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SRC Insights: First Quarter 2002

Fraud Prevention: Risk Mitigation Principles and Techniques for Payment Card Operations

by Daniel L. Hutchinson, Supervising Examiner

In the aftermath of the horrific events of September 11, President Bush and the Congress have reacted decisively on varied fronts to meet the continuing threats posed by international terrorists. Recognizing that unfettered access to the global payments system allows terrorists to pay and receive funds in support of their operations, the United States and many other concerned countries are in the process of strengthening and expanding existing tools to more effectively monitor and interdict funds transfers related to terrorism. This article will discuss some of the actions being taken and their implications for banks operating in the U.S. and abroad. The comments are descriptive only and do not purport to interpret law. Interested parties are encouraged to access the source references.

An important action taken by Congress, which was signed into law on October 26, 2001 by the President, was the passage of Title III of H.R. 3162, the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001.1 This law was in the making for some time prior to September 11, so it had been given considerable scrutiny and was not devised hurriedly. It reflects nearly 25 years of experience with successes and failures in the fight against criminal use of the banking system. It builds on an existing framework of laws, regulations, policies, and procedures that are well known and that have resulted in some important setbacks to narcotics dealers and other criminal elements. The nature of terrorist operations is sufficiently different from the more familiar drug schemes that new and broader powers have been given to law enforcement agencies, regulators, and banking institutions to deter and detect criminal financial activity relating to terrorism. Some of these powers are granted in new law, but most are reflected in amendments to existing law.

Anti-Money Laundering Provisions
Not the least important amendment is the strengthening of so-called "safe-harbor" protection extended to financial institutions, their officers, directors, and employees who voluntarily divulge to authorities information about financial transactions that would ordinarily be considered privileged. This amendment expands existing immunity from liability for making such disclosures. Other amendments require each financial institution to establish anti-money laundering programs that, at a minimum, address internal policies, procedures, and controls for anti-money laundering programs; designate a compliance officer; provide for an on-going employee training program; and provide for independent audits to test the programs. Other amendments require registered securities brokers and dealers to file suspicious activity reports; grant access by U.S. intelligence agencies to records of account information maintained by financial institutions; subject to suspicious activity reporting (SAR) requirements any person engaged in the transmission of funds outside of the conventional financial institutions system; and, to support the increased level of surveillance, upgrade the Financial Crimes Enforcement Network (FinCEN)2 to Bureau status within the Treasury Department with a special hot line for reporting suspicious activities related to terrorism (1-866-556-3974).

Amendments also address the stated legislative intent, which was "to provide a clear national mandate for subjecting to special scrutiny those foreign jurisdictions, financial institutions operating outside of the United States, and classes of international transactions or types of accounts that pose particular, identifiable opportunities for criminal abuse" (i.e., "of primary money laundering concern").3 Specifically identified are enhanced record keeping and reporting, more complete information relating to beneficial ownership of accounts owned by foreigners in the United States, and detailed information about payable through and correspondent accounts opened in the United States and owned by foreigners. Covered financial institutions are prohibited from establishing correspondent accounts with foreign shell banks (i.e., a foreign bank that does not have a physical presence in any country).

Anti-Money Laundering Responsibilities
Banks are not destined to shoulder the entire anti-money laundering burden. The Treasury Department - essentially the lead U.S. Government agency for developing and implementing appropriate policies in consultation with relevant regulatory, judicial, and intelligence counterparts - has an ambitious national strategy for anti-money laundering action both domestically and internationally. The Department's goals as articulated in The 2001 National Money Laundering Strategy are:

  • Focus law enforcement efforts on the prosecution of major money laundering organizations and systems
  • Measure the effectiveness of anti-money laundering efforts
  • Prevent money laundering through cooperative public-private efforts and necessary regulatory measures
  • Coordinate law enforcement efforts with state and local governments to fight money laundering throughout the United States
  • Strengthen international cooperation to combat the global problem of money laundering4

While banks play an essential role in the process, it is clear that many public and other private institutions are contributing resources to the anti-money laundering effort. The banking privacy paradigm is shifting away from absolute privacy of individual relationships to a standard that speaks to the national security interest and international concerns about the abuse of the financial system for criminal and terrorism purposes. Today's framework of legislation, institutions, and task forces has the formidable potential to severely inhibit, if not totally eradicate, money laundering. What is needed for success is the proactive participation of the key players, domestic and international, public and private.

Know Your Customer
The Federal Reserve and other regulatory agencies have long been active in setting standards for bank compliance with the developing body of anti-money laundering regulations. Experience tells us that one of the thorniest compliance areas is the "know your customer" requirements. Relationship managers and senior bank officials are reluctant to be perceived by customers or prospects as intrusively inquisitive about the sources and extent of bankable assets. Yet, such knowledge is the most essential element underlying a financial institution's ability to gauge the appropriateness of transactions conducted by or on behalf of its customers, and to determine whether a SAR should be filed. The importance of "know your customer" policies extends beyond individual or private banking relationships. The USA Patriot Act requires screening of all foreign correspondent bank accounts and also requires enhanced due diligence for accounts in the name of a foreign bank operating under an offshore banking license. Financial institutions subject to the law must demonstrate compliance and be able to respond to official requests for information and account documentation within certain prescribed time limits (generally, 120 hours). The advent of electronic banking has considerably heightened the complexity of know your customer issues. An August 15, 2001, SR Letter 01-20 FFIEC Guidance on Authentication, addresses the risks and risk management controls needed to authenticate the identity of e-banking customers.5 However, the underlying need for actual knowledge of the customer transcends the technical problems of transaction authentication.

International Cooperation
It might appear at first glance that the increasingly severe regulations applicable to U.S. financial institutions will create a competitive disadvantage vis-à-vis institutions operating in countries with strict bank privacy laws that tend to shield criminal activity from official detection. While there may be some temporary regulatory incongruity, there are strong efforts in enlightened foreign jurisdictions to effect changes that might result in a more level playing field. In the global scheme of things, FinCEN is one of 58 Financial Intelligence Units (FIU) that comprise the Egmont Group.6 These FIUs meet to exchange information and to provide training in support of their respective governments' efforts to stop financial crime.

The OECD has sponsored the Financial Action Task Force on Money Laundering (FATF), notable for its list of Non-Cooperative Countries and Territories (NCCTs) with critical weaknesses in anti-money laundering systems.7 The FATF regularly reviews the NCCT list, and adds and deletes countries and territories as warranted. Notably, in June 2001, the FATF removed the Bahamas, Cayman Islands, Liechtenstein, and Panama from the NCCT list, while adding five other countries.8

The 31 FATF members, together with 18 regional bodies and observers, met at the end of October and agreed to expand the FATF mission to participate in the worldwide effort to combat terrorist financing. The Special Recommendations on Terrorist Financing emanating from this meeting commit the members to implement new international standards intended to deny terrorists and their supporters access to the international financial system. These standards are:

  • Take immediate steps to ratify and implement the relevant United Nations instruments
  • Criminalize the financing of terrorism, terrorist acts, and terrorist organizations
  • Freeze and confiscate terrorist assets
  • Report suspicious transactions linked to terrorism
  • Provide the widest possible range of assistance to other countries' law enforcement and regulatory authorities for terrorist financing investigations
  • Impose anti-money laundering requirements on alternative remittance systems
  • Strengthen customer identification measures in international and domestic wire transfers
  • Ensure that entities, in particular non-profit organizations, cannot be misused to finance terrorism

The FATF also committed itself to closer cooperation and coordination with other organizations such as the UN and the Egmont Group. If the standards are adopted globally, the question of competitive disadvantage should be put to rest.

Clearly, there is a developing global consensus at both the public and private levels that the gloves need to come off in the fight against criminal use of the financial system. We encourage all Third District financial institutions to stay informed of developments in this critical area and to implement best practices with respect to anti-money laundering and the detection of suspicious activities.

If you have any questions on the new anti-money laundering requirements, please contact your institution's central point of contact at the Federal Reserve Bank of Philadelphia. Alternatively, you can contact William Brown at 215-574-7291.

Additional Sources of Information

websites

Federal Reserve Sources

  • Bank Secrecy Act Examination Manual
  • SR 01-23 Reporting Suspicious Transactions Relating to the Recent Terrorist Attacks to Law Enforcement
  • SR 97-19 Private Banking Activities
  • SR 96-5 Anti-Money Laundering Controls in Foreign Offices of U.S. Banks
  • SR 95-10 Payable Through Accounts
  • All SR Letters

Other Sources

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.