Tag: Suspicious Activity reports

The One with Insufficient Compliance Resources

The Bank Secrecy Act requires broker-dealers to file suspicious activity reports. Under the SAR Rule (31 C.F.R. § 1023.320(a)(2)), every broker-dealer has to file a report for a transaction of at $5000 that

  1. Involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity
  2. Is designed to evade any requirements under the Bank Secrecy Act
  3. Has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage
  4. Involves use of the broker-dealer to facilitate criminal activity

That’s all a bit vague. So FINRA has produced a list of more actionable items, most recently compiled in FINRA Regulatory Notice 19-18 (May 2019).

There are vendors who sell software that will monitor transactions and flag those that meet the criteria in the FINRA Notice.

OTS Link used one of those automatic surveillance systems. For the first six months of 2021 the system raised over 1800 alerts for transactions to be reviewed. For those 300 alerts a month, the compliance team at OTS Link only devoted 5 hours a month. No surprise, they failed to investigate any or file any SARs.

In the Order, the SEC says that if OTS Link had properly surveilled transactions it would have spotted:

(a) a large volume of thinly-traded, low-priced securities;
(b) a sudden spike in investor demand for, coupled with a rising or decreasing price in, thinly-traded, low-priced securities;
(c) suspicious manipulative, pre-arranged or wash trading activity;
(d) subscribers who were publicly known to be the subject of criminal, civil or regulatory actions for crime, corruption, or misuse of public funds.

In response to the SEC exam, OTS Link added two people to its AML compliance team and hired a third-party compliance consultant to review the program.

The SEC order mandates additional reporting and levied a $1.19 million fine. You either pay for compliance or you PAY for compliance failure.

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Suspicious Activity Reports and Private Funds

fincen logo

Over the years, the Financial Crimes Enforcement Network (FinCEN) has required banks, brokers, and other financial entities to officially report suspicious activities of its customers. Investment advisers and private fund managers have managed to sty outside the requirements. In large part, that’s because a fund’s custodial accounts are already subject to the self-policing. since the account is with a broker subject to the FinCEN requirements.

But changes are coming. James H. Freis, Jr., Director of the FinCEN, let us know that his agency is working on anti-money laundering requirements for investment advisers. At a November 15, 2011 speech at the American Bankers Association/American Bar Association’s Money Laundering Enforcement Conference he raised the issue and mentioned that a new rule is in the works.

Reuters is reporting that a proposed rule is likely to come out in the first half of 2013. The rule would likely address anti-money laundering concerns. Although that may be an issue for some types of funds, it’s not a concern for most private funds. Once you limit redemption rights, you make the investment very unpalatable for drug kingpins and other bad guys trying to hide their money. They are not typically patient investors looking for long term returns.

Hedge funds were thrown into the bucket of “shadow banking” and private equity firms were labeled as “vulture funds” during Romney’s presidential campaign. It looks like the federal government will continue to pile regulatory requirements on private fund managers for the foreseeable future.

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Mortgage Fraud Rises in 2011

The Financial Crimes Enforcement Network released its full year 2011 update (.pdf) of mortgage loan fraud reported suspicious activity reports. It  reveals a 31% increase in submission.It also shows some of the trends that lead to the 2008 financial crisis.

Financial institutions submitted 92,028 MLF SARs in 2011, compared to 70,472 submitted in 2010. Financial institutions submitted 17,050 MLF SARs in the 2011 fourth quarter, a 9 percent decrease in filings over the same period in 2010 when financial institutions filed 18,759 MLF SARs. While too soon to call a trend, the fourth quarter of 2011 was the first time since the fourth quarter of 2010 when filings of MLF SARs had fallen from the previous year.

Since 2001, the number of mortgage loan fraud SARs has grown each year.

The report pins the sharp increase in 2011 on mortgage repurchase demands. Those demands prompted a review of mortgage loan origination files where filers discovered fraud. In 2011 a majority of the SAR filings related to fraud that was more than 4 years old. So this is the fraud leading up to the bubble now being detected.

Simply redo the chart by focusing on the year of the fraudulent activity instead of the date of filing.

You can see the rise in fraud tracking the heights of the real estate bubble in 2005 through 2008.

Going back to the 2011 reports:

  • 21% involved occupancy fraud, when borrowers claim a property is their primary residence instead of a second home or investment property
  • 18% involved income fraud, either overstating income to qualify for a larger mortgage or understating to qualify for hardship concessions.
  • 12% involved employment fraud

The up and coming frauds are related to the repercussions of the housing bubble.

Short sales are a source of fraud. SAR filers noted red flags in short sale contracts, such as language indicating that the property could be resold promptly, or “common flip verbiage” in the sales contract, or discovered that the “buyer’s
agent” was not a licensed realtor.

Several SAR filers described borrowers who “stripped” or removed valuable items from their foreclosed homes before vacating the premises. In one SAR, borrowers removed $33,000 worth of fixtures from the home, including major appliances and fixtures.

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