement … in potentially unlawful activity." This authorization is not limited to money laundering activity, but to unlawful activity in general. The information disclosed may even be information reported in an SAR, even though the disclosure of the contents of an SAR is strictly prohibited, as long as the employment reference does not disclose that the information was in an SAR (§351).

Amendments to The Money Laundering Control Act

Section 315 expands the Money Laundering Control Act to include transactions involving proceeds derived from foreign corruption. In particular, financial transactions involving the bribery of public officials, the theft or embezzlement of public funds and smuggling or export control violations of foreign law can be considered illegal money laundering. The inclusion of these provisions will have a direct and burdensome impact on banks and securities brokers and dealers, since it will require them to be able to identify and report suspicious transactions relating to these violations of foreign law. Section 315 also adds the Foreign Corrupt Practices Act to the list of money laundering violations, thereby potentially rendering bribery of foreign officials by US companies an act of money laundering.

Increased Penalties for BSA Violations

Not only has the scope of the Money Laundering Control Act dramatically expanded, the civil and criminal penalties for violation of the Bank Secrecy Act have been greatly enhanced. Section 363 increases the civil penalties for each violation to the greater of twice the amount involved in the financial transaction or $1 million, and the criminal penalties to not less than twice the amount involved in the financial transaction or $1 million.

Conclusion

The USA Patriot Act has affected virtually every aspect of current anti-money laundering efforts, and enormously enhanced the Government's ability to combat it. Almost no aspect of existing law has been left untouched. But the Act is likely only the beginning. Numerous sections of the Act require Treasury to make various reports to the Congress concerning the need for yet more laws and regulations designed to enhance the war against money laundering. One thing is certain: the new Act is only the opening salvo of what is likely to become a barrage of future money laundering legislation and regulation.

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