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Proposed Adoption of Interpretive Notice Regarding FCM And IB Anti-Money Laundering Program
(to read as follows)

INTERPRETIVE NOTICE NFA COMPLIANCE RULE 2-9: FCM AND IB ANTI-MONEY LAUNDERING PROGRAM

The International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 ("Title III"),1 which was signed into law on October 26, 2001, imposes significant new anti-money laundering requirements on all "financial institutions," as so defined under the Bank Secrecy Act ("BSA"),2 including FCMs.3 In particular, Section 352 of Title III requires all financial institutions to establish anti-money laundering programs which, at a minimum, must include internal policies, procedures and controls; a designated compliance officer to oversee anti-money laundering surveillance; an ongoing training program for employees; and an independent audit function to test the program.

NFA's Board of Directors recently adopted NFA Compliance Rule 2-9(c) to impose these requirements on NFA Member FCMs and IBs.4 NFA recognizes, of course, that the exact form of program adopted by a Member will vary based on a Member's type of business, the size and complexity of its operations, the breadth and scope of its customer base, the number of firm employees and the firm's resources. Nevertheless, the Board believes that certain minimum standards must be a part of any adequate program. The purpose of this interpretive notice ("Notice") is to highlight those minimum standards and provide Members with additional guidance on satisfying the requirements of Compliance Rule 2-9(c). Members must be aware, however, that the laws in this area are changing rapidly and that they need to conduct a regular review of their anti-money laundering program to ensure that the program is in compliance with any subsequent changes to the federal law or NFA Rules.

Many of the procedures discussed in the Notice are practices that firms may already employ in their businesses. In particular, bank or bank holding company-owned FCMs or IBs are already required to comply with certain components of the anti-money laundering programs of the banks. FCMs may also have procedures in place related to deposits of cash or cash-like instruments and procedures to obtain identifying information on customers. FCMs and IBs should use their existing programs and procedures as the building blocks for their anti-money laundering compliance programs. Moreover, FCMs and IBs that are registered as broker-dealers under the federal securities laws are subject to similar anti-money laundering requirements. In most cases, programs that comply with requirements applicable to the securities industry will comply with the requirements of this Notice.

Money laundering occurs when funds from an illegal/criminal activity are moved through the financial system in such a way as to make it appear that the funds have come from legitimate sources. Money laundering usually follows three stages. First, cash or cash equivalents are placed into the financial system. Second, the money is transferred or moved to other accounts (e.g. futures accounts) through a series of financial transactions designed to obscure the origin of the money (e.g. executing trades with little or no financial risk or transferring account balances to other accounts). Finally, the funds are reintroduced into the economy so that the funds appear to have come from legitimate sources (e.g. closing a futures account and transferring the funds to a bank account). Trading accounts that are carried by FCMs are one vehicle that can be used to launder illicit funds. In particular, a trading account could be used to execute financial transactions that help obscure the origin of the funds. FCMs and IBs need to be aware of potential money laundering abuses that could occur in a customer account and implement a compliance program to deter, detect and report potentially suspicious activity.

DEVELOPING POLICIES, PROCEDURES AND INTERNAL CONTROLS

The starting point is for an FCM and IB to adopt a policy statement that clearly outlines the firm's policy against money laundering and its commitment to follow all applicable laws and regulations to ensure that its business is not used to facilitate money laundering. The policy statement should also make clear that all employees of the firm have a responsibility to follow the firm's written anti-money laundering procedures and controls, and to abide by all applicable laws and regulations involving anti-money laundering programs. The policy statement also should discuss the consequences of not following these procedures. The firm's procedures and controls should enable personnel to recognize suspicious customers and transactions; require them to report suspicious or unusual activity to appropriate supervisory personnel, including senior management; and ensure that the firm maintains an adequate audit trail to assist law enforcement agencies in any investigation. The key components of these policies, procedures and controls are discussed below.

A. Customer Identification and Verification
An effective anti-money laundering compliance program must include "know your customer" procedures that ensure that the firm takes reasonable steps to identify and verify the identity of the owner of an account before transacting any business with the customer.5 Because NFA Compliance Rule 2-9(c) requires both FCMs and IBs to establish and implement anti-money laundering compliance programs, each such Member has an independent customer identification and verification obligation. NFA believes, however, that the interests of business efficiency and anti-money laundering effectiveness may best be served if FCMs and IBs cooperate with each other in order to meet their respective obligations. An FCM and an IB may allocate between themselves certain elements of their customer identification and verification procedures. For example, an IB may agree to use its direct relationship with the customer to obtain certain customer identification information and documentation, while an FCM may agree to use its automated systems to fulfill certain verification functions, such as checking customer names and addresses against government generated lists. Any such allocation agreement, however, must be clearly set forth in writing, and the FCM and IB must have a reasonable basis for believing that the other party is performing its required function. However, Treasury takes the position that any such allocation does not relieve either the FCM or the IB from its independent obligation to comply with applicable customer identification and verification rules or other applicable anti-money laundering rules. IBs and FCMs should also share with each other their customer identification/verification information, to the extent necessary to meet their obligations.

Although the types of reliable information/documentation a firm should require before opening an account will vary based on, among other things, the nature of the business of the FCM or IB and the type of customer (e.g. corporation, trust, individual, etc.), the ultimate goal in obtaining this information should be to learn the true identity of the customer; the nature of the customer's business; and the intended purpose of the customer's transactions.

Therefore, a firm should obtain certain minimum information. For all customers, a firm should obtain the customer's name and address and for non-natural persons, the customer's principal place of business. For an account of a U.S. person, a firm should obtain the customer's social security number or taxpayer identification number. For an account of a natural person that is not a U.S. person, a firm should obtain a current passport or other valid government identification document. Firm procedures should require that firm personnel obtain and maintain copies of any documents used to identify and verify the customer's identity and maintain those records in accordance with firm procedures and regulatory requirements.6

A firm's procedures should also include a mechanism to identify potentially high-risk accounts in the account opening process and devote additional resources to monitoring these accounts. Although attempts to launder money can come from numerous sources, FCMs and IBs should be aware that certain types of entities or entities from certain geographic locations are more vulnerable to money laundering. FCMs and/or IBs should consult government generated lists of high risk countries, restricted countries that are subject to sanctions by the Office of Foreign Assets and Control ("OFAC") and non-cooperative jurisdictions to determine whether a customer seeking to open an account is from one of those jurisdictions.7 If the customer is from one of the identified restricted, high risk or non-cooperative jurisdictions, the FCM and/or IB needs to determine what, if any, additional due diligence is necessary in deciding whether to accept the account and if the account is accepted, what, if any, additional monitoring of account activity is appropriate. OFAC also maintains a list of Specially Designated Nationals and Blocked Persons that identifies known or suspected terrorists or terrorist organizations. If the customer's name appears on this list, the firm needs to immediately report this to federal law enforcement.8

An FCM may carry and an IB may introduce accounts for other intermediated accounts, such as omnibus accounts and accounts for commodity pools and other collective investment vehicles. Traditionally, with respect to such intermediated accounts, the FCM or IB will have little or no contact with the underlying participants or beneficiaries. In general, the FCM and IB would be responsible for a risk-based analysis of the money laundering risks posed by the intermediary and the pool or other collective investment vehicle.9 In most instances, this risk-based analysis will result in the FCM or IB not having to conduct due diligence with respect to the underlying participants or beneficiaries.

FCMs may also carry accounts introduced or referred by a regulated intermediary located in a foreign jurisdiction. In those instances, the FCM must make a risk-based determination whether it can rely on the foreign intermediary's due diligence with respect to its customer. Some factors to consider in making this determination include whether the foreign intermediary is located in a FATF member jurisdiction; the FCM's historical experience with the foreign intermediary; and the intermediary's reputation in the investment business.

FCMs also execute transactions on a give-up basis, where the broker executing the trade has little or no contact with the underlying customer. The executing and carrying FCMs would be responsible for conducting a risk-based analysis of the money laundering risks posed by the transactions. In the vast majority of instances, this risk-based analysis will result in the FCM that carries the account being responsible for carrying out the customer identification and verification procedures.

B. Detection and Reporting of Suspicious Activity
Another essential component of an effective anti-money laundering compliance program is a set of systems and procedures designed to detect and require reporting of suspicious activity. As with most components of a firm's compliance program, the manner in which a firm monitors for suspicious activity will vary based on the firm's size and the nature of its business.

For some firms, appropriate manual monitoring of transactions in excess of a certain dollar amount may constitute acceptable review for suspicious transactions, while other firms may need to implement an automated monitoring process. Although in some instances the carrying FCM may be in the best position to monitor accounts for suspicious transactions, an FCM or IB that is involved in the order flow process should be alert to suspicious transactions and, where appropriate, refuse to accept a suspicious order and report such suspicious activity to the carrying FCM and its DSRO.10

Examples of suspicious transactions are those that have no business or apparent lawful purpose, are unusual for the customer, or lack any reasonable explanation. As discussed above, recognizing suspicious transactions requires familiarity with the firm's customers, including the customer's business practices, trading activity and patterns. What constitutes a suspicious transaction will vary depending on factors such as the identity of the customer and the nature of the particular transaction.

Since suspicious transactions may occur at the time an account is opened or at any time throughout the life of an account, FCMs and IBs must train appropriate staff to monitor trading activity in order to detect unusual behavior. Identifying suspicious activity may prove difficult and often requires subjective evaluation because the activity may be consistent with lawful transactions.

One area that firms should give heightened scrutiny is wire transfer activity. Monitoring of this area should include review of unusual wire transfers, including those that involve an unexpected or extensive number of transfers by a particular account during a particular period and transfers involving certain countries identified as high risk or non-cooperative.11

Firms should provide employees with examples of behavior or activity that should raise a "red flag" and cause further inquiry. These "red flags" may alert employees to possible suspicious activity. Some examples of "red flags" that could cause further investigation include:12

  • A customer exhibits an unusual level of concern for secrecy, particularly with regard to the customer's identity, type of business or source of assets;

  • A corporate customer lacks general knowledge of its own industry;

  • A customer is unconcerned with risks, commissions or other costs associated with trading;

  • A customer appears to be acting as an agent for another entity or individual but is evasive about the identity of the other entity or individual (except situations involving the identity of ownership interests in a collective investment vehicle);

  • A customer is from, or has accounts in a country identified as, a haven for bank secrecy, money laundering or narcotics production;

  • A customer engages in extensive, sudden or unexplained wire activity (especially wire transfers involving countries with bank secrecy laws);

  • A customer engages in transactions involving more than $5,000 in currency or cash equivalents (in one transaction or a series of transactions in one or more days and in any number of accounts); and13

  • A customer makes a funds deposit followed by a request that the money be wired out or transferred to a third party, or to another firm, without any apparent business purpose.

Monitoring accounts for suspicious activities is a fruitless activity without timely and effective follow-up and investigative procedures. Although the internal structure for reporting suspicious activities will vary from firm to firm, each firm's compliance program must require employees to promptly notify identified firm personnel of any potential suspicious activity. Appropriate supervisory personnel must evaluate the activity and decide whether the activity warrants reporting to its DSRO or FinCEN.14 In making this determination, an IB should consult with its carrying FCM.

C. Hiring Qualified Staff
It is also important for the firm to ensure that the individuals that staff areas that are susceptible to money-laundering schemes are trained to work in this area. A firm may also want to conduct background checks on key employees to screen employees for criminal or disciplinary histories.

D. Recordkeeping
An adequate compliance program for money laundering must also include written requirements on the types of records that should be maintained. The program also must specify where the records should be maintained and that the records must be maintained in accordance with CFTC recordkeeping requirements under Regulation 1.31 (e.g., maintained for five years and be readily accessible for the first two years). The ultimate goal of the recordkeeping requirements is to provide an adequate audit trail for law enforcement officials investigating potential money laundering schemes.

DESIGNATION OF A COMPLIANCE OFFICER

NFA Compliance Rule 2-9(c) also requires that a Member firm designate an individual or individuals to oversee the anti-money laundering program. This person may be the compliance officer that is responsible for other compliance areas of the firm. Although the compliance officer need not be a designated principal or Associate Member, the person should ultimately report to the firm's senior management.

The firm must provide this compliance officer with sufficient authority and resources to effectively implement the firm's anti-money laundering program. Among other duties with respect to suspicious activity reporting, this person should:

  • Receive reports of suspicious activity from firm personnel;

  • Gather all relevant business information to evaluate and investigate suspicious activity; and

  • Determine whether the activity warrants reporting to senior management, and, if authorized to do so, the firm's DSRO or FinCEN.

Obviously, the person responsible for overseeing the anti-money laundering procedures should not be the same employee responsible for the functional areas where money-laundering activity may occur.

EMPLOYEE TRAINING PROGRAM

Another important component of NFA Compliance Rule 2-9(c) is the requirement that FCM and IB Members provide ongoing education and training for all appropriate personnel. This training program should include annual training on the firm's policies and procedures, the relevant federal laws and NFA guidance issued in this area. Firms should also maintain records to evidence their compliance with this requirement.

INDEPENDENT AUDIT FUNCTION

NFA Compliance Rule 2-9(c) also requires that an FCM and IB Member provide for annual independent testing of the adequacy of its money laundering compliance program. A firm can satisfy this requirement with its own personnel (such as an internal audit staff) that is independent of the personnel working in the areas that are exposed to potential money laundering or by hiring an outside party with experience with this type of auditing.15 In either circumstance, the audit function should test all affected areas to ensure that personnel understand and are complying with the anti-money laundering policies and procedures and that these policies and procedures are adequate. The results of any audit should be documented and reported to the firm's senior management or an internal audit committee or department, and follow up should be done to ensure that any deficiencies in the firm's anti-money laundering program are addressed and corrected.

CONCLUSION

Money-laundering schemes in the financial services industry lessen the public's faith in the integrity of the system. Therefore, NFA Members must ensure that they take adequate steps to identify and verify the identity of their customers and to detect, deter and report suspicious transactions that could be part of a money-laundering scheme. The guidelines set forth in this Notice should provide FCMs and IBs with the tools needed to develop an effective anti-money laundering program. Member firms should keep in mind, however, that this is an evolving area and NFA expects to provide further guidance as additional requirements in this area are imposed.



1 Pub.L. 107-56, 115 Stat. 296, 324 (2001). This Act is Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001.

2 31 U.S.C. 5311 et seq. (2000). Title III amended the BSA, adding certain entities to the definition of financial institution. Regulations implementing the BSA can be found, for the most part, in Part 103 of Title 31 of the Code of Federal Regulations.

3 Title III also defines CPOs and CTAs as "financial institutions" under the BSA; however, the Secretary of the Treasury ("Treasury ") intends to defer temporarily application of these requirements to certain financial institutions, including CTAs and CPOs, pending further review and analysis of the money laundering risks posed by these entities. NFA will issue separate anti-money laundering program guidance for CPOs and CTAs, at such time as they become subject to the requirements of section 352.

4 IBs are not explicitly defined as "financial institutions" under the BSA. We understand that Treasury will clarify that IBs are within the "financial institution" definition based on its residual authority under 31 U.S.C. 5312 (a)(Y) and (Z). Treasury has requested that NFA include IBs in Rule 2-9(c) and the Notice.

5 Clearly, the focus of these procedures is different from the focus of NFA Compliance Rule 2-30. Rule 2-30's purpose is to gather sufficient information on futures customers who are individuals to ensure that adequate risk disclosure is provided. The procedures under Rule 2-9, by contrast, are focused on learning the true identity of the account owner.

6 Section 326 of Title III requires the Secretary to issue rules jointly with the CFTC that will require "financial institutions," as so defined, to implement customer identification and verification procedures. FCMs and IBs are specifically advised to conduct a regular review of the relevant federal laws, and guidance issued in this area by NFA, to ensure that they are in full compliance with Section 326 and any other customer identification and verification requirements under the BSA.

7 The following organizations circulate lists of high-risk countries or non-cooperative jurisdictions: The Financial Action Task Force ("FATF") http://www1/.oecd.org/fatf and U.S. Department of the Treasury's Financial Crimes Enforcement Network ("FinCEN") http://www.ustreas.gov/fincen/.

8 OFAC's list of blocked persons, restricted countries and specially designated nationals can be found at http://www.ustreas.gov/ofac/. Executive Order 13224, (66 F.R. 49079 (Sept. 23, 2001)), prohibits transactions with blocked persons. See, e.g., 66 F.R. 54404 (Oct. 26, 2001).

9 However, Section 356(c)(4) of Title III requires the Secretary to submit a report to Congress by no later than October 26, 2002 containing recommendations on whether certain personal holding companies should be treated as financial institutions and whether such companies also should be required to disclose their beneficial owners when opening accounts or initiating funds transfers at any domestic financial institution.

10 Although dually registered broker-dealer/ FCMs are required to file a Suspicious Activity Report ("SAR") with FinCEN for suspicious activity involving securities accounts and transactions, this Notice does not require broker-dealer/FCMs to file a SAR for suspicious activity involving futures accounts or transactions. However, this Notice does require FCMs and IBs to make reports of suspicious activities to their DSRO, or, in lieu of reporting this information to their DSRO, firms may comply with this requirement by voluntarily filing a SAR with FinCEN. Firms that voluntarily file a SAR with FinCEN are immune from liability for disclosures made in the SAR. See 31 U.S.C. 5318(g)(3). Firms that voluntarily report about a suspicious transaction may not notify the person involved in the transaction that the transaction has been reported. Id. at 5318(g)(2). It should be noted that FCMs and IBs likely will be subject to requirements similar to broker-dealer SAR reporting requirements in the near future, and additional guidance will be provided at that time if necessary. See Title III, Pub.L. 107-56, Section 356(b), 115 Stat. 296, 324 (2001).

11 See supra note 7.

12 Each firm should determine whether it needs to develop additional "red flags" based on the nature of its customers and its business.

13 If a customer engages in a transaction or series of related transactions that involves more than $10,000 in currency or cash equivalents, the firm must report this information to FinCEN and the Internal Revenue Service ("IRS") by filing a Form 8300 with the IRS. A firm may voluntarily file Form 8300 for a transaction that does not exceed $10,000 if it appears that a customer is structuring a transaction to avoid triggering the firm's requirement to file Form 8300 or there is any indication of illegal activity.

14 See supra note 10.

15 For small firms with limited staff, the audit function can be accomplished by a staff person who is not involved in the anti-money laundering program.

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