Anti-Money Laundering and Correspondent Accounts

Summary
Correspondent accounts are defined by the USA PATRIOT Act as “an account established to receive deposits from, make payments on behalf of a foreign financial institution, or handle other financial transactions related to such institution.” It is important to note that one of the exclusions from this definition is an account handled by an executing broker in a prime brokerage arrangement. In this arrangement, the prime broker has the responsibility for following the correspondent account rule. Sections 312, 313, and 319b of the USA PATRIOT Act address rules around correspondent accounts. These rules include requirements for conducting due diligence and the prohibition on opening “foreign shell banks,” defined as foreign banks that do not maintain a physical presence in any country.

Regulations
Section 312 of the USA PATRIOT Act requires broker-dealers to establish risk-based due diligence and enhanced due diligence policies, procedures, and controls when necessary. The purpose of this is to detect and report money laundering through correspondent accounts established or maintained by U.S. broker-dealers for foreign entities. “Enhanced due diligence,” as opposed to “due diligence,” would be conducted when required by the firm’s risk-based procedures or when one of the following situations applies:

1) The foreign bank is operating under an offshore banking license (The term “offshore banking license” means a license to conduct banking activities, which, as a condition of the license, prohibits the licensed entity from conducting banking activities with the citizens of, or with the local currency of, the country which issued the license.)
2) The banking license was issued by a country identified as non-cooperative with international anti-money laundering (AML) policies or procedures. (See www.fatf-gafi.org for more information.)
3)  The banking license was issued by a country that has been designated by the Secretary of the Treasury as warranting special measures.

Firms must gather information on these accounts, including information on ownership, a point of contact in the U.S., and verification that these institutions have an AML program.

Section 313 of the USA PATRIOT Act prohibits broker-dealers from having correspondent accounts for any foreign bank that does not have a physical presence in any country. Additionally, the broker-dealer is required to establish risk-based policies and procedures to ensure the correspondent accounts are not used to indirectly provide services to shell banks. 

Section 319b of the USA PATRIOT Act addresses record retention requirements for correspondent accounts. Specifically, this includes identification of the foreign bank’s owners and the name/address of the authorized person in the U.S. who will act as a point of contact for accepting service of legal records for the account.

A certification form has been created to assist firms in gathering necessary information from correspondent accounts. This form should be completed within 30 days of the account opening, and every three years by the anniversary date. The form can be found on the U.S. Department of the Treasury’s website. (www.ustreas.gov)

Examples and Guidance
Example #1: A bank formed in the Cayman Islands attempts to open an account with a U.S. broker-dealer. This bank does not have a physical location. It was formed through government filings and only has a P.O. Box address.  

Guidance: This would be considered a “Foreign Shell Bank.” The account should not be opened. If already open, the account should be closed immediately.

Example #2: A bank formed in Iran has a physical presence in many locations and attempts to open an account with a U.S. broker-dealer.

Guidance: The broker-dealer should follow its risk-based policies and procedures for conducting enhanced due diligence because the Financial Actions Task Force (FATF) has identified Iran as a high-risk country and threat to the international financial system.    

Example #3: A bank in London has many locations internationally and attempts to open an account with a U.S. broker-dealer.

Guidance: The broker-dealer should follow its risk-based policies and procedures for conducting due diligence. Enhanced due diligence would not be required unless the firm has difficulty completing standard due diligence procedures, the U.K. is identified as non-cooperative or requiring special measures, or other risk factors are identified per the firm’s risk-based procedures.

Example #4: A bank in Brazil has many physical locations internationally and opens a prime brokerage account with a U.S. broker-dealer. The U.S. broker-dealer then forms a relationship with an executing broker-dealer for purposes of executing trades only, and then delivering shares through the RVP/DVP settlement process.

Guidance: The executing broker-dealer is not required to conduct due diligence in this case, as FinCEN guidance dated September 5, 2007 has addressed this relationship and identified the prime broker as being responsible for due diligence obligations.

Conclusion
Ensuring that your firm’s AML policies, procedures, and controls are risk-based when addressing due diligence and enhanced due diligence around correspondent accounts is very important. Also, effectively detecting and prohibiting accounts with foreign shell banks will reduce the firm’s AML risk and avoid potentially costly regulatory fines. Finally, obtaining foreign bank certifications at least every three years will provide required information on correspondent accounts and also provide a safe harbor around certain requirements.  

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