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A Bank’s Bid for Innovative AML Solutions: Innovation Remains A Perilous Endeavor

One Bank Asked the OCC to Have an “Agile Approach to Supervisory Oversight”

On September 27, 2019 the OCC published an Interpretive Letter answering an unknown bank’s request to make some innovative changes to how it files cash structuring SARs. Tacked onto its three technical questions was a request by the bank to do this innovation along with the OCC itself through something the bank called an “agile approach to supervisory oversight.” After qualified “yes” answers to the three technical questions, the OCC’s Senior Deputy Comptroller and Chief Counsel indicated that the OCC was open to “an agile and transparent supervisory approach while the Bank is building this automated solution” but he didn’t actually write that the OCC would, in fact, adopt an agile approach. This decision provides some insight, and perhaps the first public test, of (i) the regulators’ December 2018 statement on using innovative efforts to fight money laundering, and (ii) the OCC’s April 2019 proposal around innovation pilot programs. Whether the OCC passed the test is open to discussion: what appears settled, though, is that AML innovation in the regulated financial sector remains a perilous endeavor.

Regulators’ December 2018 Joint Statement on Innovative AML Efforts

On December 3, 2018 the five main US Bank Secrecy Act (BSA) regulators issued a joint statement titled “Innovative Efforts to Combat Money Laundering and Terrorist Financing”.[1] The intent of the statement was to encourage banks to use modern-era technologies to bolster their BSA/AML compliance programs. The agencies asked banks “to consider, evaluate, and, where appropriate, responsibly implement innovative approaches to meet their Bank Secrecy Act/anti-money laundering (BSA/AML) compliance obligations, in order to further strengthen the financial system against illicit financial activity” and “[t]he Agencies recognize[d] that private sector innovation, including new ways of using existing tools or adopting new technologies, can help banks” to do so.

The statement was a very positive step to encourage private sector innovation in fighting financial crime by testing new ways of using existing tools as well as adopting new technologies.

But it wasn’t the “green light to innovate” that some people have said it is. There was some language in the statement that made it, at best, a cautionary yellow light. And the September 27th OCC letter seems to clarify that banks can innovate, but the usual regulatory oversight and potential sanctions still apply.

The Agencies’ December 2018 statement included five things that bear repeating:

  1. “The Agencies recognize that private sector innovation, including new ways of using existing tools or adopting new technologies, can help banks identify and report money laundering, terrorist financing, and other illicit financial activity by enhancing the effectiveness and efficiency of banks’ BSA/AML compliance programs. To assist banks in this effort, the Agencies are committed to continued engagement with the private sector and other interested parties.”
  2. “The Agencies will not penalize or criticize banks that maintain effective BSA/AML compliance programs commensurate with their risk profiles but choose not to pursue innovative approaches.”
  3. “While banks are expected to maintain effective BSA/AML compliance programs, the Agencies will not advocate a particular method or technology for banks to comply with BSA/AML requirements.”
  4. Where test or implemented “artificial intelligence-based transaction monitoring systems … identify suspicious activity that would not otherwise have been identified under existing processes, the Agencies will assess the adequacy of banks’ existing suspicious activity monitoring processes independent of the results of the pilot program”
  5. “… the implementation of innovative approaches in banks’ BSA/AML compliance programs will not result in additional regulatory expectations.”

Note the strong, unqualified language: “the Agencies are committed to continued engagement”, “the Agencies will not penalize or criticize”, “the Agencies will not advocate …”, “the Agencies will assess”, and “the implementation of innovative approaches will not result in additional regulatory expectations”.

The qualified “assurances” come in the paragraph about pilot programs (with emphasis added):

“Pilot programs undertaken by banks, in conjunction with existing BSA/AML processes, are an important means of testing and validating the effectiveness of innovative approaches.  While the Agencies may provide feedback, pilot programs in and of themselves should not subject banks to supervisory criticism even if the pilot programs ultimately prove unsuccessful.  Likewise, pilot programs that expose gaps in a BSA/AML compliance program will not necessarily result in supervisory action with respect to that program.  For example, when banks test or implement artificial intelligence-based transaction monitoring systems and identify suspicious activity that would not otherwise have been identified under existing processes, the Agencies will not automatically assume that the banks’ existing processes are deficient.  In these instances, the Agencies will assess the adequacy of banks’ existing suspicious activity monitoring processes independent of the results of the pilot program.  Further, the implementation of innovative approaches in banks’ BSA/AML compliance programs will not result in additional regulatory expectations.”

Here there are the qualified assurances (a qualified assurance is not an assurance, by the way): “should not” is different than “will not”; “will not necessarily” is very different than “will not”; and “not automatically assume” isn’t the same as “not assume”.  These are important distinctions. The agencies could have written something very different:

“… pilot programs in and of themselves will not subject banks to supervisory criticism even if the pilot programs ultimately prove unsuccessful.  Likewise, pilot programs that expose gaps in a BSA/AML compliance program will not result in supervisory action with respect to that program.  For example, when banks test or implement artificial intelligence-based transaction monitoring systems and identify suspicious activity that would not otherwise have been identified under existing processes, the Agencies will not assume that the banks’ existing processes are deficient …”

The OCC’s April 2019 Innovation Pilot Program

On April 30, 2019 the OCC sought public comment on its proposed Innovation Pilot Program, a voluntary program designed to provide fintech providers and financial institutions “with regulatory input early in the testing of innovative activities that could present significant opportunities or benefits to consumers, businesses, financial institutions, and communities.” See OCC Innovation Pilot Program. As the OCC has written, the Innovation Pilot Program clearly notes that the agency would not provide “statutory or regulatory waivers and does not absolve entities participating in the program from complying with applicable laws and regulations.”

Twenty comments were posted to the OCC’s website. A number of them included comments that innovators needed some formalized regulatory forbearance in order to be able encourage them to innovate. The Bank Policy Institute’s letter (BPI Comment), submitted by Greg Baer (a long-standing and articulate proponent of reasonable and responsible regulation), provided that:

“… the OCC should clarify publicly that a bank is not required to seek the review and approval of its examination team prior to developing or implementing a new product, process, or service; that unsuccessful pilots will not warrant an MRA or other sanction unless they constitute and unsafe and unsound practice or a violation of law; and that innovations undertaken without seeking prior OCC approval will not be subject to stricter scrutiny or a ‘strict liability’ regime. We also recommend that the OCC revisit and clarify all existing guidance on innovation to reduce the current uncertainty regarding the development of products, processes and services; outdated or unnecessary supervisory expectations should be rescinded.”

The American Bankers Association comment ABA Comment also asks for similar guidance:

“For institutions to participate confidently in a pilot, there must be internal agreement that OCC supervision and enforcement will not pursue punitive actions. In other words, the program should produce decisions that have the full support of the OCC and bind the agency to those conclusions going forward … One way for the OCC to accomplish this is to clarify that a participating bank will not be assigned Matters Requiring Attention (MRAs) if it acts in good faith as part of a Pilot Program. The nature of technological innovation means that banks must try new things, experiment, and sometimes make mistakes. The Pilot Program has been designed as a short-term limited-scale test to ensure that any mistakes made are unlikely to have an impact on the safety and soundness of an institution. Clarifying that MRAs will not be issued for mistakes made in good faith may help give banks the certainty they need to participate in a Pilot Program.”

And the Securities Industry and Financial Markets Association (SIFMA) comment letter SIFMA Comment Letter included the following:

“Relief from strict regulatory compliance is a vital prerequisite to draw firms into the test environment, precisely so that those areas of noncompliance may be identified and remediated and avoid harm to the consumers. Without offering this regulatory relief, the regulatory uncertainty associated with participating in the Pilot Program could, by itself, deter banks from participating. Similarly, the lack of meaningful regulatory relief could limit the opportunity the program provides for firms to experiment and innovate.”

So where did that leave banks that were thinking of innovative approaches to AML?  For those that choose not to pursue innovative pilot programs, it is clear that they will not be penalized or criticized, but for those that try innovative pilot programs that ultimately expose gaps in their BSA/AML compliance program, the agencies will not automatically assume that the banks’ existing processes are deficient. In response to this choice – do not innovate and not be penalized, or innovate and risk being penalized – many banks have chosen the former. As a result, advocates for those banks – the BPI and ABA, for example – have asked the OCC to clarify that it will not pursue punitive actions against banks that unsuccessfully innovate.

How has the OCC replied? It hasn’t yet finalized its Innovation Program, but it has responded to a bank’s request for guidance on some innovative approaches to monitoring for, alerting on, and filing suspicious activity reports on activity and customers that are structuring cash transactions.

A Bank’s Request to Have the OCC Help It Innovate

The OCC published an Interpretive Letter on September 27, 2019 that sheds some light on how it looks at its commitments under the December 2018 innovation statement.[2]  According to the Interpretive Letter, on February 22, 2019 an OCC-regulated bank submitted a request to streamline SARs for potential structuring activity (the Bank also sought the same or a similar ruling from FinCEN: as of this writing, FinCEN has not published a ruling). The bank asked three questions (and the OCC responded):

  1. Whether the Bank could file a structuring SAR based solely on an alert, without performing a manual investigation, and if so, under what circumstances (yes, but with some significant limitations);
  2. Whether the proposed automated generation of SAR narratives for structuring SARs was consistent with the OCC’s SAR regulations (yes, but with some significant limitations);
  3. Whether the proposed automation of SAR filings was consistent with the OCC’s BSA program regulations (yes, but with some significant limitations).

The most interesting request by the Bank, though, was its request that the OCC take an “agile approach to supervisory oversight” for the bank’s “regulatory sandbox” initiative. Pages 6 and 7 of the OCC letter provide the particulars of this request. There, the OCC writes:

“Your letter also requested regulatory relief to conduct this initiative within a “regulatory sandbox.” Your regulatory sandbox request states ‘This relief would be in the form of an agile approach to supervisory oversight, which would include the OCC’s full access, evaluation, and participation in the initiative development, but would not include regulatory outcomes such as matters requiring attention, violations of law or financial penalties. [The Bank] welcomes the OCC to consider ways to participate in reviewing the initiative outcomes outside of its standard examination processes to ensure effectiveness and provide feedback about the initiative development.’”

NOTE: I had to read the key sentence a few times to settle on its intent and meaning. That sentence is “This relief would be in the form of an agile approach to supervisory oversight, which would include the OCC’s full access, evaluation, and participation in the initiative development, but would not include regulatory outcomes such as matters requiring attention, violations of law or financial penalties.”

Was the bank saying the relief sought was an agile approach to supervisory oversight that included the OCC’s full participation in the process and no adverse regulatory outcomes? Or was the bank saying the relief sought was an agile approach to supervisory oversight that included the OCC’s full participation in the process, but did not include anything to do with adverse regulatory outcomes?

I settled on the latter meaning: that the bank was seeking the OCC’s full participation, but did not expect any regulatory forbearance.

The OCC first reiterated its position from the December 2018 joint statement by writing that it “supports responsible innovation in the national banking system that enhances the safety and soundness of the federal banking system, including responsibly implemented innovative approaches to meeting the compliance obligations under the Bank Secrecy Act.” It then wrote that it “is also open to an agile and transparent supervisory approach while the Bank is building this automated solution for filing Structuring SARs and conducting user acceptance testing.” This language is a bit different than what the OCC wrote at the top of page 2 of the letter: “the OCC is open to engaging in regular discussions between the Bank and appropriate OCC personnel, including providing proactive and
timely feedback relating to this automation proposal.”

Notably, the OCC wrote that it is “open to an agile and transparent supervisory approach”, and “open to engaging in regular discussions between the Bank and appropriate OCC personnel”, but being open to something doesn’t mean you approve of it or agree to it. In fact, the OCC didn’t appear to grant the bank’s request. In the penultimate sentence the OCC wrote: “The OCC will monitor any such changes through its ordinary supervisory processes.”

How About Forbearance to Innovate Without Fear of Regulatory Sanctions?

As set out above, in June 2019 the BPI and ABA (and eighteen others) commented on the OCC’s proposal for an innovation pilot program. The BPI commented that “the OCC should clarify publicly that … unsuccessful pilots will not warrant an MRA or other sanction unless they constitute and unsafe and unsound practice or a violation of law”, and the ABA commented that the OCC should “clarify that a participating bank will not be assigned Matters Requiring Attention (MRAs) if it acts in good faith as part of a Pilot Program”.

The OCC seems to have obliquely responded to both of those comments. In its September 2019 Interpretative Letter, the OCC took the time to write that it “will not approve a regulatory sandbox that includes forbearance on regulatory issues for the Bank’s initiative for the automation of Structuring SAR filings.” Note that the OCC made this statement even though the bank appears to have specifically indicated that the requested relief did not include forbearance from “regulatory outcomes such as matters requiring attention, violations of law or financial penalties”. And the OCC letter includes a reference to both the Interagency statement on responsible innovation and the OCC’s April 2019 Innovation Pilot Program (see footnote 25 on page 7): “banks must continue to meet their BSA/AML compliance obligations, as well as ensure the ongoing safety and soundness of the bank, when developing pilot programs and other innovative approaches.”

So although the OCC hasn’t formally responded to the comments to its June 2019 innovation program to allow banks to innovate without fear of regulatory sanction if that innovation doesn’t go well, it has made it clearer that a bank still has the choice to not innovate and not be penalized, or to innovate and risk being penalized.

(In fairness, in its Spring 2019 Semiannual Risk Perspective Report, the OCC noted that a bank’s inability to innovate is “a source of significant strategic risk.” See OCC Semiannual Risk Perspective, 2019-49 (May 20, 2019)).

Timely Feedback – Is Seven Months Timely?

As set out above, the OCC wrote that it “is open to engaging in regular discussions between the Bank and appropriate OCC personnel, including providing proactive and timely feedback …”.  The bank’s request was submitted on February 22, 2019. The OCC’s feedback was sent on September 27, 2019. So it took the OCC seven months to respond to the bank’s request for an interpretive letter. In this age of high-speed fintech disruption, seven months should not be considered “timely.” What would be timely? I would aim for 90 days.

Conclusion

This unnamed OCC-regulated bank appears to have a flashing green or cautionary yellow light from the OCC to deploy some technology and process enhancements to streamline a small percentage if its SAR monitoring, alerting, and filing.  The OCC will remain vigilant, however, warning the bank that it “must ensure that it has developed and deployed appropriate risk governance to enable the bank to identify, measure, monitor, and control for the risks associated with the automated process. The bank also has a continuing obligation to employ appropriate oversight of the automated process.”

So the message to the 1,700 or so OCC banks appears to be this: there’s no peril in not innovating, but if you decide to innovate, do so at your peril.

[1] The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Financial Crimes Enforcement Network (FinCEN), the National Credit Union Administration, and the Office of the Comptroller of the Currency. The statement is available at https://www.occ.gov/news-issuances/news-releases/2018/nr-occ-2018-130a.pdf

[2] https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2019/int1166.pdf