Anti-Money Laundering Developments at FinCEN

The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has been busy – both on offense and defense. In just the past few months, two foreign banks have filed novel lawsuits against FinCEN in response to draconian “Section 311” FinCEN actions against those banks. At the same time, FinCEN is broadening the reach of its anti-money laundering rules, proposing a rule that would extend AML program requirements to investment advisors. Both of these developments are discussed below. Foreign Banks Fight Back Against FinCEN Under Section 311 of the USA PATRIOT Act, FinCEN has authority to designate a foreign financial institution as a “primary money laundering concern.”[1] Once a bank is designated, FinCEN can promulgate a rule imposing “special measures” on the bank. The “fifth special measure” is the most severe—it bars U.S. financial institutions from maintaining correspondent accounts for the targeted foreign bank,[2] effectively precluding access to the U.S. financial system. FinCEN has found approximately two dozen targets for these draconian Section 311 actions. Recently, however, banks have begun to take a new approach to fight back against FinCEN’s designations. Two banks—FBME Bank Ltd. and Banca Privada d’Andorra Group—have filed lawsuits against FinCEN challenging FinCEN’s Section 311 designations.[3] In the FBME case, the Bank has made some progress—at least on its procedural claims. On August 27, 2015, the Court issued a preliminary injunction, blocking the FinCEN final rule, which would have officially prohibited U.S. financial institutions from working with FBME.[4] In issuing the preliminary injunction, the Court found that FBME was likely to prevail on its claim that the agency did not adhere to the procedural requirements in the Administrative Procedure Act (APA). The Court stated that the APA requires FinCEN to provide, and enable FBME to respond to, all non-classified, non-privileged information upon which FinCEN relied.[5] The Court also found that FinCEN had to explain why potentially viable but less drastic alternative penalties (such as the imposition of conditions on the opening or maintaining of correspondent accounts, rather than the full prohibition) were not chosen.[6] The Court recognized that “Plaintiffs no doubt will always lack a complete picture of the agency’s reasoning” due to its reliance on classified or privileged information.[7]   But it stated that, particularly in these circumstances, the agency had a heightened obligation to disclose unclassified materials in this situation.[8] Ultimately, however, the Court stated that it did not find FBME likely to prevail on its claim that FinCEN’s actual finding is arbitrary and capricious under the APA. In making this finding, the Court simply stated that it “is not inclined to second guess FinCEN’s exercise of its broad discretion in finding that FBME poses a primary money laundering concern, or its resulting imposition of the fifth special measure.”[9] Statements such as these made by the Court in FBME are typical of the high degree of discretion given to the Executive Branch in these areas. And they suggest that procedural victories might not be that helpful in the long run. Courts tend to give the Executive Branch wide latitude on national security issues. While forcing adherence to certain procedures may slow down final imposition of the rule, prevailing in the end seems unlikely. FinCEN presumably can simply provide FBME with the unclassified information, consider its rebuttal, and reach the same conclusion.[10] Further, even with a preliminary injunction temporarily preventing FinCEN from finalizing its proposed action, a bank targeted by FinCEN via a proposed rule may still suffer significant harm prior to the rule being finalized. Risk-averse U.S. banks likely will not be willing to work with a targeted foreign bank while litigation is ongoing – the mere fact that FinCEN has proposed to cut off a foreign bank from access to the U.S. financial system may be enough to accomplish that goal, notwithstanding ongoing litigation. Another option does exist for banks subject to such proposed designations, although it also has its costs. Banks can attempt to engage with FinCEN and address its concerns. Unfortunately, this option likely means accepting FinCEN’s finding and proposed rule, which will isolate the bank for some period of time, likely a year or more. But if a bank believes it can take that temporary hit, working it out with FinCEN may be a more productive avenue. While the outcome of this approach is by no means certain, and the time period may be as long as litigation, we have had success getting proposed designations withdrawn by engaging directly with FinCEN on their concerns. FinCEN Expands AML Program Requirements to Investment Advisors Also noteworthy, FinCEN has recently proposed to broaden the reach of its AML regulatory requirements. On August 25, 2015, FinCEN proposed a rule regulating investment advisers registered with the US Securities and Exchange Commission (“SEC”), including advisors to certain hedge funds, private equity funds, and other private funds.[11] The proposal’s motivation is a concern that illicit actors may use an investment advisor to gain access to the financial system and avoid detection because such advisors are not subject to the same regulatory requirements as other financial institutions. The rule proposed three main regulatory changes:

• (1) expanding the definition of “financial institution” in the regulations implementing the Bank Secrecy Act (BSA), which is the primary statutory basis for anti-money laundering regulations; the expanded definition would make investment advisors a type of financial institution and therefore subject to certain requirements of the BSA
• (2) requiring investment advisors to report suspicious activities to FinCEN pursuant to the Bank Secrecy Act (BSA); and
• (3) requiring investment advisors to establish risk-based anti-money laundering (AML) programs.

Under the proposed rule, the investment advisor’s AML program must be approved by the advisor’s board of directors or persons performing similar corporate functions. And it must contain four core components: (a) establish and implement written internal policies, procedures, and controls designated to address AML issues and comply with minimum standards in the rule; (b) provide for independent testing of the advisor’s AML program; (c) designate an AML compliance officer responsible for implementing and monitoring the operations and internal controls of the program; and (d) provide an ongoing AML employee training program. The AML program must encompass all advisory activity, including primary adviser services, subadvisory activity, and other advisory services, such as research reports and financial planning, whether or not the activity entails management of client assets. Investment advisors must also apply these AML policies, procedures, and controls not only to the investment funds managed by the advisor, but to the underlying investors in these funds as well. The financial advisors must make risk-based assessments of the AML and terrorist financing risk of such investors. The proposed rule delegates to the SEC the authority to examine registered investment advisors to ensure compliance with the proposed rule. While the proposed rule is subject to a comment period ending on November 2, 2015, and the rule likely will not be finalized until well after that date, investment advisors nevertheless should take note now of the likely changes to their compliance responsibilities. [1] 5 U.S.C. § 5318A(c). [2] 31 U.S.C. § 5318A(b)(5). [3] Cierco v. Lew, No. 1:15-cv-01641-CRC (D.D.C. filed Oct. 7, 2015); FBME Bank Ltd. v. Lew, No. 15-cv-01270-CRC (D.D.C. filed Aug. 7, 2015). [4] See Mem. Op., FBME Bank Ltd. v. Lew, No. 1:15-cv-01270-CRC (D.D.C. Aug. 27, 2015); see also Imposition of Special Measure Against FBME Bank Ltd., Formerly Known as the Federal Bank of the Middle East Ltd., as a Financial Institution of Primary Money Laundering Concern, 80 Fed. Reg. 45057 (July 29, 2015). [5] Mem. Op. at 3, 9, 20. [6] Mem. Op. at 3, 9, 20. [7] Mem. Op. at 16. [8] Mem. Op. at 16. [9] Mem. Op. at 2-3. Most recently, FinCEN has moved for a voluntary remand asking the Court to grant more time for FinCEN to reconsider its final ruling against FBME to address the failings in its original action. Mot. to Remand to FinCEN, FBME Bank Ltd. v. Lew, No. 1:15-cv-01270-CRC (D.D.C. filed Sept. 28, 2015). FBME has opposed the motion. Mem. in Opp. of Mot. to Remand to FinCEN, FBME Bank Ltd. v. Lew, No. 1:15-cv-01270-CRC (D.D.C. filed Oct. 5, 2010). [10] Similar issues were raised in the only litigation against CFIUS, the inter-agency committee that reviews foreign transactions that raise national security concerns. Ralls v. CFIUS, 758 F.3d 296 (D.C. Cir. 2014). In that case, Ralls, a US company owned by Chinese nationals, challenged a Presidential Order, made at CFIUS’s recommendation, directing Ralls to divest certain windfarm projects located near a US defense facility. The Court found that Ralls’ procedural due process rights had been violated, and order CFIUS to provide unclassified information it had relied on to Ralls, after which Ralls would be given an opportunity to rebut the information, and CFIUS would issue a new recommendation to the President. As we discussed in December last year, while the holding was significant, due to the Executive Branch’s discretion in such national security matters, the likely outcome was that that CFIUS would simply affirm its prior decision. The parties to that case have since announced a settlement, which we discuss here. [11]See FinCEN Proposes AML Regulations for Investment Advisors, Press Release, FinCEN (Aug. 25, 2015), http://www.fincen.gov/news_room/nr/html/20150825.html; Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisors, 80 Fed. Reg. 52680 (Sept. 1, 2015).