If you’re reading this, then you undoubtedly already know that FINRA and SEC are, simply, AML crazy. Rightly or wrongly, they are both focusing more than ever on broker-dealers’ fulfillment of their supervisory obligation to be sensitive to the laundry list of red flags first articulated in a Notice to Members back in 2002 that are, theoretically anyway, indicative of potential money laundering. The good news, to the extent there is good news, is that based on a FINRA hearing panel decision from 2010 involving Sterne Agee & Leach, as long as you have a good set of AML procedures, see the red flags, investigate the red flags, and memorialize your investigation, it is not really important whether or not you actually file a SAR. Well, based on an SEC settlement from a week ago, that may no longer be the case, at least when the red flags are numerous, obvious, and dangerous.
In the settlement, Alfred Fried & Co., LLC agreed to pay a $300,000 civil penalty to the SEC – a sum that would have been even higher absent the firm’s explicit cooperation with the SEC – based on its failure to have filed SARs in light of what the settlement characterized as such obvious and numerous red flags. The question is whether the Alfred Fried case marks a turning point in how regulators view SARs filings.
Back in 2010, the FINRA hearing panel in the SAL case “emphasized the importance of focusing on the process, rather than on whether a particular SAR was filed,” which makes perfect sense to me, and the industry. It stated: “The decision to file a SAR is an inherently subjective judgment. Examiners should focus on whether the [firm] has an effective SAR decision-making process, not individual SAR decisions.” While it acknowledged the existence of two prior settlements that included among the noted violations the failure by the respective respondents to have filed SARs, the panel noted that it was more important to the analysis of an AML charge to determine whether the firm’s “procedures in monitoring” the accounts “were sound,” and whether, having spotted the red flags as a result of that monitoring, the determination not to file a SAR “was reasonable.” Thus, if that decision not to file was appropriately analyzed, reflecting a legitimate deliberative process, then not filing a SAR was ok.
Alfred Fried, it seems, did not meet that standard. Viewed objectively, you can see why the Commission was upset that for a period of five years the firm did not file a single SAR. First, what was supposed to happen:
- The firm had a policy to rely on employee reporting, detection through ongoing review, transaction information, operations personnel education, and clearing firm reports to spot potentially suspicious activities.
- Once suspicious activity was identified, it was to be reviewed and investigated by the AML officer to determine whether the obligation to file a SAR had been triggered.
- Compliance staff was required to retain notes and other documented reviews created while investigating suspicious activities and other red flags.
- The policies required Albert Fried to file SARs “for transactions that may be indicative of money laundering activity.”
- Suspicious activities were defined as “a wide range of questionable activities,” including “trading that constitutes a substantial portion of all trading for the day in a particular security,” “heavy trading in low-priced securities,” and “unusually large deposits of funds or securities.”
- The firm’s policies also stated that if it received a grand jury subpoena concerning one of its customers, the AML officer had to “conduct a risk assessment of the customer subject to the subpoena as well as review the customer’s account activity.” If the customer’s trading was determined to be suspicious in light of the risk assessment and review, the policies required the firm to file a SAR. (The mere receipt of a grand jury subpoena concerning a customer did not require the firm to file a SAR.)
- Under the policies, a SAR should have been filed within 30 days of Albert Fried’s staff becoming aware of a suspicious transaction.
Next, what actually happened:
- The firm allowed its customers to deposit hundreds of millions of shares of low-priced securities obtained from convertible debentures, and then immediately go about selling them.
- These sales were often in large volumes and constituted a substantial percentage of the daily market volume in the security. On more than one occasion, a single customer’s trading in a security on a given day exceeded 80% of the overall market volume. In another instance, on three of the four days in which one customer sold a particular security, the customer’s trading accounted for more than 59% of the daily market volume – ranging from 59.07% to 77.65%.
- Customers were trading in certain issuers that were delinquent in their SEC filings or that had ongoing penny stock promotional campaigns, executive employees with histories of securities fraud, or significant accumulated deficits.
- The firm received regulatory inquiries and grand jury subpoenas concerning its customers’ trading.
- Other broker-dealers rejected the firm’s attempts to transfer its customers’ securities.
- Immediately following the liquidation of an issuer’s securities, a customer transferred the entirety of its cash proceeds out of its Albert Fried account.
- The firm became aware of a customer’s executive being charged with criminal securities fraud charges.
- The Commission suspended trading in a security that was recently liquidated by its customer.
Despite all of this, no SAR was ever filed. More importantly, however, the firm never even investigated the activity to determine whether it was, in fact, suspicious. Thus, there is no way that the firm could meet the standard articulated in the 2010 FINRA case against SAL, regardless of whether or not a SAR was filed. Given that, perhaps the lesson from Alfred Fried is not that the regulators are suddenly anxious to begin bringing cases based on a failure to file SARs, even though that represented the SEC’s specific finding here; rather, maybe it is the same lesson from the SAL case, namely, that having robust policies in place, and then actually following those policies (and documenting that you followed them), is the still the best way to defend an AML charge. If Alfred Fried had, in fact, done what its AML policies required, perhaps its failure to have filed a SAR could have been successfully defended. Because it ignored its policies, however, its fate was sealed.
- Review your AML policies to be sure they are robust and up-to-date
- Be sensitive to red flags of potentially suspicious activities as they manifest themselves
- Respond to red flags promptly and in accordance with your policies
- Document the dickens out of the response
- And then, if you reasonably conclude the red flags do present activity consistent with money laundering, file a SAR
- If you reach the opposite conclusion, however, and don’t file a SAR, document that decision and the basis for it even better.
 According the SEC, Albert Fried entered into two tolling agreements, prepared a 57-page summary of its conduct explaining its AML policies, providing background for each transaction, and took “a number of remedial measures,” including retaining a third-party AML compliance firm to improve compliance with the BSA’s SAR filing requirement and the execution of its written policies and procedures,” revising its policies to reflect updated regulatory guidance and input, and adding a low-priced security checklist to its process of accepting the deposit of securities and a customer AML risk assessment component to its account opening procedures.