B ANKING F INANCIAL S ERVICES

Transcription

1 THE REVIEW OF & B ANKING F INANCIAL S ERVICES A PERIODIC REVIEW OF SPECIAL LEGAL DEVELOPMENTS AFFECTING LENDING AND OTHER FINANCIAL INSTITUTIONS Volume 22, No. 3 March 2006 FINANCIAL INSTITUTIONS IN THE CROSS-HAIRS: LESSONS FROM RECENT MAJOR ANTI-MONEY LAUNDERING ENFORCEMENT CASES Domestic and Foreign Financial Institutions Doing Business in the United States Must Have Anti-Money Laundering Programs that Include Internal Controls, Independent Testing, Designated Personnel, and Adequate Training. Last Year A Number of Banks and a Wall Street Firm Received Substantial Fines for Program Failures, with Three of the Major Cases Targeting U.S. Branches of Banks Based Outside the U.S. By Douglas N. Greenburg & Jonathan C. Su* Prosecutors and regulators in the United States have increasingly targeted for investigation and sanction financial institutions that fail to comply with the anti-money laundering ( AML ) requirements of the Bank Secrecy Act ( BSA ). This focus led to a number of major enforcement actions in For example, to settle charges related to deficiencies in its AML program and the failure of its U.S. branches to comply with U.S. law prohibiting financial transactions with certain countries, ABN AMRO Bank, N.V. agreed to pay $80 million in civil penalties, the largest fine ever imposed on a financial institution for violating AML laws.1 The Israel Discount * DOUGLAS N. GREENBURG is a partner in the Washington, D.C. office of Latham & Watkins LLP. He served in on the professional staff of the 9/11 Commission, where he investigated the financing of the 9/11 attacks and the al Qaeda organization, the efforts of the U.S. government to detect and disrupt the financing of terrorist organizations, and the role of financial inst i t ut i ons i n co mb a tin g ter r o r is t fin a n c ing. M r. Greenburg can be reached at douglas.greenburg@lw.com. JONATHAN C. SU is an associate at the Washington, D.C. office of Latham & Watkins LLP. Mr. Su can be reached at jonathan.su@lw.com. March 2006 Bank of New York agreed to pay up to $25 million to resolve allegations brought by New York state law enforcement and banking officials. The Bank of New York paid $38 million to settle two major criminal investigations into money laundering and related issues. The New York branch of Arab Bank paid $24 million to settle charges related to a deficient AML program that allegedly resulted in Arab Bank s failure to report suspicious activity regarding money laundering and terrorist financing. Oppenheimer & Co. agreed to pay a $2.8 million civil penalty, the first major penalty against a Wall Street securities firm for BSA violations. This article discusses these and other significant cases in the context of major trends observable in the government enforcement actions in 2005: 1 Most of the settlements discussed herein were entered without the institution admitting or denying the underlying allegations, and this article takes no position on the merit of the government s allegations or the culpability of any entity or person. IN THIS ISSUE Financial Institutions in the Cross-Hairs: Lessons from Recent Major Anti-Money Laundering Enforcement Cases Page 17

2 1. Recent enforcement actions highlight the need for non-u.s. financial institutions operating in the United States to comply with U.S. law. 2. There has been no clear trend to criminalize BSA enforcement. 3. Non-bank financial institutions subject to the BSA should expect increasing scrutiny. 4. State regulators and law enforcement will play an increasing role in enforcing anti-money laundering laws. 5. Money laundering remains an area of continued focus for federal and state authorities. 6. Financial institution boards and senior management must lead BSA compliance and investigation of compliance breakdowns. BACKGROUND The approach of United States authorities to preventing criminals from taking advantage of the financial system relies on the basic premise that financial institutions themselves are in the best position to detect money laundering and related illicit transactions. Thus, the BSA and its implementing regulations require banks to implement policies and procedures to detect money laundering and other financial crimes, and to report such activity to the government. The USA PATRIOT ACT, passed in the wake of the 9/11 terrorist attacks, dramatically expanded the scope of entities deemed financial institutions subject to suspicious activity reporting. Such financial institutions now include a myriad of entities beyond banks, such as securities broker-dealers, credit card companies, casinos, money service businesses, and insurance companies. 2 Financial institutions must also ensure that they do not engage in transactions with countries or persons subject to U.S. economic sanctions, as set forth in regulations promulgated by the U.S. Department of Treasury s Office of Foreign Assets Control ( OFAC ) U.S.C. 5312(a)(2)(A)-(X), as amended by the Patriot Act, defines the term financial institution for purposes of the BSA. The BSA authorizes the Secretary of the Treasury to promulgate regulations requiring financial institutions to report suspicious activity. See Derek M. Bush and Katherine M. Carroll, Suspicious Activity Reporting: Recent Developments, Rev. Banking and Fin. Services, Nov. 1, OFAC s regulations, promulgated under various statutes and executive orders, prohibit or strictly limit transactions with certain countries, such as Cuba and Iran, and terrorist organizations, such as al Qaeda or Hamas, and various people or entities designated as terrorists, narco-traffickers, weapons proliferators, or other enemies of the United States. See 31 C.F.R (2005). Standard & Poor s The Review of Banking & Financial Services is a periodic supplement of the The Review of Securities & Commodities Regulation, which is published 22 times a year by Standard & Poor s, a division of The McGraw- Hill Companies. Executive Office 55 Water Street, New York, New York Editorial Office, 299 Park Avenue 16th floor, New York, New York Subscription rates: $1,140 per year in U.S., Canada and Mexico; $1,205 elsewhere (air mail delivered). A 15% discount is available for qualified academic libraries and universities. For subscription information and customer service, please call (800) General Editor: Michael O. Finkelstein. Associate Editor: Sarah Strauss Himmelfarb. Copyright 2006 by Standard & Poor s. ISSN: Reproduction in whole or in part prohibited except by permission. All rights reserved. Officers of The McGraw-Hill Companies: Harold W. McGraw III, Chairman, President and Chief Executive Officer; Kenneth M. Vittor, Executive Vice President and General Counsel; Robert J. Bahash, Executive Vice President and Chief Financial Officer; John Weisenseel, Senior Vice President and Treasurer. Information has been obtained by The Review of Banking & Financial Services from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, The Review of Banking & Financial Services does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. General Editor Michael O. Finkelstein Associate Editor Sarah Strauss Himmelfarb Board Members Roland E. Brandel Morrison & Foerster San Francisco, CA H. Rodgin Cohen Sullivan & Cromwell New York, N.Y. Joseph Diamond Consultant New York, N.Y. Carl Felsenfeld Professor of Law Fordham Law School New York, N.Y. Ralph Ferrara Debevoise & Plimpton Washington, D.C. Connie M. Friesen Sidley Austin Brown & Wood LLP New York, N.Y. David L. Glass Clifford Chance Rogers & Wells LLP New York, N.Y. Robert Kurucza Morrison & Foerster Washington, D.C. C. F. Muckenfuss, III Gibson, Dunn & Crutcher Washington, D.C. Morris Simkin Katten Muchin Rosenman New York, N.Y. Brian W. Smith Mayer, Brown Rowe & Maw Washington, D.C. Thomas Vartanian Fried, Frank, Harris, Shriver & Jacobson Washington, D.C. Page 18 March 2006

3 The BSA regime requires financial institutions to understand, control, and report transactions that have a questionable origin or purpose. Generally, institutions must have a BSA/AML compliance program that includes: (1) a system of internal controls to ensure ongoing compliance, (2) independent testing of BSA/AML compliance, (3) designated individual(s) responsible for managing compliance, and (4) training for appropriate personnel. Among other obligations, financial institutions must report any transaction they deem suspicious by filing a Suspicious Activity Report ( SAR ) with the U.S. Department of Treasury s Financial Crimes Enforcement Network ( FinCEN ). 4 An institution s failure to report suspicious activities, or to have a system in place that could reasonably detect money laundering or other suspicious financial transactions, is punishable by a combination of administrative sanctions, civil fines, and criminal penalties. An institution s compliance program must be commensurate with its BSA/AML risk profile TRENDS IN BSA ENFORCEMENT 1. Recent Enforcement Actions Highlight The Need For Non-U.S. Financial Institutions Operating In The United States To Comply With U.S. Law. Three of the largest fines imposed in 2005 for violations of the BSA and related regulations were brought against U.S. branches or subsidiaries of institutions based outside the United States. While government regulators are adamant in maintaining that they are not targeting foreign institutions, these cases demonstrate that non-u.s. institutions must take steps to ensure that any operations doing business in the United States do not run afoul of U.S. law. The ABN AMRO case illustrates the dangers for non-u.s. financial institutions of failing to ensure their U.S. operations comply with U.S. requirements. In December 2005, ABN AMRO paid $80 million to settle civil charges brought by several agencies: the Board of Governors of the Federal Reserve System, FinCEN, OFAC, and state bank regulators in New 4 See, e.g., 31 C.F.R (2005) (AML requirements for banks); id (AML requirements for broker-dealers); id (AML requirements for money services businesses). 5 See, e.g., Federal Financial Institutions Examination Council Bank Secrecy Act Anti-Money Laundering Examination Manual, available at pages_manual/olm_004.htm. 6 In the Matter of The New York Branch, ABN AMRO Bank N.V., FinCEN Assessment of Civil Money Penalty, Dec. 19, (footnote continued on next column ) York and Illinois. 6 ABN AMRO is based in the Netherlands and has a network of over 3,000 branches, agencies, offices, and subsidiaries in over 60 countries, including the United States. The bank is a wholly owned subsidiary of ABN AMRO Holding N.V, a public, limited liability company organized under Netherlands law. ABN AMRO s problems arose in its New York branch, the assets of which $35 million as of June 2005 were a tiny fraction of ABN AMRO s approximately $830 billion in total assets. Yet, despite its relatively small operation, the New York branch caused major problems for the bank. Much of ABN AMRO s problems arose at its North America Regional Clearing Center ( NARCC ), a unit within its New York branch that operated as a clearing institution for funds transfers in U.S. dollars. In addition to serving the needs of institutions affiliated with ABN AMRO, NARCC provided clearing services to financial institutions independent of the ABN AMRO network. As of May 31, 2003, more than 400 such independent institutions held correspondent accounts with NARCC. The problems started in the late 1990s when New York branch officials saw a business opportunity in providing services to small and medium-sized financial institutions in Russia that needed access to the U.S. financial system. In 1998, the New York branch began marketing its services to these smaller Russian institutions, and by 2000 over 100 Russian institutions held correspondent accounts there. Most of these Russian institutions had no relationship with ABN AMRO other than this correspondent relationship with the New York branch, which they used primarily for dollar clearing and settlement purposes. In conducting this business, NARCC processed approximately 30,000 funds transfers per day. According to Fin- CEN, this large volume, and the nature of the clientele smaller Russian financial institutions created a substantial risk of money laundering. 7 The U.S. government determined that ABN AMRO entirely failed to implement AML programs commensurate (footnote continued ) 2005 (hereinafter referred to as FinCEN ABN AMRO Settlement ). The factual discussion below of the BSA aspect of the ABN AMRO matter is derived from this document. 7 FinCEN ABN AMRO Assessment at 3. March 2006 Page 19

4 with the risk posed by the operations of NARCC. FinCEN determined that the BSA violations of the New York branch were serious, long-standing and systematic. 8 First, FinCEN determined that the New York branch lacked an adequate system of internal controls. Among the deficiencies cited in this regard were that ABN AMRO lacked documentation about foreign institutions and their businesses necessary to assess the money laundering risk posed by the institutions, and failed to adequately monitor funds transfers processed by NARCC for suspicious activity. Second, FinCEN determined that ABN AMRO failed to devote sufficient staff to AML responsibilities at the New York branch. The number of ABN AMRO staff responsible for day-to-day BSA compliance one person until December 2001 and three until July 2002 was found to be clearly inadequate in light of the volume of the activities that the New York branch of ABN AMRO conducted, and the risk that those activities posed. 9 Moreover, Fin- CEN determined the personnel responsible for BSA compliance were not adequately trained for this role. Given the weaknesses cited in the New York branch s BSA compliance program, it is not surprising that FinCEN also determined that the New York branch failed to comply with the BSA s SAR requirement. Indeed, FinCEN found that the lack of internal controls, dedicated personnel, and training resulted in extensive violations of the requirement to report suspicious activity. 10 FinCEN noted that the New York branch filed only 12 SARs from 1996 through 2001, filing far more from 2002 to 2004 after the Federal Reserve and New York state officials began subjecting the New York branch s BSA compliance to higher scrutiny. FinCEN also found that the SARs that the New York branch did file were either incomplete or inaccurate. 11 To settle the BSA issues with FinCEN, ABN AMRO, without admitting or denying FinCEN s allegations, agreed to pay a $30 million dollar civil penalty. 8 Id. 9 Id. at Id. at Id. 12 In the Matter of ABN AMRO Bank N.V., Board of Governors of the Federal Reserve System Order to Cease and Desist Issued Upon Consent, Dec. 19, 2005 (hereinafter Federal Reserve ABN (footnote continued on next column ) The BSA violations were not the only problems at ABN AMRO discovered by federal regulators, however. The Federal Reserve determined that ABN AMRO had violated OFAC regulations prohibiting transactions with Iran and Libya. 12 Specifically, the Federal Reserve determined that ABN AMRO lacked adequate risk management and legal review policies to ensure compliance with U.S. law and failed to follow the policies it did have. The investigation concluded that one of ABN AMRO s foreign branches was able to develop special procedures for evading the bank s OFAC compliance system and that, by using these special procedures, overseas ABN AMRO branches concealed or altered the identity of certain parties prohibited from engaging in banking transactions in the United States. 13 As a result, these parties did business through ABN AMRO s U.S. branches in violation of U.S. law. The New York branch engaged in transactions with a bank owned or controlled by the government of Iran, and the Chicago branch engaged in transactions with a bank in the United Arab Emirates, which the Department of Treasury had determined to be owned or controlled by the Libyan government. These transactions with Iranian and Libyan institutions violated OFAC regulations. As a result of ABN AMRO s OFAC violations, the Federal Reserve assessed a civil penalty of $40 million, $30 million of which was satisfied by the concurrent civil penalties assessed by FinCEN. In addition, state regulators imposed significant financial penalties. The New York State Banking Department assessed a $20 million penalty, the Illinois Department of Financial and Professional Regulation assessed a $15 million penalty, and ABN AMRO agreed to make a voluntary $5 million contribution to the Illinois Bank Examiner s Education Foundation. In addition to these monetary penalties, ABN AMRO agreed to retain a third-party examiner to review certain of its overseas operations, both historically and going forward, and report any violations of OFAC regulations to OFAC. ABN AMRO also agreed to substantial remedial measures, including the implementation of an extensive program to ensure compliance with U.S. law. 14 (footnote continued ) AMRO Cease & Desist Order ). See also In the Matter of ABN AMRO Bank N.V., Board of Governors of the Federal Reserve System Order of Assessment of a Civil Money Penalty, Monetary Payment and Order to File Reports Issued Upon Consent, Dec. 19, 2005 (hereinafter Federal Reserve ABN AMRO Penalty Order ). The factual discussion below of the OFAC aspect of the ABN AMRO matter is derived from these documents. 13 Federal Reserve ABN AMRO Penalty Order at See also Glenn R. Simpson and John R. Wilke, Sanction Threat Prompts Big Firms to Cut Iran Ties, THE WALL STREET JOURNAL, Jan. 31, 2006, at A3. Page 20 March 2006

5 Another major settlement involving a non-u.s. financial institution was announced on August 17, 2005, when the New York branch of Jordan-based Arab Bank, without admitting or denying the allegations lodged against it, agreed to pay a $24 million civil penalty assessed jointly by FinCEN and the Office of the Comptroller of the Currency ( OCC ) to settle allegations that it failed to implement a proper AML program. 15 This settlement came in the wake of OCC enforcement actions in February 2005 that required various remedial measures and substantially restricted the banking activities of the New York branch. Arab Bank is a leading provider of financial services in the Middle East and North Africa. It has approximately 400 branches, offices, and subsidiaries (collectively known as the Arab Bank Group) in thirty countries. Like ABN AMRO, Arab Bank ran into problems with its New York branch, which served as a clearing institution for fund transfers in United States dollars, processing 500,000 funds transfers per year. FinCEN determined that the customer base and geographic locations of the Arab Bank Group, and the volume of funds transfers that Arab Bank-New York cleared, posed heightened risks of money laundering and terrorist financing. 16 According to FinCEN, Arab Bank-New York failed to apply adequate internal controls to the funds transfers, failed to develop adequate systems to test its BSA compliance and, as a result, failed to identify and report suspicious activity in a timely manner. Another significant case regarding the U.S. operations of a foreign bank concerned Banco de Chile ( BC ), which agreed in October 2005 to pay a $3 million dollar civil penalty, without admitting or denying the government s findings. 17 After an investigation, the government concluded that BC s New York and Miami branches had failed to implement an effective AML program, citing three major deficiencies. First, FinCEN noted that BC did not implement adequate internal controls to ensure compliance with the BSA. For example, BC s customer identification program did not incorporate independent testing or establish guidelines for closing an account when a customer s identity could not be verified. BC also failed to implement procedures requiring additional information for high-risk account holders. FinCEN determined that BC s lack of internal controls allowed a politically exposed, high-profile Chilean person, whom press reports identified as Augusto Pinochet, to engage in apparent money laundering through BC accounts. 18 Even where BC had established AML policies, FinCEN concluded that those policies were not adequately implemented as senior BC branch personnel circumvented the policies on several occasions. Second, FinCEN determined that BC failed to conduct independent testing to ensure its compliance with the BSA. BC s auditors were not trained on requirements of AML statutes such as the BSA. The scope of BC s audits did not include reviewing new accounts, wire transfer and cash activity, and monitoring existing accounts. FinCEN also faulted BC for tasking its compliance officer with the responsibility of the audit function, reasoning that doing so compromised the independence of the audit function. 19 Third, FinCEN noted that BC failed to designate staff with the responsibility of ensuring the bank s BSA compliance. FinCEN criticized BC s BSA-compliance staffing structure as ambiguous and insufficiently segregated from the rest of [BC] FinCEN also found that BC violated the suspicious activity reporting requirements of the BSA by failing to review certain large dollar value transactions and consequently failing to report suspicious activities related to these transactions. BC agreed to pay a $3 million civil penalty for these violations. 21 These cases make clear that foreign banks face substantial liability if they do not bring their AML and compliance programs up to the expectations of U.S. regulators. This includes operations with only limited U.S. contact, like clearing dollars or processing wire transfers on behalf of a foreign customer. U.S. law gives regulators and pros- 15 In the Matter of The Federal Branch of Arab Bank PLC, FinCEN Assessment of Civil Money Penalty, Aug. 17, 2005 (hereinafter FinCEN Arab Bank Settlement ). The factual discussion below of the Arab Bank matter is derived from this document. 16 FinCEN Arab Bank Settlement at In the Matter of The New York Branch of Banco de Chile, Fin- CEN Assessment of Civil Money Penalty, Oct. 12, 2005 (hereinafter FinCEN BC Settlement ). The factual discussion below of the Banco de Chile matter is derived from this document. 18 Jim Wyss, U.S. Fines Chilean Bank, THE MIAMI HERALD, Oct. 14, 2005, at C3. 19 FinCEN BC Settlement at Id. 21 In December 2005, Israel Discount Bank of New York ( IDBNY ), a wholly owned subsidiary of Tel Aviv-based Israel Discount Bank, Ltd., agreed to pay up to $25 million to settle allegations of deficient AML controls stemming from an investigation by New York state law enforcement and banking officials. The IDBNY case is discussed in more detail below. March 2006 Page 21

6 ecutors broad jurisdiction, and as evidenced by the enforcement actions brought in 2005, they often are aggressive in asserting it. Any transaction touching in any way on the U.S. will be subject to scrutiny. To achieve the requisite level of compliance, senior management at a foreign institution s headquarters must emphasize that compliance with U.S. law is mandatory and ensure appropriate policies and training to achieve that compliance. Leadership from the top is critical both to set the tone for the organization and to ensure that personnel outside the U.S. understand the need to comply with U.S. law. Even conduct overseas can cause major problems in the U.S. The ABN AMRO case makes this point clear, as the special procedures used by an ABN AMRO overseas branch to conceal the identities of its Iranian and Libyan customers caused the U.S. branches to engage in transactions with these customers in violation of U.S. law. Leadership of a non-u.s. institution that does business in the U.S. has an obligation to ensure that all of its branches understand and comply with U.S. law. Indeed, the ABN AMRO settlement obligates the bank to implement a compliance program to ensure that non- U.S. offices and affiliates do not engage in practices aimed at evading or circumventing ABN AMRO s compliance programs and controls in the United. States. 22 Other foreign banks operating in the United States would be well advised to take the same action. U.S. regulators have stated publicly that they are not particularly targeting foreign banks for enforcement actions. FinCEN Associate Director William Langford recently stated that his agency does not have an overarching concern that foreign banks operating in the U.S. are more likely to be deficient in their compliance. 23 Still, the 2005 cases demonstrate that foreign-based banks face substantial challenges in ensuring their global operations do not put their U.S. branches in violation of U.S. law. 2. There Has Been No Clear Trend To Criminalize BSA Enforcement. One trend that did not manifest itself in 2005 was the criminalization of BSA enforcement, which many bankers feared as 2004 drew to a close. The criminal prosecution 22 Federal Reserve ABN AMRO Cease & Desist Order at Damian Paletta, BSA Scrutiny at its Peak? Most Say No, AMERI- CAN BANKER, Dec. 29, of AmSouth Bank in October 2004, which resulted in a deferred prosecution agreement and a $40 million civil forfeiture for failure to report suspicious activity, had raised widespread concern that prosecutors would increasingly view the failure to file SARs as a criminal violation as opposed to a regulatory deficiency to be addressed by bank regulators and FinCEN. In light of the AmSouth Bank matter, even FinCEN Director William Fox expressed concern about the apparent trend to criminalize behavior designed to be governed by civil standards. 24 This trend did not materialize in Instead, BSA violations continued to be treated as regulatory offenses albeit with potentially serious and expensive consequences but still less severe than criminal prosecutions. Indeed, the most significant criminal BSA case of 2005 involving a major financial institution, the Bank of New York ( BONY ) matter, was primarily notable because it did not result in an indictment of the bank or even a deferred prosecution agreement. On November 8, 2005, BONY simultaneously resolved two long-standing criminal investigations by entering into a non-prosecution agreement with the United States Attorney s Offices for the Eastern and Southern Districts of New York. 25 The two cases were not related except that both concerned the BONY s failure to meet AML requirements. Although BONY avoided criminal indictment, it agreed to significant relief, including substantial monetary penalties and the implementation of a comprehensive AML program to be administered by an independent monitor. The first investigation concerned allegations investigated by the U.S. Attorney s Office for the Eastern District of New York that BONY: (a) aided and abetted the fraudulent activities of a third party, RW Professional Leasing Services Corp. ( PLS ) by executing sham escrow agreements that PLS presented to other banks in support of 24 See Douglas N. Greenburg, Stakes Raised for Banks: The Threat of Criminal Prosecution for Failing to Report Suspicious Activity, Rev. Banking and Fin. Services, February 2005 (quoting Statement of William Fox, ABA Conference, available at 25 Non-Prosecution Agreement Between The Bank of New York and the U.S. Attorney s Offices for the Eastern and Southern Districts of New York, Nov. 4, 2005 (hereinafter BONY Settlement ). The factual discussion below of the BONY matter is derived from this document. Page 22 March 2006

7 medical equipment loan applications; and (b) willfully failed to file a SAR in a timely and complete manner, and failed to notify law enforcement authorities of suspicious activities related to PLS and the escrow agreements. Specifically, government investigators concluded that from 1991 to 2002 branch managers and employees at BONY s Island Park Branch engaged in misleading and deceptive conduct by executing unauthorized, and materially false and misleading escrow agreements for PLS with reason to believe the escrow agreements would be presented to Bank Funding Institutions in support of lease financing applications. The government further concluded that from approximately February 2002 to June 2002, managers and senior executives in BONY s Legal, Audit, Retail Banking, and Commercial Banking Divisions became aware of the misconduct by PLS and a certain employee at the Island Park Branch but consciously failed to take the actions required to timely file a... SAR or timely notify law enforcement authorities. 26 The second investigation, conducted by the U.S. Attorney s Office for the Southern District of New York, concerned a scheme involving a BONY vice-president and her husband to move large amounts of suspect money on behalf of Russian nationals. Specifically, the government determined that in 1996 Peter Berlin, a Russian émigré, opened accounts at a retail branch of BONY in the names of Benex International Co., Inc. ( Benex ) and BECS International LLC ( BECS ). Berlin opened the accounts with the assistance of his wife, Lucy Edwards, who served as a BONY vice-president until she was terminated in August From February 1996 through July 1999, approximately $7 billion in deposits entered the Benex and BECS accounts. The deposits were made to the accounts in bulk cash on an almost daily basis and then transferred out by wire transfer to a large number of third-party transferees around the world. The government determined that Benex, BECS, and another affiliated company operated front companies on behalf of Depozitarno Klirgingovy Bank ( DKB ), a Russian bank, and principals of DKB. The Benex and BECS accounts were part of an underground money transfer business that was operated by DKB from Moscow, Russia and Queens, New York, without being licensed either as a money transmitting business, or a branch or agency of a 26 BONY Settlement, Exhibit A at 1. foreign bank as required by U.S. law. In February 2000, Berlin and Edwards pled guilty to, among other things, conspiracy to conduct unauthorized and unregulated banking activities, conspiracy to establish an unlicensed branch of a foreign bank in the United States, conspiracy to operate an illegal money transmitting business, and conspiracy to launder money to promote wire fraud, in connection with the operation of the Benex and BECS accounts at BONY. Berlin and Edwards admitted that the Benex and BECS accounts were used to launder money on behalf of persons in Russia. Not surprisingly, the government determined that during the period this misconduct was taking place, BONY did not have an effective AML program, did not fulfill its AML obligations with respect to the Benex and BECS accounts and, as an institution, did not pay sufficient attention to AML and compliance issues. The government also concluded that BONY: (1) failed to put in place an effective system for analyzing wire transfer activity by its customers for potential money laundering; (2) failed to conduct adequate due diligence on Benex and BECS to understand their true nature of business and the activity in their accounts; (3) failed to monitor or scrutinize the wire transfer activity in the Benex and BECS accounts from an AML perspective; and (4) failed to make any effort to determine whether the activity in the accounts required either a money transmitting license or a license to operate as a branch or agency of a foreign bank under New York or federal law. Although its problems were serious, BONY substantially improved its position with the government through extensive and long-standing cooperation. The government pointed out that, although some of BONY s initial responses to its investigation in 1998 were flawed, BONY fully cooperated with the investigation since April In addition, the government noted that BONY satisfied remedial measures specified in an agreement that BONY entered into with the Federal Reserve Bank of New York and the New York State Banking Department in February As a result of its cooperation with the government, BONY escaped indictment or even the increasingly common deferred prosecution agreement whereby prosecutors file criminal charges but agree to dismiss them at a certain point in the future if the defendant meets certain March 2006 Page 23

8 defined obligations. Here, prosecutors did not bring criminal charges against BONY deferred or otherwise. This relatively lenient treatment appears to have resulted from BONY s extensive cooperation. The bank hired a major law firm to conduct internal investigations of both the escrow agreements matter and the Benex/BECS matter, and shared the results of the investigations, including privileged material, with the United States Attorney s offices. Indeed, BONY explicitly acknowledged in its agreement with the government that its prior, ongoing, and future, cooperation are important factors in the [United States Attorney s Offices ] decision to enter into the Agreement. 27 Nevertheless, BONY s settlement called for the adoption of serious remedial measures on its part. BONY agreed that it accept[ed] and acknowledge[d] responsibility for the conduct of its employees that was the subject of the investigations. 28 BONY agreed to pay a total of $38 million; $12 million into a fund established to make restitution to institutions that suffered losses in reliance on the BONY escrow agreements, and $26 million in forfeiture. The agreement also provided that BONY would take a number of significant remedial steps, many of which focused on enhancing BONY s AML controls. The resolution of the BONY case and the lack of any major BSA prosecutions of banks in 2005 should help ease concerns about criminalization of the BSA. 29 Financial institutions should be aware, however, that the U.S. Department of Justice (the Justice Department ) remains willing to prosecute those institutions where it views BSA or related violations as serious and systemic. Indeed, as noted above, press reports indicate a criminal investigation of ABN AMRO is continuing, although its focus and ultimate disposition is unknown. To avoid Justice Department scrutiny, 27 BONY Settlement Id. 2, In another positive development for banks concerned about BSA prosecutions, the Justice Department promulgated a rule in July 2005 requiring the 93 United States Attorney s offices to obtain approval from Justice Department headquarters before bringing criminal charges, including deferred prosecution agreements, against any bank or certain other financial institutions. See U.S. Attorney s Manual Title This policy should reduce the likelihood that an overly aggressive prosecutor in a U.S. Attorney s office will bring a criminal BSA case without the broader perspective of the prosecutors responsible for coordinating the national AML strategy. financial institutions should develop effective compliance programs commensurate with the money laundering risks posed by their lines of business. In addition to addressing the specific requirements of the BSA and its implementing regulations, an effective compliance program should meet the Federal Sentencing Guidelines criteria for an Effective Compliance and Ethics Program. 30 An effective compliance program will not only help prevent violations but mitigate the consequences when they do occur. In addition, when serious compliance issues do arise, financial institutions should always consider the potential benefit of retaining experts to conduct a thorough internal investigation and cooperate with law enforcement by sharing the results of that investigation. BONY employed this strategy, and it appears to have been successful. 3. Non-Bank Financial Institutions Subject To The BSA Should Expect Increasing Scrutiny. The BSA s AML requirements extend not only to banks but to a wide variety of other institutions deemed financial institutions under federal law. Securities brokerdealers have been subject to these requirements since April Broker-dealer BSA compliance is subject to review by the industry self-regulatory organizations ( SROs ) (e.g., the New York Stock Exchange ( NYSE ) and the National Association of Securities Dealers ( NASD )), the Securities and Exchange Commission ( SEC ), FinCEN, and potentially the Justice Department. Over the past several years, the SEC and SROs have publicly stated that they are placing a priority on AML compliance in their examination programs. Still, until very recently, no significant enforcement action was brought against any major securities firm. On December 29, 2005, Oppenheimer & Co. ( Oppenheimer ) became the first major Wall Street firm to be sanctioned for violating the BSA. 31 Oppenheimer settled allegations that it failed to implement appropriate AML controls and consented to a finding by the NYSE that it violated various NYSE rules regarding AML compliance 30 U.S. Sentencing Guidelines Manual 8B2.1 (2005). 31 In the Matter of Oppenheimer & Co., FinCEN Assessment of Civil Money Penalty, Dec. 29, See also Oppenheimer & Co., Inc., Exchange Hearing Panel Decision , New York Stock Exchange, Inc., Dec. 29, The factual discussion below of the Oppenheimer matter is derived from these documents. Page 24 March 2006

9 programs, bookkeeping, and maintaining procedures for supervision and review. Without admitting or denying the allegations, Oppenheimer agreed to pay a $2.8 million fine to be divided equally between FinCEN and NYSE. FinCEN concluded that Oppenheimer had violated the BSA and the regulations promulgated thereunder in several ways. First, FinCEN alleged that Oppenheimer failed to develop an effective system of internal controls to ensure compliance with the BSA and its suspicious activity reporting requirements. FinCEN noted that between 2002 and 2004, wire activity at Oppenheimer was being reviewed manually by only one compliance employee. More significantly, FinCEN concluded that Oppenheimer s suspicious activity reporting mechanisms did not aggregate incoming or outgoing wire transfers by customer, account, branch office or destination, resulting in Oppenheimer s inability to fully capture its customers account movements. Oppenheimer also allegedly failed to collect customer information and complete new account forms for new customers. Second, FinCEN alleged Oppenheimer failed to develop an adequate system for independent testing of BSA compliance. Oppenheimer s internal audit reports failed to address higher risk activities between Oppenheimer s foreign and domestic branches, and an overlap between the audit department s auditing and AML compliance responsibilities undermined the independence of the AML function. Third, FinCEN alleged Oppenheimer failed to task a sufficient number of personnel to staff its BSA compliance function and failed to properly train personnel who had been so staffed. FinCEN noted that Oppenheimer had only two employees in its AML department (a BSA officer and an analyst), and that given Oppenheimer s 100 domestic and foreign branch offices serving 360,000 individual customers, this function was understaffed. Oppenheimer also failed to properly train employees critical to BSA compliance, such as margin department managers. Finally, FinCEN alleged that Oppenheimer failed to comply with the BSA s suspicious activity reporting requirements by failing to file several SARs, and that SARs that were filed were incomplete NYSE made consistent findings. NYSE concluded that Oppenheimer had failed to, among other things, establish an AML compliance program, keep proper books and records, adopt procedures to monitor transactions in foreign branches, and adopt an effective system of supervision, and review of its AML unit. The Oppenheimer case is surely not the last of the AML cases involving Wall Street firms. Indeed, press reports indicate that securities regulators have several other investigations well underway. Securities broker-dealers and the other financial institutions subject to the BSA s AML requirements are well advised to prepare for the type of scrutiny that banks have increasingly come to accept as a normal part of doing business. 4. State Regulators And Law Enforcement Will Play An Increasing Role In Enforcing Anti-Money Laundering Laws. Another trend that emerged in 2005 is the increasing role of state officials in the enforcement of regulation of financial institutions. Perhaps taking their cue from other regulatory areas, state banking officials increasingly are unwilling to sit on the sidelines and yield enforcement activity to federal regulators and law enforcement authorities. Instead, state officials are asserting themselves into the resolution of investigations or even leading investigations on their own. The most striking example of this trend is the case of Israel Discount Bank of New York ( IDBNY ), which entered into agreements with the District Attorney of New York County (the District Attorney ) and the Superintendent of Banks of the State of New York on December 15, The District Attorney had alleged that $2.2 billion in illegal Brazilian funds had been moved through IDBNY over a five-year period. This was not the first time that IDBNY had drawn interest from regulators, as in 2001 it was informed of deficiencies in its AML program. IDBNY accepted the findings of the District Attorney and agreed to pay a $8.5 million penalty. The District Attorney also concluded that IDBNY: (1) knew of deficiencies in its AML programs as early as 2001 but failed to remediate those deficiencies; (2) failed to properly identify the ownership and activities of certain foreign accounts; (3) failed to file SARs, and (4) failed to stop the flow of criminal proceeds into IDBNY accounts. According to the District Attorney, the bank may face additional Civil 33 Settlement and Cooperation Agreement Between The Israel Discount Bank of New York and the District Attorney of the County of New York, Dec. 15, See also In the Matter of Israel Discount Bank of New York, Order to Cease and Desist Pursuant to Section 39 of the New York Banking Law Issued Upon Consent, Superintendent of the Banks of the State of New York, Dec. 15, The factual discussion below of the IDBNY matter is derived from these documents. March 2006 Page 25

10 Money Penalties not to exceed $16.5 million in the aggregate to State Banking officials, the FDIC and FinCEN. IDBNY and the Superintendent of Banks of the State of New York also entered into an Order to Cease and Desist Issued Upon Consent on the same date. Pursuant to the order, IDBNY agreed to cease its violations of, among other things, the BSA and the USA PATRIOT Act. Specifically, IDBNY agreed to, among other things: (1) commission an independent review of its response to the 2001 inquiries regarding its AML program, (2) designate a BSA officer responsible for compliance with BSA and other AML regulations; (3) develop a system of internal controls to comply with the BSA; (4) establish an independent testing program for BSA compliance as well as additional training; (5) conduct a review of its accounts to determine whether its account-holders records were accurate; and (6) establish a compliance committee within its board of directors. However, the parties agreed that the order did not constitute an admission of wrongdoing or admission of any allegation made by the Superintendent of Banks of the State of New York. The IDBNY settlement is notable in that it arose out of a long-term money laundering investigation being conducted by New York County s District Attorney, rather than federal law enforcement authorities more traditionally thought of as taking the lead against money laundering. The New York Superintendent of Banks, which, with the FDIC, supervises IDBNY, joined with the District Attorney to impose remedial measures on the IDBNY. This case instructs that financial institutions must be concerned about investigations led by state law enforcement. Financial institutions should treat any such investigation as seriously as federal investigations, as either can result in serious sanctions on the institution. Another aspect of the trend towards greater involvement of state officials in AML compliance is state officials seeking to participate in the settlement of federal investigations. This situation occurred in the ABN AMRO case discussed above. There, an investigation led by federal authorities ultimately resulted in a $40 million federal penalty, and an additional $40 million in penalties imposed by New York and Illinois state banking officials. This result mirrors similar occurrences in other regulatory areas, such as securities and health care, where companies often find it difficult to settle a major federal investigation without having to pay substantial penalties to state officials as well. Finally, the possibility of additional state regulation took another twist in late December when New York State banking officials introduced a proposed rule which would require banks and other financial institutions operating in New York to submit certain types of SARs directly to the New York Banking Department s Director of Criminal investigations. Although state officials currently get access to SARs in some circumstances, a direct requirement to file SARs with state officials potentially opens institutions up to new liability with state officials. Indeed the proposed rule explicitly provides that failure to comply may result in commencement of appropriate enforcement proceedings by state banking officials. 34 Whether this rule is ultimately adopted and what impact it may have remains to be seen. 5. Money Laundering Remains An Area Of Continued Government Focus. The significant cases in 2005 demonstrate that federal and state regulators continued the trend to enforce vigorously U.S. AML laws, including the BSA and its SAR filing requirements. This trend is likely to continue into 2006 and beyond. There are a number of reasons for the government focus in this area. First, the post-9/11 concern about terrorists exploiting the financial system has concentrated government resources in the area. Although many doubts have been raised about the effectiveness of the BSA in addressing terrorist financing as opposed to money laundering many government officials believe the BSA plays an important role in the war on terrorism by denying known terrorists access to the financial system, deterring any large- scale terrorist fund-raising operations and providing a database with a wealth of detailed information that can be mined for use in a terrorism investigation. Second, law enforcement authorities have increasingly recognized that certain crimes often beyond the reach of U.S. officials, such as corruption overseas, can at least be partially addressed by detecting the proceeds of corruption if they pass through the U.S. financial systems. U.S. officials expect U.S. financial institutions to be the gatekeepers in preventing the U.S. financial system from being used to facilitate this illicit activity. Institutions that fail to take this role seriously through effective BSA compliance can expect to be scruti- 34 See Proposed New Part 302 of the Superintendent s Regulations (Reporting of Suspicious Transactions). The comment period on the new proposal ran through February 11, Page 26 March 2006

11 nized by the government. Third, the post 9/11 expansion of the types of institutions subject to the SAR requirements of the BSA brought new enforcement agencies, such as the NYSE and the SEC, more directly into the fight against money laundering. While it may have taken some time for these agencies to get up to speed, they are starting to get there now, and they will likely continue to bring more cases in the future. The Oppenheimer case is likely the tip of the iceberg in this regard. Finally, the sensational scandal at Riggs Bank in Washington in 2003 and 2004, and resulting congressional scrutiny of the bank regulators who failed to detect the problems there, appears to have had significant impact. With beefed-up enforcement staffs determined to not be the ones enduring congressional criticism in the future, bank regulators in conjunction with FinCEN have plainly taken a more aggressive approach in rooting out and punishing what they deem to be BSA compliance breakdowns. And, of course, regulators know that the Justice Department is looming out there as what some prosecutors refer to as regulator of last resort ready to step in where prosecutors see systemic AML breakdowns. As in other regulatory areas which have become subjects of criminal law enforcement focus, the threat of the Justice Department s entry to the playing field likely spurs the regulators to tougher and more aggressive action. 6. Financial Institution Boards And Senior Management Must Lead BSA Compliance And Investigation Of Compliance Breakdowns. In the current environment, the boards of directors and senior management of all financial institutions subject to U.S. jurisdiction must make BSA compliance a priority for their organizations. As the Comptroller of the Currency explained in a recent speech, it is absolutely necessary that banks have a firm commitment to BSA compliance that starts at the board and senior management level, and runs through all levels and departments of the institution. 35 Only such leadership from the top of the organization can ensure the requisite resources and management focus to ensure effective compliance with these requirements. Although officers and directors, of course, have a myriad of responsibilities, they cannot afford to ignore BSA compliance. A major BSA compliance breakdown can result in increasingly large fines, as the significant cases of 2005 make clear. The indirect costs from a major 35 John C. Dugan, Comptroller of the Currency, Remarks at the American Bankers Association / American Bar Association Money Laundering Enforcement Conference (Nov. 1, 2005). investigation can also be enormous, in terms of the legal, consulting, and other professional fees, and in lost management and employee time, and business disruption. Institutions that allow themselves to be used by criminals or terrorists also face serious reputation harm, and, potentially, lawsuits from the victims of the illicit activity. Indeed, victims of terrorism have increasingly sought to hold accountable the financial institutions purportedly involved in financing the terrorists who harmed them. 36 Although plaintiffs must overcome substantial legal and factual hurdles to prove such claims, the specter of these suits is something banks must take seriously. As shown in some of the major BSA-related settlements in 2005, the U.S. government plainly believes that compliance must be led from the top. For example, the enhanced U.S. Law Compliance Program adopted by ABN AMRO as part of its settlement with U.S. regulators explicitly requires high-level leadership involvement including the designation of a committee of ABN AMRO s Supervisory Board to oversee the program and review significant compliance incidents, and the designation of a high-ranking executive to be responsible for the U.S. compliance program. These requirements require direct involvement of the leadership of the international institution not just the U.S. leaders. Other financial institutions should take note and make sure their top leadership play an active role in ensuring compliance. In addition to ensuring appropriate attention to compliance, the leaders of financial institutions must take decisive action when problems do arise. The BONY case provides a good example. Although the bank experienced serious problems, it was able to mitigate the harm by hiring effective counsel to do a thorough investigation, cooperating with the government, and implementing serious remedial measures. Obviously, any investigation of a financial institution itself should become a top priority for the institution. In addition, any investigation of a bank employee or customer for illicit activity involving the bank should be grounds for concern and further investigation. Financial institution boards and senior management should ensure that their businesses adopt and implement appropriate procedures to ensure full compliance with the BSA and related laws and regulations. 36 See, e.g., Carrick Mollenkamp and Glenn R. Simpson, Carrick Mollenkamp and Glenn R. Simpson, Making Banks Accountable for Terror, The WALL STREET JOURNAL, Jan. 6, 2006, at C3. March 2006 Page 27