Anti-money laundering compliance managers at US clearing brokers will need to take a closer look at their process for when they file suspicious activity reports and what they say in light of a recent court ruling involving penny-stock clearing broker Alpine Securities.
In granting summary judgment in favor of the US Securities and Exchange Commission’s ruling against Salt-Lake City based firm, Judge Denise Cote of the Southern District of New York last month agreed with the agency’s prescriptive guidelines for when a SAR should be filed and what type of information must be included in the narrative section. Financial firms including clearing brokers, can’t be robo-filers when it comes to completing suspicious activity reports (SARs) for possible anti-money laundering violations. Neither can financial firms be too brief when it comes to explaining why a SAR was filed in the first place. Quality trumps quantity.
The SEC’s case against Alpine Securities dates back to 2017 when the regulatory agency alleged that Alpine Securities violated Rule 17a-8 of the Securities Exchange Act of 1934, which requires broker-dealers to report potentially illegal trading activities under the Bank Secrecy Act of 1970. The SEC said that Alpine Securities either omitted from more than 1,500 SARs required information on the rationale for filing the SARs, failed to file SARs to report suspicious sales following large deposits of low-priced securities, or filed late SARs.
Judge Cote agreed and can now decide how much Alpine Securities should pay the SEC in penalties. If the SEC has its way that figure could be far higher amount based on a violation of the Securities Exchange Act of 1934 rather than a violation of the BSA. However, the fine might not come any time soon. Alpine Securities apparently wants to keep on fighting, despite the fact it faces an uphill battle.
“Alpine Securities views Judge Cote’s ruling as deeply concerning on many levels including the court’s construction of hard and fast rules for SAR filings, contrary to the consistent statements of the Financial Crimes Enforcement Network [FinCEN] that such filings are inherently subjective and requires firms to make judgment calls,” says Alpine Securities in a statement to FinOps Report. “Alpine intends to appeal the ruling and looks forward to having these issues, including whether the SEC has jurisdiction to pursue enforcement action, under the BSA, considered by the Second Circuit.”
FinCEN, a unit of the US Treasury, accepts SARs to draw its own conclusion about wrongdoing and sometimes passes along its enforcement recommendations to other agencies to execute. The SEC has been increasingly active in fining brokers for alleged AML failures under the BSA even though its authority to do so has never been established either by statute or an appellate court. Past enforcement actions also appear to have been focused on blatant lapses in filing SARs rather than the actual content of the SARs.
Judge Cote agreed with the SEC that Alpine Securities’ language in explaining its rationale for filing SARs was too repetitive and boilerplate. She said that Alpine missed the basics and should have included verbiage in its narrative about one or more red flags. Judge Cote also agreed with the standards the SEC set as to when SARs should have been filed which are far more specific than Alpine believed was required under its interpretation of the BSA. The rationale for when to file a SAR involving penny stock, Judge Cote says can be objective, such as whether underlying transactions involve a large deposit of low-priced securities (LPS) or whether they indicate one of six red flags such as being conducted through a shell company or foreign entity.
AML compliance managers at some US clearing brokers tell FinOps Report they are worried that Judge Cote’s ruling leaves them with no room for judgment when it comes to when to file a SAR. What’s more anything they write could easily become second-guessed by the SEC on the grounds it was not detailed enough. So far, AML compliance managers they have been relying on guidance from FinCEN, which is subjective rather than prescriptive.
Clearing brokers and other financial firms typically have anti-money laundering (AML) compliance departments that are responsible for setting customer onboarding requirements and monitoring subsequent transactions. Any activity which might be perceived as falling outside the norm based on pre-established rules and thresholds set in transaction monitoring systems are investigated. If the client’s explanation is legit or another legit reason is uncovered the case is typically closed. Otherwise, it usually gets escalated to a senior level AML compliance director who can ultimately decide whether a SAR must be filed with FinCEN and what information to include on the paperwork. The SEC then receives a copy of the SAR.
“What the case against Alpine Securities highlights is the need for clearing brokers to have more vigorous oversight of trading activities involving penny stocks,” says Peter Hardy, a partner specializing in white collar crime iwith the law firm of Ballard Spahr in Philadelphia.”The case also provides clearing brokers with some standards on when to file SARs and how to defend their decisions.”
What’s wrong with using boilerplate language in narratives? “The SEC isn’t satisfied with a firm randomly filing lots of SARs for the sake of appearing to meet regulatory compliance,” warns Hardy. “The SEC wants to understand the circumstances and thought process the financial firm used to come up with its decision.”
AML compliance managers at US clearing firms tell FinOps Report that they do their best to provide as much information as possible in the narrative section, but they acknowledge they don’t give it a second thought. Instead, they are far more concerned about whether they have filed a SAR in the first place, because they believe that FinCEN will further investigate the allegations.
In cracking down on fraud in the microcap market, the SEC has unjustly usurped FinCEN’s authority, say some AML compliance managers at US broker-dealers and clearing brokers. But that’s not what Judge Cote thinks. She disputed Alpine Securities’ argument that only the US Treasury or the Department of Justice has the right to enforce the BSA. “The SEC has its own independent authority to require broker-dealers to make reports and has enforcement authority over those broker-dealer reporting obligations,” says Judge Cote. That means that the SEC’s authority to require broker-dealer reporting incorporates BSA reporting.
Judge Cote rejected Alpine Securities’ other argument that the standard set in the BSA for the filing of SAR as “reason to suspect” criminal activity should be interpreted in the same manner as the standard of “reasonable suspicion” under the Fourth Amendment of the US Constitution. Alpine Securities’ use of a standard applicable in criminal law for seizures doesn’t hold water, because broker-dealers don’t have to make any findings of wrondoing before filing SARs. The SEC’s proposed litmus test for filing SARs, says Judge Cote, is valid because the market for LPS is vulnerable to securities fraud and market schemes which depend on the deposit of a large amount of securities with the broker-dealer.
Had Alpine Securities crossed its Ts and dotted its Is on its SARs to the SEC’s liking would it have been off the hook? Maybe not. Neither Judge Cote nor the SEC give any guidance on whether clearing brokers involved in penny stocks should continue to do business with clients they suspect could be involved in criminal activities based on the volume of SARs filed. Most of the SARs at the center of the case involving Alpine Securities were originated by an introducing brokerage owned by the same principals. Therefore, some legal experts argue that the SEC could have still ruled against Alpine Securities.
“It is entirely possible that had Alpine convinced the SEC that it had filed all the required SARs in a timely fashion and with sufficient narrative information and supporting documentation, that the SEC might have taken the position that Alpine Securities should have stopped doing business with at least some of its customers that routinely were generating multiple SARs,” says Hardy. Therefore, by Alpine Securities not doing so, he reasons, the SEC could have decided that the firm violated the BSA.
Such a possibility has clearing brokers in penny stock on edge. Based on Judge Cote’s ruling on when to file a SAR, they might have to file far more SARs than is currently the case, they tell FinOps Report. Does that then mean that clearing brokers must automatically presume their clients were engaged in wrongdoing and terminate the relationship? Clearing brokers aren’t certain.
To some AML compliance specialists, the case involving Alpine Securities at the very least sends one additional clear message beyond the need to pay attention to the SEC’s prescriptive rules. That message is that when you are warned about your AML practices you had better fix whatever is wrong quickly or you will face even worse consequences. Alpine was repeatedly admonished for SAR deficiencies before 2017. “Alpine didn’t put processes and procedures in place needed to satisfy is regulatory burden and it should have acted a lot sooner,” says Douglas Wilbert, managing director of the risk and compliance practice for global consultancy Protiviti in New York.
In defending itself, Alpine Securities noted that the violations at the heart of the SEC’s case were historical and insisted it had since fixed its shortcomings. Such an argument might carry weight with FinCEN in mitigating any potential fine, but it didn’t faze Judge Cote. She would only agree that the infractions were historical.