On Monday, March 29, 2021, the Division of Examinations (“EXAMS”) of the U.S. Securities and Exchange Commission (“SEC”) issued a Risk Alert on “Compliance Issues Related to Suspicious Activity Monitoring and Reporting at Broker-Dealers.” EXAMS is concerned that broker/dealers and mutual funds are failing to meet their obligations as “financial institutions” subject to monitor and report to the Financial Crimes Enforcement Network (“FinCEN”) Division of the U.S. Treasury activities that are “suspicious.” As the Risk Alert states, anti-money laundering (“AML”) “compliance is critically important to helping the Commission and law enforcement pursue misconduct that could threaten the safety of investor assets and the integrity of the financial markets.” For a more in-depth discussion of AML issues see my January 12, 2021, blog post, “In Defense of the Realm: The NDAA, Money Laundering, and Terrorist Financing.”
The SEC Warns Broker/Dealers on AML
The failures noted in the Risk Alert depict an industry focused on earning commissions and neglectful of its AML obligations. Some of the shortcomings are as follows:
- Inadequate policies and procedures to detect suspicious activities, including failure to detail “red flags” that would aid in identifying potentially violative activities
- Failure to have automated systems to monitor and report suspicious activities involving large volume trading (see my January 14, 2021, blog post, “Taming the Elephants: SEC Jumbo Trader Risk Alert”)
- Failure to have automated monitoring of trading in stocks priced between $1 and $5 per share, even though they have long been regarded as “penny stocks” subject to fraudulent sales activity
- Using trading amounts higher than the $5,000 threshold for filing Suspicious Activity Reports (“SARs”)
- “Allowing” clearing firms and/or introducing firms, rather than the broker/dealer itself, to identify and report suspicious activities
- Failure to explain why no SAR was filed when activity seemed to call for one
- Failure to have procedures to identify “red flag” activities, such as deposits and immediate liquidation of low-priced securities.
- Allowing trading in “penny stocks” when the firm’s policies and procedures prohibited that
- Inadequately filling out SARs (often using “generic boilerplate”) obscuring the facts about the activity that triggered filing the SAR in the first place
- Not reporting customers trading large volumes of multiple issuers, or trading with sudden price spikes and/or the majority of a daily trading volume in low-priced securities
- Allowing trading in the stock of shell companies or of issuers subject to trading suspensions
- Accepting customers with criminal or regulatory histories
- Allowing trading in stocks of companies subject to over-the-counter quotation system warnings (see also my October 29, 2020, blog post, “Keeping Securities Disclosures in the Pink: Amendments to SEC Rule 15c2-11”)
- Failure to take into account publicly available information when evaluating activity in customer accounts
Red Flags and SARs
Broker/dealers are required to meet their AML obligations pursuant to SEC Rule 17a-8 under the Securities Exchange Act of 1934, as amended. Failures to comply can and have led to enforcement actions, which may include enhanced procedural obligations, or even suspension or loss of licensure, in addition to financial penalties. See SEC v. Alpine Securities Corp., 982 F. 3rd 68 (2d Cir. 2020). Further, the AML reporting standard is: if the broker/dealer “knows, suspects, or has reason to suspect” suspicious activity, the broker/dealer is obligated to file a SAR.
This Risk Alert is a “RED FLAG” warning to broker/dealers. They dare not trust that any adverse financial consequences for failure are “just a cost of doing business,” lest they find that they no longer have a business.