There is a lot of media attention around the need for a new way to tackle financial crimes risk management. Apparently the current regime is “broken” (I disagree) or in desperate need of repair (what government-run programs are not in some sort of state of disrepair?), or, at the very least, not particularly effective nor efficient. And there are a lot of suggestions from the private and public sectors on how to make the regime more effective and more efficient. I’ll offer seven things to consider as we all work towards renovating our BSA/AML regime, to take it from its tired, dated (the last legislative change to the three statutes we call the Bank Secrecy Act was made in 2004) state to something that provides a more balanced, effective, and efficient regime.
I. Transaction Monitoring Systems
Apparently, current customer- and account-based transaction monitoring systems are highly inefficient, because for every 100 alerts they produce, five or fewer actually end up being reported to the government in a Suspicious Activity Report. The transaction monitoring software is often blamed (although bad data is the more likely culprit), and machine learning and artificial intelligence are often touted (by providers of machine learning and artificial intelligence) as the solutions. Consider the following when it comes to transaction monitoring and false positives:
- If a 95% false positive rate is bad … what is good? Human-generated referrals will result in SARs about 50% of the time: that might be a good standard.
- We have to stop tuning our transaction monitoring systems against SARs filed with law enforcement, and start tuning them against SARs used by law enforcement. I’ve written about this on many occasions, and have offered up something called the “TSV” SAR – a SAR that law enforcement indicates has Tactical or Strategic Value.
- High false positives rates may not be caused by bad data or poor technology at all, but by regulatory expectations – real or imagined – that financial institutions can’t afford the audit, regulatory, legal, and reputational costs of failing to identify (alert on) something unusual or anomalous that could eventually be found to have been suspicious.
(I’ve written about this on a few occasions: see, for example, RegTech Consulting Article).
It may be that transaction monitoring itself is the culprit (and not bad data, outmoded technology, or unreasonable regulatory expectations). My experience is that customer- and account-based transaction monitoring is not nearly as effective as relationship-based interaction surveillance. Let’s parse this out:
- Customer versus relationship – focusing on a single customer is less efficient than looking at the entire relationship that customer is or could be part of. Bank’s marketing departments think in terms of households as the key relationship: credit department’s think in terms of parent and subsidiary entities and guarantors as the needed relationship in determining credit worthiness. Financial crimes departments need to also think in the same terms. It is simply more encompassing and more efficient.
- Transaction versus interaction – customers may interact with a bank many times, through a phone call, an online session, a balance inquiry, or a mobile look-up, before they will perform an actual transaction or movement of value. Ignoring those interactions, and only focusing on transactions, doesn’t provide the full picture of that customer’s relationship with the bank.
- Monitoring versus surveillance – monitoring is not contextual: it is simply looking at specific transaction types, in certain amounts or ranges, performed by certain customers or customer classes. Surveillance, on the other hand, is contextual: it looks at the context of certain activity compared against all activity of that customer over time, and/or of certain activity of that customer compared to other customers within its class (Whatever that class may be).
So the public sector needs to encourage the private sector to shift from a customer-based transaction monitoring regime to a relationship-based interaction surveillance regime.
II. Information Sharing
Crime and criminal organizations don’t operate in a single financial institution or even in a single jurisdiction. Yet our BSA/AML regime still encourages single entity SAR filers and doesn’t promote cross-jurisdictional information sharing. The tools are available to better share information across a financial institution, and between financial institutions. Laws, regulations, and regulatory guidance all need to change to specifically and easily allow a single financial institution operating in multiple jurisdictions to (safely) share more information with itself, to allow multiple institutions in a single and multiple jurisdictions to (safely) share more information between them, and to allow those institutions to jointly investigate and report together. Greater encouragement and use of Section 314(b) associations and joint SAR filings are critical.
III. Classical Music, or Jazz?
Auditors, regulators, and even a lot of FinTech companies, would prefer that AML continue to be like classical music, where every note (risk assessments and policies) is carefully written, the music is perfectly orchestrated (transaction monitoring models are static and documented), and the resulting music (SAR filings) sounds the same time and time again regardless of who plays it. This allows the auditors and regulators to have perfectly-written test scripts to audit and examine the programs, and allows the FinTech companies to produce a “solution” to a defined problem. This approach may work for fraud, where an objective event (a theft or compromise) produces a defined result (a monetary loss). But from a financial institution’s perspective, AML is neither an objective event nor a defined result, but is a subjective feeling that it is more likely than not that something anomalous or different has occurred and needs to be reported. So AML is less like classical music and more like jazz: defining, designing, tuning, and running effective anti-money laundering interaction monitoring and customer surveillance systems is like writing jazz music … the composer/arranger (FinTech) provides the artist (analyst) a foundation to freely improvise (investigate) within established and consistent frameworks, and no two investigations are ever the same, and similar facts can be interpreted a different way by different people … and a SAR may or may not be filed. AML drives auditors and examiners mad, and vexes all but a few FinTechs. So be it. Let’s acknowledge it, and encourage it.
IV. Before Creating New Tools, Let’s Use the Ones We Have
The federal government has lots of AML tools in its arsenal: it simply needs to use them in more courageous and imaginative ways. Tools such as section 311 Special Measures and 314 Information Sharing are grossly under-utilized. Information sharing is discussed above: section 311 Special Measures are reserved for the most egregious bad actors in the system, and are rarely invoked. But the reality is that financial institutions will kick out a customer or not (knowingly) provide services to entire classes of customers or in certain jurisdictions for fear of not being able to economically manage the perceived risk/reward equation of that customer or class of customer or jurisdiction. But that customer or class or jurisdiction simply goes to another financial institution in the regulated sector, or to an institution in an un- or under-regulated sector (the notion of “de-risking”). The entire financial system would be better off if, instead of de-risking a suspected bad customer or class of customer or jurisdiction, financial institutions were not encouraged to exit at all, but encouraged to keep that customer or class, and monitor for and report any suspicious activity. Then, if the government determined that the customer or class of customers was too systemically risky to be banked at all, it could use section 311 to effectively blacklist that customer or class of customers. Imposing “special measures” shouldn’t be a responsibility of private sector financial institutions guessing at whether a customer or class of customers is a bad actor: it is and should be the responsibility of the federal government using the tool it currently has available to it: Section 311.
V. … and Let’s Restore The Tool We Started With
The reporting of large cash transactions was the first AML tool the US government came up with (in 1970 as part of the Currency & Foreign Transactions Reporting Act). Those reports, called Currency Transaction Reports, or CTRs, started out as single cash transactions on behalf of an accountholder, for more than $10,000. They have since morphed to one or more cash transactions aggregating to more than $10,000 in a 24-hour period, by or on behalf of one or more beneficiaries. There will be more than 18 million CTRs filed this year, and apparently law enforcement finds them an effective tool. But there is nothing more inefficient: simply put, CTRs are now the biggest resource drain in BSA/AML. Because of regulatory drift, CTRs are de facto SAR-lites … we need to get back to basic CTRs and redeploy the resources used to wrestle with the ever-expanding aggregation and “by or on behalf of” requirements, and deploy them against potential suspicious activity. And forget about increasing the threshold amount from the current “more than $10,000” standard. We’ve all read the arguments that “$10,000 in 1970 is like $65,000 in today’s dollars” to support the idea of increasing the CTR threshold. Those espousing this nonsense are ill-informed and naïve, at best. When the CTR threshold was set in 1972 (yes, 1972), there were no ATMs, no mobile banking, no automated check clearing, no ACH, etc. Cash transactions were common. Today, $10,000 is almost 5,000 times the amount of the average cash transaction in the United States today (which is $22, according to multiple reports from the Federal Reserve), the median cash transactions is about $5, and 95% of cash transactions are $50 or less. Also, with $10,000 in cash you can pay for 10 assault rifles, traffic 4 human beings, or buy enough fentanyl to kill everyone in Richmond, Virginia. It’s easier to argue that $10,000 in cash in 2021 is rarer than $10,000 in cash in 1970! No one should argue that having a requirement to report a transaction or transactions that are 200 times the amount of 95% of all cash transactions, or 500 times the average transaction, or 2,000 times the median transaction, is unreasonable. And it isn’t the amount that causes inefficiencies, it is the requirements to (i) aggregate multiple transactions totaling more than $10,000 in a 24-hour period, (ii) to identify and aggregate transactions “by or on behalf of” multiple parties and accountholders, and (iii) exempt, on a bank-by-bank basis, certain entities that can be exempted (but rarely are) from the CTR filing regime. If anything, we could save and redploy resources if the CTR threshold was the same as the SAR threshold – $5,000 – and we used the CTR to report single transactions. Aggregation and structuring should be left to reporting suspicious activity.
VI. The Clash of the Titles
And remember the “Clash of the Titles” … the protect-the-financial-system (filing great SARs) requirements of Title 31 (Money & Finance … the BSA) are trumped by the safety and soundness (program hygiene) requirements of Title 12 (Banks & Banking), and financial institutions act defensively because of the punitive measures in Title 18 (Crimes & Criminal Procedure) and Title 50 (War … OFAC’s statutes and regulations). There is a need to harmonize the Four Titles – or at least Titles 12 and 31 – and how financial institutions are examined against them. BSA/AML people are judged on whether they avoid bad TARP results (from being Tested, Audited, Regulated, and Prosecuted) rather than on whether they provide actionable, timely intelligence to law enforcement. Today, most BSA Officers live in fear of not being able to balance all their commitments under the four titles: the great Hugh MacLeod was probably thinking of BSA Officers when he wrote: “I do the work for free. I get paid to be afraid …”
VII. A Central Registry for Beneficial Ownership Information
At the root of almost all large money laundering cases are legal entities with opaque ownership, or shell companies, where kleptocrats, fraudsters, tax evaders, and other miscreants can hide, move, and use their assets with near impunity. Greater corporate transparency has long been seen as one of the keys to fighting financial crime (the FATF’s Recommendation 24 on corporate transparency was first published in 1993), and accessible central registries of beneficial ownership information have been proven to be the key to that greater transparency. Yet the United States is one of the few major financial centers that does not have a centralized registry of beneficial ownership information. I’ve written that without such a centralized registry, the current beneficial ownership requirements are ineffective. See Beneficial Ownership Registry Article. Two bills currently before Congress – the Senate’s ILLICIT Cash Act (S2563) and the House’s Corporate Transparency Act (HR2513) both contemplate a centralized registry of beneficial ownership maintained by FinCEN. But both of those bills – and FATF recommendations and guidance on the same issue – fall short in that they only allow law enforcement (or “competent authorities” using the FATF term) to freely access that database. The bills before Congress allow financial institutions to access the database but only with the consent of the customer they’re asking about and only for the purposes of performing due diligence on that customer. I have proposed that those bills be changed to also allow financial institutions to query the database without the consent of the entity they’re asking about for the purposes of satisfying their suspicious activity reporting requirements.
Conclusion – Seven Fixer-Upper Projects for the BSA/AML Regime
- Shift from customer-centric transaction monitoring systems to relationship-based interaction surveillance systems
- Encourage cross-institutional and cross-jurisdictional information sharing
- Encourage the private sector to be more creative and innovative in its approach to AML – AML is like jazz music, not classical music
- Address de-risking through aggressive use of Section 311 Special Measures
- Simplify the CTR regime. Please. And forget about increasing the $10,000 threshold – in fact, reduce it to $5,000
- As long as financial institutions are judged on US Code Titles 12, 18, 31, and 50, expect them to be both ineffective and inefficient. Can Titles 12 and 31 try to get along?
- A central registry of beneficial ownership information that is freely accessible to financial institutions is a must have