Drug Cartels As Foreign Terrorists: AML Spotlight

US President Donald Trump’s decision in January to classify drug cartels as foreign terrorist organizations and specially designated global terrorists has put anti-money laundering compliance executives at US financial institutions doing business in Latin America on high alert when it comes to their AML programs.

Based on the US Department of State including eight drug cartels on the FTO and SDGT lists in February, banks and broker-dealers are starting to pay closer attention to their customers, their customer’s customers, and business activities south of the border in reviewing their AML programs. If they don’t, they could face hefty regulatory, criminal, and civil penalties for any mistakes. Legal experts don’t expect a sea change in AML programs, but an extra focus on clients from Latin America, particularly Mexico.  “Financial firms that have already been implementing a risk-based AML program will be well-prepared,” says Andrew Lorentz, a partner with the law firm of Davis Wright Tremaine in Washington DC. “Those with weaker AML programs will need to review their procedures and technology.”

The Bank Secrecy Act requires banks and certain non-bank institutions to develop AML compliance programs that detect and prevent money-laundering and terrorist activities. The largest banks, broker-dealers and fund managers typically rely on a risk-based program which means they take into account the country of origin of the customer, its business line, and its supply chain to determine just how rigorously to monitor its activities. For small to mid-sized firms the common thought is that costs of building and maintaining such programs may be cost-prohibitive. Hence, hence they could be prone to more errors. However, even the largest financial institutions can make a mistake based on the high volume of customers and transactions.

The designation of cartels as FTOs was considered under President Trump’s first term in office but never came to pass because of concerns over potential harm to US-Mexico relations. Issued on January 20, President Trump’s executive order required the US Secretary of State in consultation with the Attorney General and Secretary of Homeland Security to designate transnational criminal groups as FTOs and SDGTs. The following month US Secretary of State Marco Rubio announced the designation of Tren de Aragua, Mara Salvatrucha, Cartel de Sinaloa, Cartel del Noreste, La Nueva Familia Michoacana, Cartel del Golfo, and Cartel Unidos as FTOs and SDGTs. Of the eight organizations, Carteles Unidos is the only one not on other sanctions lists. As a result, AML professionals are likely to already be on alert to prevent any business transactions with the first seven and must just add Carteles Unidos to their oversight.

The FTO and SDGT labels are unusual because a terrorist organization designation is normally reserved for groups, like Al-Qaida, that use violence for political gain rather than for money-focused crime risks such as cartels. The categorization gives the US government more ammunition to go after those it considers responsible for the US drug epidemic by cutting off their financing. “The FTO designation increases the legal peril to any person or entity that knowingly engages with the designated entity and puts a premium on due diligence,” says Steve Ganis, an attorney with the law firm of Mintz in Boston specializing in AML regulations. Financial firms offering “material support” to FTOs and SDGTs may face criminal and civil charges, in addition to regulatory penalties. They could pay up to twice the value of the illegal transaction, with individuals sent to prison for up to 20 years. Financial firms could also be sued by US nationals or their families harmed by the FTOs and SDGTs. Even if they don’t win, the reputational damage is staggering.

The AML compliance executives at US banks and broker-dealers who spoke with FinOps Report on condition of anonymity acknowledge they may allocate additional resources — meaning extra AML analysts — to reviewing customer on-boarding procedures and any fund transfers to Latin America. “Thresholds for transaction monitoring systems could be lowered and customer accounts could be reviewed more frequently after onboarding,” says an AML manager at an East Coast bank. “Beneficial ownership of possible corporate accounts will also need to be more closely verified to avoid any affiliation with cartels on the FTO and SDGT lists.”

Making the AML review process more cumbersome is that financial firms will have to “look-back on their existing clients and historical transaction reports to refresh their risk ratings. They can’t perform due diligence only on new business. None of the executives who spoke with FinOps Report would provide specifics on any change in the dollar value of transaction monitoring thresholds or frequency, but they acknowledge that the problem with tweaking thresholds or frequency of reviewing fund transfers is the potential for a higher number of “false positives” which will require further human research. Transaction monitoring technology has advanced with the help of artificial intelligence to become more real-time and to reduce the number of false positives, but that doesn’t provide AML executives with much comfort. “We will likely still have more alerts to investigate,” insists an AML manager at an East Coast bank who spoke with Finops Report.

Yet another possible ramification from the inclusion of eight new names on the FTO and SDGT lists, predicted by some AML managers, is an increase in suspicious activity reports (SARs) designed to alert law enforcement about the possibility of a criminal act. “Defensive reporting” is often done to avoid regulatory penalties. The Financial Crimes Enforcement Network, the unit of the US Department of Treasury responsible for enforcing AML oversight, won’t fine a firm for filing too many SARs. However, FinCEN could fine a firm for not filing enough.

Keeping track of material support won’t be easy. The first is understanding what offering the support “knowingly” actually means and the second is defining the term “material.”  It is unclear to AML compliance managers who spoke with FinOps Report how the premise of “knowingly” could be made. “The question is whether the litmus test for showing intent would be exceedingly high or whether simple negligence, as in overlooking red flags would be enough,” bemoans one AML manager at a West Coast bank.

The term “material support” also doesn’t reflect the value of a transaction but its purpose. That purpose could apply to a broad range of categories such as financial services, transportation, lodging and expert advice. “There are no hard and fast rules on finding red flags for material support and financial services affected include payments, custody, correspondent banking, and brokerage.” explains Hdeel Abdelhady, a principal at MassPoint PLLC, a Washington,D.C.-based legal and strategy firm for international trade and sanctions.”Given that drug cartels are so enmeshed in Latin American countries, a ransom payment or protection payments to a cartel to stay in business could be construed as material help.” Pleading duress might not get a financial firm off the hook.

Performing due diligence to avoid material support when it comes to correspondent banking and brokerage accounts is more difficult than for direct clients because the cooperation of other financial institutions is needed. A US bank may not be able to find out the ultimate beneficial ownership of any company sending funds located in the other country or even a third country if a foreign bank has an account with the US bank. US banks and broker-dealers acting as brokers for investors from other countries in the US securities market may face similar challenges.

Due diligence is about more than just trying to match whether the name of a customer or recipient of funds is on an FTO list. “Cartels don’t operate under their own names,” says Ganis. “Instead, they work through agents, nominees, fronts, and shell companies so merely screening transaction data for cartel names to find material financial support may prove inadequate.”  When onboarding a company in a high-risk businesses or jurisdiction as a customer, a financial firm will need to figure out whether anyone affiliated with a cartel owns or controls the company. Adverse media services, says Ganis, might help determine whether the company or its related individuals have links to a cartel. Among the most popular adverse media services are LexisNexis Solutions, Moody’s Analytics, and ComplyAdvantage.

Once the client onboarding and risk categorization process is completed, keeping track of the supply chain in possible drug production and transport will become critical to preventing material support. “The new requirement for assessing AML process risk will mandate that financial firms analyze the risks of their customers’ distribution channels and intermediaries,” says DWT’s Lorentz who co-chairs the law firm’s financial practice. In a recent article the law firm of DLA Piper suggests heightened transaction monitoring procedures for customers involved in shipping petroleum products or precursor chemicals for fentanyl or those who purchase such manufacturing products directly from China-based suppliers or indirectly through intermediary chemical brokers. One of Cartel de Sinaloa’s most lucrative businesses in recent years has been the production of fentanyl, blamed for tens of thousands of overdose deaths each year in the United States. Sinaloa imports the precursor chemicals from China, then produces the drug and smuggles it across the border.

AML staff at financial firms will ultimately need to be better trained in knowing the signs of potential drug trafficking when opening a client account or monitoring transactions. They  must also be free to act to prevent wrongdoing by their firms because the designation of cartels as FTOs could lead to a surge in whistleblowers, predict attorneys specializing in whistleblowers. In 2023 Congress strengthened the whistleblower rewards program based on the Anti-Money Laundering Act of 2020 to include rewarding those disclosing original information on sanctions violations to their companies, the Secretary of the Treasury, or the Attorney General anywhere from 10 percent to 30 percent of collected penalties exceeding US$1 million.

Several of the AML executives who spoke with FinOps Report acknowledge they have been advised by their legal counsel to review their whistleblower procedures to ensure that compliance departments don’t turn a blind eye to any spoken or written concerns. “Making an unintentional mistake is dumb, but not listening to warnings is even dumber,” says one AML manager at a US bank. “It’s a disaster waiting to happen.”