Where the Buck Stops: FINRA Fines BBH and Anti-Money Laundering Director

Absolute personal responsibility with little to no authority.

That’s how anti-money laundering specialists at some of the world’s largest banks summarize the job description of Brown Brothers Harriman’s global director of anti-money laundering (AML) activities.

Besides a hefty fine to be paid by BBH in a settlement, Harold (Hal) Crawford will pay US$25,000 to the US Financial Industry Regulatory Authority (FINRA). FINRA’s charge against BBH and Crawford: poor oversight of the bank’s legally required AML procedures.

Ten AML compliance specialists who spoke with FinOps Report about Crawford’s scenario say it’s all too common. Granted, they may be C-level executives, but their recommendations are often overridden by senior-level management — the chief executive officer and chief financial officer — wanting a short-term financial gain or to save money. Even trading desks can sometimes have more clout.

They shouldn’t. Had BBH done the minimum and listened to the advice given by Crawford three years ago to immediately stop doing penny stock business with questionable foreign investors and set more rigorous policies — the crux of FINRA’s case against the firm and Crawford — BBH might not be in the mess it’s in right now. Neither would Crawford.

In its settlement with BBH and Crawford, FINRA points to an ineffective AML program which failed to catch and report red flags. Regardless of whether or not Crawford had proper resources to work with or finally made the correct recommendations to his management, FINRA is holding him legally liable for his bank’s actions and inactions.

Crawford’s US$25,000 fine and one month’s suspension pales in comparison to the US$8 million the bank must now pay FINRA for a slew of charges — including allowing lots of trades in penny stocks to be executed or transferred on behalf of foreign individuals the bank shouldn’t have been doing business with in the first place. The fine is considered the largest ever imposed by FINRA on a US financial institution.

Trades involving a total of six billion shares in penny stocks were either executed by BBH or delivered as custodian to other brokerage firms from early 2009 to mid-2013. During that time, the penny stock business cited in the FINRA charges generated at least US$850 million in profits for the sellers of the assets. Of that figure, less than 20 percent was attributable to BBH acting as the executing broker. The rest came from BBH delivering the penny stock to other broker-dealers that FINRA never identifies.

FINRA never says how much BBH earned during the time period in question from either executing orders or doing “custody” transfers. However, its settlement document does say that the trade execution service was “ancilliary” to BBH’s custodial services.

What makes the case of BBH’s Crawford so troublesome for the compliance experts who spoke with FinOps on condition of anonymity is that Crawford did notify BBH’s management in late 2011 that it should no longer execute or transfer shares in penny stocks with suspect foreign customers it couldn’t identify. Crawford also made a solid attempt at setting up an AML oversight process to catch improper trading activity and to ensure that correct reports on any suspicious activity were filed.

But his efforts weren’t enough to satisfy FINRA and he was ultimately called to the carpet, along with BBH. “The AML program included suspicious activity surveillance, but the system failed to adequately monitor brokerage execution and custodial banking activity involving penny stock transactions, including delivery versus payment transactions,” writes FINRA.

In addition to a US$25,000 fine Crawford also took a month’s suspension. On the surface, that doesn’t sound too terrible, but to Crawford’s peers — many of whom were quick to praise his skillset to FinOps Report — it is no small matter. They repeatedly say they are “shocked” that Crawford is involved in a legal settlement and are even more worried that FINRA’s action sets a chilling precedent.

“It’s a scary scenario for us,” one AML compliance director at a New York brokerage says to FinOps Report. “FINRA is telling AML compliance directors they will be held accountable for the actions of their firm, even if they provided the correct written guidance.” said one. Agreed another, “They’ve turned us from advisors into policemen, but without the legal authority to do anything.”

Short of being a whistleblower to an oversight agency or quitting the job, AML directors are pretty constrained in what they can do once they have made the correct recommendations. Directors of AML programs are specifically trained — and licensed — to catch bad conduct or suspected bad conduct and report it. However, they answer to superiors in the C-level suite who may not want to violate any laws, but whose main goal is to ensure their organization is as profitable as possible. The two objectives don’t always overlap.

A playback of FINRA’s description of the events leading to its US$8 million fine for BBH and US$25,000 for Crawford shows that the fine and public embarrassment could easily have been avoided. For banks and AML experts looking to avoid this scenario, there are five basic steps they can use to keep themselves out of FINRA’s sights for enforcement, say AML specialists.

Customer identification: Banks have a tough call to make. Should they execute orders or even transfer securities on behalf of individuals they don’t know? Apparently, BBH’s senior management thought it was okay to do so until June 2013 when it stopped the practice.

“It’s a tight balancing act in managing risk,”explains Joseph Bognanno, director of AML product marketing for NICE Actimize, a financial crime and compliance software vendor. “There is never 100 percent safety in knowing just who the underlying customer is.”

A decision on whether or not to do business with a client depends first on whether or not the bank has sufficient information to identify the final underlying beneficial investor. If it doesn’t, it should then consider the type of asset, the type of trading activity and the amount of its exposure, says Bognanno. Taken in combination, the bank then comes up with a risk profile to justify the risk versus the return. Of course, such an analysis needs to be documented. “The bank may ultimately decide it’s worth the risk but it has to prove it understands the risk involved,” says Bognanno.

In the case of BBH, the trading took place in penny — or very low-priced stocks, typically under US$1 a share. Trading in such inexpensive securities is particularly worrisome to the Securities and Exchange Commission and US Treasury, which have repeatedly warned financial firms to be cautious. Fraudsters can falsely inflate trading volume and share prices, a violation of securities law and a precursor to money-laundering.

In the BBH case, there were omnibus accounts — accounts held in the name of  foreign financial intermediaries — from three known tax havens, Switzerland, Guernsey and Jersey. That alone should have been a big red flag. “BBH was obligated under federal law to investigate customer activity on a risk basis; omnibus accounts transacting in higher risk activity, such as suspicious stock transactions merited additional scrutiny,” writes FINRA in its settlement. FINRA itself has previously provided some guidance in how financial firms should track down beneficial owners of securities they can’t initially identify.

Organizational Commitment: This is the clear clincher in FINRA’s settlement with BBH, and it lends credence to Crawford’s supporters that he did his job as best as he could. When he and his colleagues realized the serious trouble BBH was in, he made a sound recommendation. ” In November 2011, the AML Compliance Group including Crawford recommended that BBH stop executing trades for penny stocks below a certain threshold value. It also recommended that BBH consider discontinuing its omnibus brokerage account structure and require clients who wished to offer brokerage to their underlying customers to set up a disclosed subaccount.”

In other words, Crawford advised the bank to force all of its foreign customers to reveal just who their individual clients were. The underlying clients could no longer hide behind the names of the foreign banks.

So what did BBH do? Either ignored or overruled Crawford and his team for quite some time. Either way, the AML team lost the argument. “The firm did not take any such step to limit its execution of penny stock transactions until June 2013,” according to FINRA.

FINRA never specifies who made the decision to continue the trading or stop it in mid-2013. Was it the trading desk’s decision, as some compliance specialists believe, or did the decision to ignore Crawford’s advice come from higher in the organization, as other compliance specialists tell FinOps? Either way, it appears that the AML team didn’t have sufficient internal authority to make its recommendation stick. In its settlement with FINRA, BBH also mentioned it plans to shut down its equity brokerage business completely in June 2014, which will have the benefit of eliminating AML-related trading risk. The motto better safe than sorry now applies.

The speculation among supporters of Crawford, a well-regarded AML specialist, is that he is falling on the sword for upper management. Of course, he still has a job at the bank. According to FINRA’s settlement, Crawford is working at a “bank affiliate” it didn’t identify. That might help his personal finances, but his resume will always carry the blemish of a FINRA fine and suspension.

BBH’s external public relations agency in New York would not provide detailed comment for this article beyond statements issued by the bank and Crawford. A receptionist answering BBH’s telephone in Boston confirms that Crawford works at 140 Broadway in New York City. Following bank policy, she could not disclose his specific title. Crawford has his own voice mail.

Training: In December 2010, says FINRA, BBH and Crawford implemented a reporting system to identify trading in penny stocks. But they didn’t establish written procedures for handling any reports generated until May 2011.

BBH also failed to provide the AML staff with the proper guidance for managing any alerts of suspicious activity. Those alerts included reports of trading ahead of market events, generated from a reporting module installed to the bank’s client transaction system in August 2011. Other reports on trade manipulation, based on  another module installed on the same client transaction system in May 2012, also weren’t followed up. Had AML staff done their job, says FINRA, they would have reviewed historical activity, contemporaneous market activity and relevant news developments once the alerts were generated.

Basic Procedures: Following up on red flags depends on knowing there are red flags. When it came to “custody movements” of the penny stock, BBH appears to have failed even more miserably than it did in executing orders. “The firm did not implement an “adequate system” to identify suspicious penny stock activity occurring through custody movements, including delivery-versus-payment transactions where BBH transferred shares to other broker-dealers to settle transactions.

Case in point: from February 2011 to May 2011, BBH transferred 27 million shares of penny stock on behalf of three of its foreign customers to other broker-dealers. The customers made US$40 million from those transfers. The problem?

BBH’s AML staff apparently was unaware of news reports during 2010 identifying the chief executive officer of the issuer as being involved in “pump and dump schemes.” News reports in May and June 2011 also showed that the penny stocks in question were part of the same scam.  

It is unclear from FINRA’s account of events whether BBH used the same or different AML surveillance software and procedures in its trade execution unit and in its investor services unit to monitor trade execution and custody movements for penny stocks. Regardless, BBH’s system, says FINRA “did not detect there were multiple customers depositing the same little known security around the same time, did not identify there was a sudden increase in the price of the penny stock and failed to uncover numerous other negative news articles regarding the security.”

Regulatory Precedence: BBH had reason to be particularly cautious in AML compliance. FINRA starts off its documentation on its settlement saying that in August 2007, BBH had entered into an written agreement with the former New York State Banking Department (now consolidated with insurance oversight into the New York Department of Financial Services). That agreement, which followed “deficiencies,” the state banking regulator found with BBH’s recordkeeping for its correspondent banking and private banking units, required the bank to improve its system of internal controls and procedures regarding the “verification of the identities of account holders and to devote the necessary resources to implement and maintain an effective program for compliance with all applicable AML regulatory requirements.”

The fact that Crawford joined BBH to head up global AML in May 2007, suggests that BBH was keen to shore up its deficiencies at the time. The FINRA settlement, which was accepted by BBH and Crawford without acknowledgement of guilt, implies that concern about the previous encounter with regulators may have faded, at least in relation to the events detailed in the case. In any case, neither BBH nor Crawford wants to discuss the matter beyond the following statements.

Here is what BBH has to say: “As previously announced to its non-US bank financial intermediary clients, BBH has made changes to its handling of low-priced securities, as well as to its surveillance of their activity to mitigate a possible recurrence of this matter,” says BBH’s statement. “The activity covered in this settlement represents a small part of our overall Investor Services business, and did not involve BBH’s investment management or private banking business.” Investor Services refers to BBH’s custody and asset-servicing unit.

Here is what Crawford has to say: “Prior to this investigation, Mr. Crawford believed he had established an appropriate system to identify and deal with global AML risks including US low-priced securities. For example, the firm terminated certain problematic clients based on Mr Crawford’s recommendation; he took steps to educate certain Swiss bank clients about the risks of low-priced securities and he implemented new trade surveillance systems. Unfortunately, FINRA did not consider his considerable work sufficient given the risk of low-priced securities and he settled with FINRA.”

If banks stand to learn from FINRA’s fine, so do their AML compliance directors. They among the most sought after — and the highest paid– compliance specialists for good reason. When something goes wrong, even if it is beyond their control, they must take the fall.

But is that asking for too much? The AML compliance specialists who spoke with FinOps Report think so. “Compliance specialists should be able to rely on a safe haven after they have made the appropriate warnings to upper management and tried to implement an oversight system in good faith,” one director tells FinOps.

Should FINRA give AML directors a break as long as they offer the correct advice and made a best effort? FinOps Report wants to hear what you think. Please send your comments to Chris.Kentouris@finops.co. They will be published without citing your name or institution, if you wish.