Broker-Dealer Alert: Filing Suspicious Activity Reports Could Get Harder

Anti-money laundering analysts and compliance managers at US broker-dealers may need to work a lot harder and worry a lot more before filing suspicious activity reports if Alpine Securities, a US penny stockbroker, loses its appeal to the Supreme Court over whether the Securities and Exchange Commission has the right to enforce the Bank Secrecy Act (BSA).

Alpine’s petition to the Supreme Court in July is the latest chapter in a saga starting in 2017 when the SEC started enforcement action against Alpine in US District Court for the Southern District of New York by intertwining the requirements of the Securities Exchange Act of 1934 with the BSA of 1970. The SEC alleged Alpine did not file some SARs, filed some SARs incorrectly, and filed some SARs late between 2011 and 2014. Therefore, Alpine violated the reporting and recordkeeping requirements of the Exchange Act by violating the BSA. Financial firms are required, under the BSA, to file SARs to the US Treasury’s Financial Crimes Enforcement Network (FinCEN) each time they think a customer’s activity looks suspicious– the transaction has no business or apparent lawful purpose or deviates from the customer’s common practice for no good reason. It is up to FinCEN to further investigate and notify law enforcement, if necessary.

The BSA establishes AML program requirements for broker-dealers and other financial firms while the Exchange Act sets reporting, recordkeeping, and record retention obligations. Until recently, the SEC would fine broker-dealers only if they did not file SARs for an extended period. In the case involving Alpine, the SEC went a step further and questioned the content of Alpine’s SARs rather than the number filed. Alpine certainly filed plenty of SARs– over 4,000 during the time evaluated.

Alpine is the first broker-dealer to legally challenge the SEC’s jurisdiction, saying it does not have the right to enforce the BSA by using a violation of the Exchange Act as an excuse. The Salt Lake City, Utah-based Alpine, lost its case in the US District Court and a subsequent appeal of the district court’s decision to the US Second Circuit Court of Appeals. The circuit court in December 2020 agreed with the New York district court’s 2018 ruling that Alpine had to pay the SEC a fine of US$12 million. The SEC had initially asked the New York district court to impose a fine of US$24 million, suggesting the figure was generous because it could have asked for a US$100 million penalty based on Alpine’s violations of the Exchange Act. Alpine countered that a fine of between US$100,000 to US$700,000 would be more reasonable based on comparable or more egregious cases. New York District Court Judge Denise Cote agreed to a fine of US$12 million.

Should the Supreme Court decide to review Alpine’s petition, the broker-dealer would not have to continue making payments to the SEC until the Supreme Court reaches a final decision. If the Supreme Court rules in Alpine’s favor, the SEC would be forced to refund Alpine the partial payment it has made towards the US$12 million fine so far. If the Supreme Court chooses to either not accept the case or rule against Alpine, the broker-dealer’s US$12 million fine would stand and so would the interpretation of the lower courts on how broker-dealers must file SARs. That interpretation is far stricter and more expensive to follow than FinCEN’s, bemoan some broker-dealer AML compliance managers who spoke with FinOps Report.

Broker-dealers do their best to complete as many SARs as possible in a limited time and don’t give them a second thought after they are filed. They worry that unless the Supreme Court overturns the Circuit Court’s decision, broker-dealers will need to spend far more time researching their customers’ activities and writing SARs. As Alpine notes in its petition to the Supreme Court, the SEC will be a more punitive than FinCEN when enforcing violations of AML regulations and has a lower standard to meet. Under the BSA, FinCEN can impose only a monetary penalty and must prove at least negligence. Under the Exchange Act, the SEC can impose exponentially higher financial fines than FinCEN for “strict liability,” without any evidence of the broker-dealer’s culpable state of mind. The SEC can also resort to administrative sanctions, such as revoking a broker-dealer’s license or barring its association with any firm in the securities industry.

Both the Southern District Court of New York and the Second Circuit Court of Appeals ruled that the SEC had the authority to fine Alpine, because broker-dealers must adhere to the BSA to comply with the Exchange Act. That adherence does not mean that the SEC is enforcing the BSA, the lower courts explained. What’s more, writes New York District Court Judge Denise Cote, neither the Exchange Act nor the BSA preclude the SEC and FinCEN from jointly fining broker-dealers over deficiencies in their filing of SARs.

In its petition to the Supreme Court, Alpine counters that the lower courts’ rulings contradict Congress’ intent of having the US Treasury’s FinCEN unit exclusively address compliance with the BSA. The broker-dealer says that the SEC erroneously enforced the BSA, rather than only the Exchange Act, when it fined Alpine. “In allowing the SEC to enforce the BSA under the guise of books-and-records powers from a separate statute, the Secon Circuit flouted Congress’s decision to assign enforcement powers to Treasury and create a consistent remedial scheme for BSA violations,” writes Alpine in its petition. “The Exchange Act does not authorize the SEC to enforce the BSA or follow the Treasury’s SAR regulations promulgated under the BSA.” The broker-dealer cites a Supreme Court decision that a suit which seeks remedies — or fines– for violating one statute is enforcing a second statute if the fines are based on enforcing the second statute. Alpine is hoping the Supreme Court will follow a decision it made in 2020 in the case of Liu v. SEC to rein in the SEC when the regulatory agency overreached the authority given by Congress. In that decision the Supreme Court limited the SEC’s power to ask courts to issue disgorgement orders, which require wrongdoers to give up money gathered illegally.

Two former FinCEN directors and the Cato Institute, a Washington D.C.-based libertarian think tank, have sent the Supreme Court letters supporting Alpine’s rationale that the SEC has no place enforcing the BSA. In their joint amicus brief, James Freis Jr., a former director of FinCEN and Charles Steele, a former deputy director of FinCEN, acknowledge that FinCEN has limited resources to monitor and examine every financial firm for AML violations, so it allows other regulatory agencies to review AML compliance. However, the delegating responsibilities doesn’t mean delegating enforcement. “The Second Circuit Court sidestepped the fact that FinCEN had not delegated its enforcement power to the SEC by holding that the SEC was exercising its private Exchange Act enforcement powers,” write Freis and Steele in their brief to the Supreme Court. They believe the SEC will do more harm than good by enforcing the BSA, because when broker-dealers are wary of the SEC’s more punitive penalties than FinCEN’s they will file more SARs than necessary to avoid the SEC unreasonably second-guessing their decisions. When financial firms file too many SARs, FinCEN will have a hard time “extracting useful intelligence” for law enforcement to do its job and national security will suffer, argue Freis and Steele. Freis is now the founder of consulting firm Market Integrity Solutions and Steele is a partner in the forensic accounting and regulatory compliance firms of FRA in Washington, DC.

Although the amicus briefs filed by FinCEN’s former directors and Cato Institute will certainly help Alpine’s cause, some legal experts still question whether Alpine’s petition will be successful. Alpine’s citing of the Supreme Court’s 2020 decision to curtail the SEC’s authority is flawed, they believe. “The [Supreme Court’s] analysis in Liu does not map well here primarily because the issue in Liu was the SEC’s broad interpretation of remedies available to it, not whether the SEC had statutory authority to bring the enforcement action in the first place,” write Kevin Toomey and Daniel Hawke, partners in the law firm of Arnold & Porter in a recent blog. Other legal experts believe that the Supreme Court won’t want to change common practice when it comes to who interprets regulations, so broker-dealers need to accept the status quo. “Courts will typically back an agency’s interpretation of its statutes, unless proven wrong,” says Richard Marshall, a partner in the financial markets and fund practice at the law firm of Katten Muchin Rosenman in New York.

Whether Alpine correctly used FinCEN’s guidance when completing the narrative section of its SARs is one of the critical factors in the case against Alpine. The narrative section of a SAR is supposed to explain why the broker-dealer filed a SAR. Based on the ruling by New York Judge Denise Cote, who refused Alpine’s request for a jury trial, Alpine neglected to file some SARs and did a poor job writing the narrative section of the SARs it filed for two reasons: it omitted the five critical elements of who, what, when, where, why, and how of the suspicious activity of the customers involved and did not include information about some activities which were red flags for suspicious activities.

“In agreeing with the SEC, the district court came up with a set of activities it felt were red flags which aren’t necessarily indicative of any potential criminal behavior that should be included in a SAR,” Maranda,” Maranda Fritz, Alpine’s attorney tells FinOps Report. In short, because Alpine didn’t think the customer’s actions were suspicious it had no obligation to refer to these circumstances in the SARs. FinCEN, she argues, allows broker-dealers leeway to decide for themselves whether activities are suspicious; there are no prescriptive rules. However, based on Judge Cote’s interpretation of how SARs should be filed, there is no wiggle room. To prove her point, she cites FinCEN’s similar instructions in 2002 and 2012 on how firms should complete SARs and specific guidance in 2003 about how to write the narrative section of a SAR, which discussed the five critical elements.

In her opinion Judge Cote uses a September 2013 SAR filed by Alpine to highlight that it did not include all the five required elements, such as the basic customer information, that the deposit of physical stock certificates was significantly disproportionate to the average daily trading volume of the low-priced securities and that a subaccount holder is foreign. That SAR was sent to FinCEN a year after the broker-dealer watchdog Financial Industry Regulatory Authority warned Alpine that the narrative sections of 823 SARs it filed from March 2011 to January 2012 were inadequate. Judge Cote also cites the findings of the SEC’s 2014 exam of Alpine that 52 percent of the 253 SARs evaluated which Alpine filed in 2013 and 2014 did not include mention of red flags which FinCEN cited in its 2003 guidance as being important. Those red flags are a customer’s civil, regulatory, or criminal history; foreign involvement with the transactions; concerns about an issuer’s stock promotion activity; and that an issuer had been a shell company.

“Broker-dealers should anticipate that the lower court decisions ensure the SEC won’t back down from its position and should prepare accordingly.” cautions Robertson Park, a partner in the white collar defense, investigations, and compliance counseling practice of the law firm of Murphy & McGonigle in Washington, D.C. “They can’t take their feet off the pedals, because the SEC will continue its heightened interest in enforcing AML compliance.” That means broker-dealers will need to evaluate whether they are following FinCEN’s guidance about the content of SARs to the letter and consider adding more eyes to the review process before filing a SAR. “Broker-dealers are subject to both FinCEN and SEC AML regulations and must know what the red flags are,” adds Aegis Frumento, a partner in the law firm of Stern Tannenbaum & Bell in New York. Large broker-dealers with big AML departments might not have to worry, but small to mid-tier ones may have to beef up their capabilities.

Debra Geister, chief executive officer of Section 2 Financial Intelligence Solutions, a New London, Minnesota-based AML consultancy recommends that broker-dealers create a clear policy for how they will define unusual business activity and determine when that activity rises to the level of  suspicious activity. “The definitions [of unusual business activity] should include the red flags explained by FinCEN and other potential risk scenarios that emerge from a risk assessment such as mirror trading and other activities specific to the business, geographies and  clients served.” Without such definitions and criteria for when activities become reportable, subjectivity kicks in and decisions can become inconsistent.  Broker-dealers also need to conduct independent reviews and audits of SARs to determine any gaps which will allow them to create additional operational controls to mitigate the potential for multi-million dollar regulatory penalties, says Geister.

So far, the SEC is operating on the premise that it is in the right and is using the New York district court and Second Circuit court opinions to prove its point. In May 2021, the SEC fined GWFS Equities US$1.5 million also on the grounds of not filing SARs correctly. GWFS, a Colorado-based broker-dealer and large recordkeeping retirement service provider did not file 130 SARs and did not include five critical elements in the narrative section of 300 SARs filed from September 2015 to October 2018. Instead GWFS used boilerplate language that was not specific enough about attempted cybersecurity breaches. For these SARs, says the SEC, GWFS did not include persons, phone numbers, URL addresses and IP addresses. GWFS disclosed only that an unauthorized person had accessed a plan participant account and omitted any details about the bad actor or bad actions. Because GWFS did not file some SARs and did not include critical information in the SARs it filed, law enforcement couldn’t do its job, says the SEC.

“It may be a long shot for the Supreme Court to take the [Alpine Securities] case,” conclude Toomey and Hawke of Arnold & Porter in their blog. “But given the suspicious activity reporting standards and expectations established in the Alpine action, combined with the SEC’s continued prioritization of broker-dealer anti-money laundering compliance, broker-dealers will be eagerly awaiting the Court’s decision.”

For some AML analysts and compliance managers, should the SEC’s stance stand, a change in workflow and additional staff could be needed. The Supreme Court’s decision might even influence to which agency they will report a potential violation of AML regulations. If the SEC’s stance in enforcing AML regulations is allowed to stand, AML whistleblowers may be swayed to reach out to the SEC instead of FinCEN because a minimum potential payout from the SEC is better than an uncertain payment from the Treasury. After all, there is no guarantee they will be paid by either agency. “AML whistleblowers have the highest chance of getting paid by FinCEN than the SEC, but there are some weaknesses to the whistleblower program under the new Anti-Money Laundering Act (AMLA) that need to be addressed, including the lack of a minimum award percentage and the lack of a reliable funding mechanism to pay whistleblower awards,” says Jason Zuckerman, an attorney with Zuckerman Law in Washington, D.C. representing whistleblowers. Hidden in the US National Defense Authorization Act of 2020, the AMLA is designed to incentivize employees at financial firms to report violations of the BSA. A tipster can collect 30 percent of the value of a fine a financial firm pays if the fine is over US$1 million. However, the Treasury can also pay whatever it wants and there is no minimum amount. By contrast, the SEC can award a minimum of 10 percent of what it nabs as a penalty.