How to work with law enforcement on suspicious activity reports

For many institutions, the Financial Crimes Enforcement Network’s (FinCEN) 2016 Final Rules may feel adversarial, forcing them to divert more internal resources towards compliance and the discovery of beneficial owners. But, fallout from the Panama Papers scandal and the emerging Bahamas Leak , along with enhanced scrutiny over state incorporation secrecy loopholes , further compels the culture of finance to evolve. In an industry disrupted by legislative reform, institutions that repurpose the compliance cost center into a competitive advantage will emerge as the new market leaders.

Illustrating the post-leak enforcement zeitgeist is the $180 million fine levied by the New York State financial regulator against a major Asian bank in August, for failing to flag suspicious activity in its Panamanian branches. Beyond aggressive fines, bank executives must now factor Deputy Attorney General Sally Yates’s 2015 memo, which authorizes the criminal prosecution of non-compliant bank employees, into their risk-management calculus. Now, a scenario where the system deploys the same type of enforcement siege used against the bygone SAC Capital, to expose insider trading, and repurposes this RICO strategy to prosecute AML violators, seems more than feasible.

While regulatory disruption has improved the number of risk variables that financial companies must assess, early-adopters of new beneficial ownership rules will realize a competitive edge. From a regulatory angle, covered institutions that take the lead in CDD and beneficial-ownership-rule implementation mitigate operational disruption in the form of legal fines, criminal penalties, tax disputes and other enforcement actions. From an investor’s standpoint, first-responders enjoy better brand visibility through enhanced transparency and reduced reputational risks. Also, enhanced beneficial- owner verification controls improve operating efficiencies by flagging adverse counterparties much earlier in onboarding, or the screening-and-assimilation phase of the business relationship.

The following paper will explore the ways that covered institutions can leverage FinCEN’s reforms to improve relations with regulators and investors, while optimizing business efficiencies.

The large fine imposed against a Taiwanese bank in August signifies the first major regulatory penalty issued as a direct result of the Panama Papers disclosures. But, with 140 politicians in over 50 countries, connected to offshore companies in 21 tax havens , and 33 people or companies blacklisted by the U.S. government, exposed in the leak, compliance analysts and financial industry observers are anticipating more enforcement actions. Compounding political corruption, graft and money laundering, the issue of tax reform is further enhancing regulatory risks for institutions on a scale that is increasingly global.

Specifically, new reforms to Base Erosion and Profit Shifting, or BEPS, a strategy used by multi-national corporations to shift profits from high-tax jurisdictions, to low or no-tax countries, present unprecedented challenges. Look no further than the recent $14 billion fine issued by the European Commission, a regulatory entity that upholds international treaties, against a major American tech company for exploiting the so-called “Irish tax holiday .” As the Organization for Economic Cooperation and Development, an economic watchdog group, and the G20, an international forum for the political and central bank leaders of the world’s 20 major economies, partner to correct global tax asymmetries, financial institutions should adapt to inevitable regulatory reform in advance.

This aggressive BEPS-reform regime is already making investors and analysts more cautious of complex tax structures and prodding their demands for more data and transparency regarding the beneficial owners of investment targets, co-investors and strategic partners. But, the triple threat of new CDD precautions, BEPS reform and Yates’ guidance has multiplied compliance risk and made regulatory relations the top priority for all financial firms.

It follows that covered institutions that adapt quickly to FinCEN’s Final Rules will be positioning themselves ahead of the curve in an industry reaching an inevitable inflection point of global tax reform. By taking the road less traveled now, early- CDD-adopters ensure smoother regulatory relations, and avoid the imminent gridlock promised by a tax-haven reckoning.

No example illustrates the value of enhanced CDD compliance as well as the Lehman Brothers debacle of 2008. At the time, Lehman was the fourth largest investment bank in the world. When Lehman declared bankruptcy, financial institutions all over the world panicked because beneficial owner data was undocumented, thus making it impossible for firms to quantify their exposure to the meltdown. This confusion further complicated and obstructed regulatory efforts to address the true stress points of the financial crisis.

But, by embracing the enhanced CDD and beneficial owner guidelines, institutions send an unequivocal message to co-investors, strategic partners, portfolio targets and clients that counterparty risk is mitigated and transparent. With analysts and investors already anticipating further BEPS reforms and demanding accurate beneficial ownership information, firms that are first to market with compliance implementation, inherently set the stage for improved investor relations.

While some clients may have legitimate needs for anonymity, enhanced due diligence controls are needed for firms to make that determination. Institutions must address the new reputational and earnings-risk variables spawned by regulatory reform in order to maintain strategic partnerships, centers of influence, key business relationships and investors. Once again, early adopters of post-Panama legislation will reap the benefits, putting existing partners at ease, and capturing new investors by leveraging counterparty transparency as a selling point.

Early beneficial ownership identification improves business efficiencies in multiple ways. The accelerated detection of adverse counterparties and clients reduces the risks of resource-waste and operational disruption, byproducts of regulatory inquiries and enforcement. Although recent trends have seen Wall Street institutions exit foreign markets en masse, according to a March 2016 Wall Street Journal article , banks like J.P. Morgan Chase & Co. still derive 60 percent of their revenue from “advisory, financing and other services that cross borders.” Using J.P. Morgan as a benchmark for foreign growth, accelerated beneficial owner discovery becomes an invaluable capability for business localization.

Localization is analogous to having boots on the ground, or selecting a local partner to guide entry into new markets. With a regulatory apparatus increasingly focused on tax avoidance, the risks and costs of selecting the wrong strategic partner are unsustainable for financial institutions. The industry’s exodus from foreign banking and advisory marketplaces inherently creates a service vacuum. Meanwhile, rising wages, mobile phone penetration and rising middle-class growth, specifically in Asia, ensure future growth opportunities abroad. Companies that move fast on FinCEN’s reforms realize a strategic advantage, enhancing localization capabilities, which will be foundational to emerging growth initiatives.

Key to the localization challenge is the identification of Specially Designated Nationals, or SDNs. Designated by the Office of Foreign Asset Control, or OFAC, SDN lists consist of individuals from blacklisted countries, terrorist groups and drug trafficking organizations. The Panama Papers’ revelation of 33 SDNs maneuvering through law firm, Mossack Fonseca, to create offshore shell companies and conceal illicit funds, has put the heat on OFAC-violation enablers. Without proper beneficial-ownership identification controls, financial firms compromise localization and client onboarding diligence. If operators fail to identify adverse selection early, they risk wasting millions, if not more, via operational disruptions, reputational damage, regulatory fines and the looming threat of criminal prosecution for OFAC infractions.

In an era of unprecedented regulatory reforms and ultimatums, financial institutions must leverage the regulatory technology solutions that big data has spawned. Described as the “use of new technologies to solve regulatory and compliance requirements more effectively and efficiently” by the think tank, Institute for International Finance, regtech repurposes machine learning and other big data innovations to solve complex compliance problems. A best-in-class, investigative regtech asset has become indispensable for financial companies seeking to mitigate counterparty risk in the diligence and onboarding phases of business, vendor and customer relationships.

Next-generation investigate software solutions have the capability to pull data from a wide variety of domestic and international law enforcement and public records databases, while querying search results in real-time. These dynamic database and search functions alert compliance personnel the moment an institutional counterparty or client become non-compliant or adverse. Additionally, leading investigative solutions have machine-learning capabilities, enabling them to autonomously process unstructured, or non-indexed-text, data from social media and other online sources. Thus, the data advancements of today empower compliance officers with a holistic, dynamic and intuitive, due-diligence directory that multiplies value by mitigating risk.

With a two-year window to fully implement FinCEN’s latest CDD reforms , covered institutions must take the steps necessary to demonstrate the integrity of their compliance processes. By selecting the right investigative technology solution, firms achieve a holistic and transparent view of all their counterparty liabilities, signaling to regulators their unyielding commitment to the law. A best-in-class regtech asset enhances relations with regulators and investors, while unlocking revenues that would otherwise vanish through detrimental ownership structures and the operational havoc they precipitate.

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