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| Constantine Lizas |
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| Ross Hofherr |
On March 7, FinCEN issued an alert[1] with 10 red flags to assist financial institutions in identifying potential sanctions evasion activity,[1] and issued a second alert on March 16, with 17 additional red flags focusing on real estate, luxury goods and other high-value assets.[2]
In a very direct manner, FinCEN reminded financial institutions of the importance of the Bank Secrecy Act, or BSA, and their duties to conduct customer due diligence, monitor transactions for suspicious activity, including transactions involving digital assets, and file suspicious activity reports, or SARs.
The alerts and their setting out of red flags for sanctions evasion will cause financial institutions to adjust, as appropriate, their policies, procedures and controls.
While FinCEN's alerts were specific to sanctions related to the invasion of Ukraine, the alerts signaled changes to the BSA.
First, FinCEN's alerts highlighted the importance of the customer due diligence and beneficial ownership rules, which have only been in effect since 2018, and in doing so created new implicit supervisory expectations.
Second, FinCEN fortified the SAR rule by illustrating, in real time, suspicious sanctions evasions activity.
Third, the March 7 FinCEN alert stressed the money laundering risks of digital assets by specifically referencing exchangers and administrators with visibility into digital asset transactions.
Fourth, by strongly encouraging financial institutions to use innovative tools and solutions to identify suspicious activity and share suspicious activity report information, FinCEN signaled a greater emphasis on innovation.
Finally, the alerts have put financial institutions on notice that FinCEN will expect a higher level of vigilance from them.
The U.S. Department of the Treasury's Office of Foreign Assets Control imposed sanctions related to the Russian financial services sector pursuant to presidential executive order, including:
- People and companies operating in the Russian financial services sector;
- Correspondent and payment processing prohibitions on certain Russian financial institutions;
- Blocking of certain Russian financial institutions;
- Expanding sovereign debt prohibitions to new issuances in the secondary market;
- Prohibitions related to new debt and equity for certain Russian entities;
- Prohibitions on transactions involving certain Russian government entities, including the Central Bank of the Russian Federation; and
- Restrictions on the export of luxury goods to Russia and Belarus.
OFAC also sanctioned numerous Russian and Belarusian elites, their family members, Russian disinformation outlets and Russian defense-related firms. In a related action, OFAC sanctioned certain Belarusian entities, including financial institutions.
Of particular note, the red flags identified in the March 7 FinCEN alert include:
- Use of legal entities or arrangements to hide ownership, source of funds or countries involved;
- Use of shell companies to conduct international wire transfers involving countries distinct from the country of the company's;
- Use of third parties to hide the identity of sanctioned persons and/or politically exposed persons, or PEPs;
- Accounts that suddenly increase in value without a clear economic or business rationale;
- Countries previously associated with Russian financial flows showing a notable recent increase in new company formations;
- New accounts that attempt to send or receive funds from a sanctioned institution or an institution removed from SWIFT;
- Nonroutine foreign exchange transactions that may indirectly involve sanctioned Russian financial institutions;
- Transactions involving certain higher-risk IP addresses including ones located in Russia, Belarus and other countries identified by the Financial Action Task Force as high-risk;
- Transactions connected to digital currency addresses listed on OFAC's specially designated nationals and blocked persons list; and
- Transactions involving a digital currency exchanger or money service business located in a high-risk country.
Not only do the FinCEN alerts place a new importance on FinCEN's customer due diligence and beneficial ownership rules, they create new implicit expectations in two important areas.
First, in the correspondent banking context, the emphasis on customer due diligence and beneficial ownership red flags goes against the basic proposition that while financial institutions must monitor for suspicious transactions in correspondent accounts, they do not have to know their customer's customer.
In the alerts, FinCEN reminded financial institutions of their general obligations for correspondent-account due diligence, but it did not limit the red flags to any specific banking products or services. As a result, financial institutions with correspondent banking relationships monitoring for the red flags identified by FinCEN will implicitly have to obtain certain information about their customer's customer.
Second, FinCEN altered the prevailing interagency guidance on PEPs that "does not require a bank to screen for or otherwise determine whether a customer or beneficial owner of a legal entity customer may be a PEP."[3]
In contrast, the March 7 alert stated that financial institutions "should establish risk-based controls and procedures that include reasonable steps to ascertain the status of an individual as a foreign PEP." In the alert, FinCEN did not limit this expectation to private banking accounts.
FinCEN, through the alerts, has elevated the importance of suspicious activity reports and increased pressure on financial institutions to file timely and accurate suspicious activity reports.
FinCEN stated that it is critical that financial institutions quickly identify potential sanctions evasion activity and file suspicious activity reports. FinCEN's issuance of red flags in what is essentially real time puts financial institutions on notice of specific activity to monitor and report.
Thus, financial institutions will not be able to assert later that they did not know that certain typologies were suspicious and required reporting. Or, to put it another way, the red flags narrow the ability of institutions to make non-SAR decisions.
It is also notable that the red flags published by FinCEN include digital assets. FinCEN also flagged transactions involving digital asset exchangers or money service businesses operating in high-risk countries.
By also flagging certain offshore IP addresses, FinCEN cautioned that many transactions to evade sanctions could be attempted from outside the U.S., and that U.S. institutions need to understand not only the nature and purpose of the relationship but also the digital presence of its customer.
Two days after the March 7 FinCEN alert, President Joe Biden issued an executive order on digital assets that signaled an integration of digital assets into the banking system.[4] However, the FinCEN alerts underscoring the money laundering risks of digital assets suggest a comprehensive regulatory framework rather than a laissez faire one.
The March 7 alert's statement that FinCEN "strongly encourages all financial institutions to make full use of their ability to share information consistent with Section 314(b) of the USA PATRIOT Act and consider how the use of innovative tools and solutions may assist in identifying hidden Russian and Belarusian assets" amplifies the prior interagency statements on the sharing of BSA resources and innovation.[5]
In these alerts, the emphasis on innovation for identifying suspicious activity, sharing SAR information and the filing of SARs quickly is implicitly greenlighting automated SAR platforms.
Two notes of caution: (1) Institutions sharing SAR information should transmit SAR information in an encrypted manner; and (2) Institutions should employ innovative tools and solutions parallel with existing BSA/anti-money laundering processes to test and validate their effectiveness. Regardless, FinCEN is forcefully stating the necessity of innovation to keep up with new threats and trends.
Through the alerts, FinCEN loudly and clearly reminded financial institutions that Bank Secrecy Act/anti-money laundering laws and regulations protect the U.S. financial system and interests.
Him Das, the acting FinCEN director, stated,
In the face of mounting economic pressure on Russia, it is vitally important for U.S. financial institutions to be vigilant about potential Russian sanctions evasion, including by both state actors and oligarchs.
As regulations resulting from the Anti-Money Laundering Act are currently being drafted, financial institutions should prepare for more stringent regulations, especially in the areas of customer due diligence and beneficial ownership.
In the present situation, detecting sanctions evasion activity without understanding the nature and purpose of customer relationships, the risk profile and the beneficial owners would be difficult. However, financial institutions can also expect some burden relief through the increased ability to use innovation.
The imposition of Russian and Belarusian sanctions has been rapid and substantial. FinCEN's actions have also been rapid and substantial. Financial institutions need to be aware of the U.S. government's BSA/AML expectations while the sanctions related the invasion of Ukraine are in effect. At the same time, financial institutions need to understand both the rapid changes in the BSA in the past few weeks and its direction going forward.
Constantine P. Lizas is a partner at Harris Beach PLLC and former FDIC lead counsel for BSA/AML matters.
Ross Hofherr is a partner at Harris Beach and leads the international trade practice group.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] FIN-2022-Alert001 https://www.fincen.gov/sites/default/files/2022-03/FinCEN%20Alert%20Russian%20Sanctions%20Evasion%20FINAL%20508.pdf.
[2] FIN-2022-Alert002 https://www.fincen.gov/sites/default/files/2022-03/FinCEN%20Alert%20Russian%20Elites%20High%20Value%20Assets_508%20FINAL.pdf.
[3] Joint Statement on Bank Secrecy Act Due Diligence Requirements for Customers Who May be Considered Politically Exposed Persons. https://www.fincen.gov/sites/default/files/shared/PEP%20Interagency%20Statement_FINAL%20508.pdf.
[4] Executive Order on Insuring Responsible Development of Digital Assets. https://www.whitehouse.gov/briefing-room/presidential-actions/2022/03/09/executive-order-on-ensuring-responsible-development-of-digital-assets/.
[5] Interagency Statement on Sharing Bank Secrecy Act Resources https://www.fincen.gov/sites/default/files/2018-10/Interagency%20Statement%20on%20Sharing%20BSA%20Resources%20-%20%28Final%2010-3-18%29%20%28003%29.pdf and Joint Statement on Innovative Efforts to Combat Money Laundering and Terrorist Financing https://www.fincen.gov/news/news-releases/joint-statement-innovative-efforts-combat-money-laundering.
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