New Legislation to Seal Money Laundering Cracks

John M. Pachkowski, J.D., Writer/Analyst, CCH Federal Banking Law Reporter and Bank Compliance Guide, Co-Author, CCH Financial Services Modernization-Gramm-Leach-Bliley Act of 1999-Law and Explanation and CCH Federal Privacy Rules for Financial Institutions; Contributing Author, CCH Focus.

 
he enactment of the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (IMLAFAT) is the latest response to the September 11 terrorist attacks, especially responding to a boast by Osama bin Laden that his modern new recruits know the “cracks” in “Western financial systems” like they know the “lines in their hands.” IMLAFAT is part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT ACT) Act of 2001, which is to provide intelligence and law enforcement officials important new tools to fight the worldwide terrorism.

Speaking on the Senate floor, Carl Levin, D.-Mich., noted that IMLAFAT will “[seal] the cracks in our financial systems that terrorists and other criminals are all too ready to exploit.”

IMLAFAT seeks to seal these cracks in three ways: 

This analysis will focus on three of the more important international counter-money-laundering measures:
  1. the “special measures” provisions found in Section 311 of IMLAFAT;
  2. the due diligence requirements for correspondent accounts and private banking customers found in Section 312 of IMLAFAT; and
  3. the ban found in IMLAFAT Section 313 preventing banks and securities firms from opening accounts for foreign shell banks that have no physical presence and no affiliation with another bank. These shell banks are also known as “brass-plate” banks.

“SPECIAL MEASURES”

Section 311 of IMLAFAT gives the Secretary of the Treasury authority to impose new “special measures” against foreign jurisdictions, entities, transactions or accounts that in the determination of the Secretary poses a “primary money laundering concern” to the United States. In a floor statement, Senate Banking Committee Chairman Paul Sarbanes, D.-Md., stated that “this new provision gives the Secretary real authority to act to close overseas loopholes through which U.S. financial institutions are abused.”

“PRIMARY MONEY LAUNDERING CONCERN”

In making the determination of whether there is a “primary money laundering concern,” the Treasury Secretary is to consult with the Secretary of State and the Attorney General. The factors that must be considered in making the “primary money laundering concerns” determination generally look at how well a country administers its bank secrecy and money laundering laws. If the determination concerns a financial institution or transaction, then the Treasury Secretary will consider the extent to which that institution or transaction is involved in money laundering as compared to legitimate banking operations.

REPORTING AND IDENTIFICATION

Once a “primary money laundering concern” determination has been made, the Treasury Secretary can impose one or more of five “special measures” generally by administrative order or regulation. In choosing which “special measure” to impose the Treasury Secretary is to consider a number of factors and must consult with Chairman of the Federal Reserve System, the other federal banking regulators, as well as other federal financial regulators and Cabinet members. The factors generally consider whether other countries or multilateral groups are taking similar actions and how the measure would impact the U.S. financial system as well as national security and foreign policy.

Once imposed, special measures will require a financial institution to keep records and/or file reports on particular transactions, or identify the “beneficial ownership” of an account opened or maintained by a foreign person in a domestic financial institution. Another special measure will also require a financial institution to identify persons or entities using a foreign bank’s payable-through account or correspondent account with a domestic financial institution. In extreme cases the Treasury Secretary is permitted to bar certain kinds of inter-bank accounts from especially problematic jurisdictions; this measure can only be imposed by a regulation issued by the Treasury Department.

DUE DILIGENCE

Section 312 of IMLAFAT is intended to tighten U.S. anti-money laundering controls by requiring all U.S. financial institutions, not just domestic banks, to exercise due diligence when opening or managing correspondent or private banking accounts for foreign financial institutions or wealthy foreign individuals. Sen. Levin summed up these requirements “as a preventative measure to stop rogue foreign financial institutions, terrorists or other criminals from using U.S. financial accounts to gain access to the U.S. financial system.”

CORRESPONDENT ACCOUNTS

In regards to correspondent accounts, all types of financial institutions operating in the United States have a general obligation to establish appropriate and specific due diligence policies, procedures and controls when opening these types of accounts. These due diligence requirements must be reasonably designed to detect and report instances of money laundering through correspondent accounts.

Additional, minimum standards for enhanced due diligence policies, procedures and controls must be established by U.S. financial institutions for correspondent accounts opened for two specific categories of foreign banks: banks operating under “offshore banking licenses” and banks operating in foreign countries that have been designated as “raising money laundering concerns.” These enhanced due diligence requirements must include three elements: (1) identifying the foreign bank’s ownership; (2) careful monitoring of the correspondent account to detect and report any suspicious activity; and (3) determining whether the foreign bank is allowing any other banks to use its U.S. correspondent account and, if so, the identity of those banks and related due diligence information.

PRIVATE BANKING ACCOUNTS

Private banking accounts maintained by non-U.S. persons are also subject to the same minimum due diligence requirements applicable to correspondent accounts. Therefore, U.S. financial institutions must have appropriate and specific due diligence policies, procedures and controls when opening these types of accounts. These due diligence requirements must be reasonably designed to detect and report instances of money laundering through private banking accounts. They do not just apply to accounts opened at accounts at U.S. banks, but also cover accounts opened at other types of financial institutions, including securities firms which have developed lines of business offering similar types of accounts to wealthy foreign individuals.

There are also some more specific due diligence requirements that a financial institution must fulfill if it has a private banking account with a foreign person. First, the financial institution must take reasonable steps to ascertain the identity of the nominal and beneficial owners of the account and the source of funds deposited into the account as needed to guard against money laundering and report any suspicious transactions. Second, the financial institution must take reasonable steps to conduct enhanced scrutiny, which is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption, for any private banking account that is requested or maintained by, or on behalf of, a senior foreign political figure. This includes any immediate family member or close associate of that political figure. This enhanced due diligence requirement involving senior foreign political figures is intended to work in tandem with the guidance issued by federal banking regulators in January 2001.

REGULATIONS/EFFECTIVE DATE

In order to provide regulatory guidance to the range of U.S. financial institutions that will be compelled to exercise due diligence before opening a private banking or correspondent banking account, Section 312 of IMLAFAT gives the Treasury Secretary 180 days to issue regulations clarifying the due diligence requirements. It should be noted that if the Treasury Secretary fails meets the 180-day deadline for regulations, the due diligence statutory requirements will go into effect no later than 270 days after Oct. 26, 2001, the date of enactment of the USA PATRIOT ACT.

SHELL BANK BAN

U.S. banks and securities firms are to be barred, under Section 313 of IMLAFAT, from opening accounts for foreign shell banks that have no physical presence and no affiliation with another bank. This prohibition on dealing with “brass-plate” banks takes effect 60 days after October 26, 2001. The brass-plate bank ban is fairly broad so as to avoid a U.S. bank, which would be required to close any accounts with the shell bank, from circumventing the ban simply by switching its shell bank clients to accounts at an affiliated broker-dealer.

The shell bank ban also requires U.S. financial institutions to take reasonable steps to ensure that other foreign banks are not allowing their U.S. accounts to be used by shell banks. This is to prevent shell banks from getting indirect access to the U.S. financial system by operating through a correspondent account belonging to another foreign bank. The Treasury Secretary is required to issue a regulation delineating the reasonable steps necessary to carry out this provision.

Section 313 of IMLAFAT provides an exception to the general prohibition in dealing with shell banks. The exception will allow U.S. financial institutions to open an account for a shell bank that meets two tests: the shell bank is affiliated with another bank that maintains a physical presence, and the shell bank is subject to supervision by the banking regulator of that affiliated bank. Sen. Levin cautioned U.S. banks and securities firms “not to abuse this exception, to exercise both restraint and common sense in using it, and to refrain from doing business with any shell operation that is affiliated with a poorly regulated bank.”

DEFINITIONS

IMLAFAT provides a number of key definitions for terms used in the special measures, due diligence and shell bank ban.

Beneficial Ownership

Perhaps the most important definition is for the phrase “beneficial ownership.” Under Section 311(e)(3) of IMLAFAT, the Treasury Secretary is required to issue a regulation defining this phrase. As noted by Sen. Levin, “How the regulations define `beneficial ownership’ will have profound implications for these new provisions as well as for other aspects of U.S. anti-money laundering laws.” In formulating this regulatory definition, the Treasury Secretary will need to address three sets of issues: the significance of “an individual’s authority to fund, direct, or manage the account”; the significance of “an individual’s material interest in the income or corpus of the account”; and the exclusion of individuals whose beneficial interest in the income or corpus of the account is immaterial.

Accounts

The term “account” is defined broadly enough to apply to a wide variety of bank accounts provided to foreign financial institutions or private banking clients. For instance, checking accounts, savings accounts, investment accounts, trading accounts or accounts granting lines of credit or other credit arrangements all fall within the definition.