Direct Business and Anti-Money Laundering Responsibilities

Summary:

In the broker-dealer industry, “direct business” is a phrase used to describe transactions that occur outside of brokerage accounts. Also called “check and app business” or “subscription-way,” there are many different types of products that may be purchased in this manner. Some examples include mutual funds, annuities, and alternative investments. Additionally, private placement transactions are considered direct business as well. It is important to understand the firm’s anti-money laundering responsibilities when engaging in these types of transactions. 

Regulations:

To understand your firm’s AML responsibilities, you should be familiar with FINRA rules, the Bank Secrecy Act, and the USA PATRIOT Act. Some of the key rules are highlighted below:

The primary FINRA rule regarding AML compliance is NASD Rule 3011. This rule requires each member to comply with the following:

1. Establish and implement AML policies and procedures that can be reasonably expected to detect and cause the reporting of potential money laundering activity
2. Establish and implement polices, procedures, and controls designed to achieve compliance with the Bank Secrecy Act
3. Provide for annual independent testing conducted by a qualified outside party (every two years for firms that do not hold customer accounts, execute transactions for customers, or engage solely in proprietary trading or business with other broker-dealers)
4. Designate to FINRA individual(s) responsible for implementing and monitoring the program

FINRA has also issued a number of Notice to Members on the subject of CIP and anti-money laundering compliance program requirements. Notice to Members 03-34 outlines requirements for customer verification and recordkeeping requirements. It also covers comparison with government lists, customer notice, and reliance on another financial institution. Notice to Members 02-21 covers enhanced due diligence, monitoring for suspicious activity, training programs, and other guidance for policies and procedures to be incorporated into a firm’s anti-money laundering program.

Firms should be familiar with requirements for screening customers and prospective customers against government lists. Both the Office of Foreign Assets Control (OFAC) and Financial Crimes Enforcement Network (FinCEN) create lists for broker-dealers to use in conjunction with their anti-money laundering compliance programs. OFAC rules prohibit transactions with certain persons, entities, and regions. This list can be accessed at www.treas.gov/ofac. FinCEN works with law enforcement to provide firms with lists every two weeks. These lists are transmitted over a secure network and should be reviewed and compared to internal lists of existing customers for possible matches. If a match is found, it must be reported within two weeks.

When regulators conduct an examination on your firm’s anti-money laundering program, they will not only verify adherence to FINRA and USA PATRIOT Act rules, but they will also ensure you are following your internal policies and procedures.

Common Examination Findings:

Some of the most common examination findings regarding direct business include the following:

• Failure to screen clients against OFAC initially, or on an ongoing basis
• Lack of documentation to show evidence of adherence to CIP and/or OFAC/FinCEN screening policies
• Lack of procedures to ensure all direct business is screened against OFAC/FinCEN lists on an ongoing basis
• Reliance on a clearing firm or other third party for CIP or OFAC/FinCEN screening responsibilities without a detailed agreement to support this arrangement.
• Failure to have an independent examination

Recommendations:

Firms should maintain a detailed record of all direct business conducted. When conducting new direct business, someone should be assigned the responsibility of following CIP and OFAC procedures. Firms should decide on a timeframe for screening all clients on an “ongoing basis” and should ensure that direct business clients are reviewed against the bi-weekly FinCEN lists. Records should be maintained to provide evidence the firm is following its policies. If a regulator asks for evidence of CIP or other documentation, the firm should be able to fulfill the request in a timely manner. Finally, as a supervisory control, firms should designate someone to oversee and make sure these procedures are being followed on an ongoing basis and test adherence to the policies periodically.

Conclusion:

By maintaining a detailed record of all direct business conducted, keeping documentary evidence to show AML procedures are being followed, and conducting periodic supervisory controls testing, your firm will be more prepared for regulatory visits and greatly reduce the chances of a finding in these areas.    

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