Securities Lawyer Blog

The Financial Industry Regulatory Authority (FINRA) is teaching brokerage firms a great deal these days and imposing fines in the process.

This time, Scottrade is in the hot seat and will pay a $600,000 fine for its alleged failure to "establish and implement an adequate anti-money laundering (AML) program to detect and trigger reporting of suspicious transactions, as required by the Bank Secrecy Act and FINRA rules."

FINRA instructs by Scottrade's example that the trading environment for each firm must be taken into account in establishing and maintaining appropriate programs for the detection of money laundering. Monitoring suspicious trading alone just doesn't cut it. Among other things, that's what got Scottrade in trouble.

The firm did not establish automated surveillance of transactions until 2005 and once it did it "focused only on suspicious trading that was accompanied by suspicious money movement," noted Susan L. Merrill, FINRA's Executive Vice President and Chief of Enforcement.

FINRA informs the industry that is not sufficient. Its rules require brokerage firms to establish policies and implement procedures that are "reasonably designed" to detect and ultimately to report suspicious transactions. But that does not necessarily mean that only suspicious transactions are to be watched and/or reported. More is required, as Scottrade has learned.

In Scottrade's case, the agency found that between April 2003 and April 2008, the firm did not establish or maintain an AML program that was appropriately targeted for its business model of on-line trading. The increased volume over a period of years of its on-line trading volume, brought with it such risks as identity theft and the use of customer accounts to launder funds by hiding behind securities transaction for illegal activity and other securities violations.

One major problem for the firm was its failure to adequately staff the monitoring function. For some period of time there was only one AML compliance officer at the firm. Eventually, a risk management analyst was hired to assist. But FINRA determined that the volume of trading called for more than two individuals. Another problem for the firm was its reliance for several years on a manual system for monitoring suspicious activities, relying on internal personnel and branch and other employees to identify and report suspicious activities.

Despite Scottrade's eventual implementation of proprietary automated systems to monitor suspicious trading activity, FINRA found that this too was not sufficient. Suspicious activity generated an alert, but that alone would not detect various other techniques used by those seeking to launder funds such as through account intrusions and the use of bona fide accounts for laundering purposes.

Scottrade was also found to have provided inadequate written guidance to employees on the detection and review of transactions that might be used for money laundering.

Related Web Resources

To learn more about AML requirements, visit www.FINRA.org where you will find resources for industry professionals and investors.

Continue reading "Learning the Hard Way -- Inadequate Anti-Money Laundering Program Costs Scottrade $600,000 " »

Citigroup Global Markets Inc. experienced a bit of self-inflicted pain last week.

The firm's failure to supervise tax-related stock transactions is carrying a censure and a $600,000 fine, according to the Financial Industry Regulatory Authority (FINRA).

In a recent statement, FINRA's Executive Vice President and Chief of Enforcement, Susan Merrill instructed that "[i]ncreasingly, complex trading strategies must be governed by supervision that is equally sophisticated and detailed ... In this case, Citigroup's inadequate supervision resulted in improper trading related to the execution of strategies involving transactions with a principal purpose of limiting tax liability."

Point well-taken perhaps as the issue for Citigroup was their alleged failure to establish procedures that would detect improper trades and to supervise or control these activities.

The trading involved several strategies and complex trading moves described generally as follows.

Citigroup's equity finance desk would purchase stock from generally foreign, broker-dealer clients. Once the taxable dividends had been paid, the stock would be sold back to the customer.

The problem for Citigroup is that when U.S. stock dividends are paid out to foreign investors, there may in fact be a taxable event that would require withholding. In the transactions at issue, Citigroup and its clients apparently believed these transactions were not subject to tax withholding, viewing them as "dividend equivalents" and part of a swap agreement.

To participate in this strategy, foreign Citigroup clients would sell U.S. equities to the firm's equity finance desk in New York, which served as custodian for these dividend-bearing stocks for the firm's London affiliate.

As FINRA elaborates on the scheme: The affiliate would in turn use the stock as "the underlying equity hedge in a 'total return swap' entered into with the customer. Under the swap, the London affiliate paid the customer a 'total return,' which was any income the stock generated, including any appreciation in value, as well as an amount equivalent to the dividend. In exchange for the 'total return payments,' the customer paid the London affiliate interest and covered any decline in the share price."

Between 2002 and 2005, these transactions resulted in foreign clients receiving the full value of U.S. company dividends, without paying the withholding tax.

Citigroup already paid (around 2006) a substantial $24 million to the Internal Revenue Service due to this strategy. They did so after coming to the conclusion that they could not verify whether some trades were independent.

However, in a somewhat inexplicable failure to supervise, even after the firm put written procedures in place, traders did not follow them.

Related Web Resources

For more detailed information on the Citigroup transactions subject to the supervisorial failure and related matters, visit www.FINRA.org where you will also find extensive resources for industry professionals and investors.

Continue reading "Seriously Taxing -- Citigroup Fined $600,000 in Failure to Supervise " »

As just about every lawyer in the country knows by now, Bank of America has waived attorney-client privilege with regard to its communications in the Merrill Lynch merger. Some are questioning the wisdom of that decision, or at least its implementation.

The AmLaw Daily posed the question in a piece last week and noted that at least one expert believes the bank's waiver could lead to "more lawyers getting access to privileged documents than the bank intended."

As the Securities Lawyer Blog has reported, the Securities and Exchange Commission (SEC) sued BofA for allegedly violating required shareholder disclosures in the merger with Merrill Lynch late last year. The case has been the subject of significant media attention as Judge Rakoff refused to approve the settlement between the SEC and BofA after extensive briefing and argument.

Once this occurred, the attention turned to the bank's lawyers at Wachtell, Lipton, Rosen & Katz who had represented and provided advice to the bank on the merger. BofA was under a great deal of pressure to "waive" attorney-client privilege in its communications with its lawyers as BofA had focused on its reliance on the advice of counsel in the alleged failure to follow disclosure requirements.

Last week, BofA agreed to "waive" attorney-client privilege in the SEC matter. Relying on Federal Rule of Evidence 502, BofA's counsel in the pending matter, drafted a waiver order that was presented to and signed by Judge Rakoff. The waiver also applies to the New York attorney general's investigation.

Rule 502 is intended to allow a limited disclosure of what would otherwise be privileged, so that investigation targets can disclose privileged documents to investigators without providing a broad waiver that might apply to other pending litigations.

However, Gregory Joseph who was involved in the drafting of Rule 502, believes that BofA and its lawyers did not properly word the waiver and as a result, 58 cases (including a class action) that it intended would not be subject to the disclosure, might in fact be exposed to a waiver argument.

That could hurt a great deal. Joseph's conclusion is that the order "does not operate to preserve the privilege as it is phrased because it is not authorized by Federal Rule of Evidence 502." The potential error in the drafting of the order is that according to Joseph, Rule 502 does not in fact deal with waivers, but rather allows corporations a limited disclosure, not a waiver.

Only time will tell whether other parties will attempt to use the disclosure order and its reliance on Rule 502, as a blanket waiver in the cases BofA (and the SEC which co-drafted the order) intended to protect.